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IMPAIRMENT LOSS VALUATION - ASC 350 & ASC 360
Major triggering event - Pandemic Catastrophe - COVID 19
Not to mention on the current on-going Pandemic Catastrophe has had a major impact across both the real economy as well as in the financial and credit markets. With such uncertainty as to when the dislocations will resolve themselves, companies need to begin proactively assessing what this means for the value of their assets, with impairment considerations being a focal point. While analyst often focus on goodwill when considering impairment, it is equally important for companies to evaluate other assets that may be impaired such as:
- property, plant and equipment
- definite and indefinite-lived intangibles
- inventory, trade receivables
- right of use assets
- debt and equity investments
Impairment Testing Intervals
Impairment testing is to be conducted at annual intervals. You may conduct the impairment test at any time of the year, provided that the test is conducted thereafter at the same time of the year. If the company is comprised of different reporting units, there is no need to test them all at the same time. It may be necessary to conduct more frequent impairment testing if there is an event that makes it more likely than not that the fair value of a reporting unit has been reduced below its carrying amount. Examples of triggering events are a lawsuit, the on-going pandemics catastrophe, restructuring reorganization, regulatory changes, the loss of key employees, and the expectation that a reporting unit will be sold.
The information used for an impairment test can be quite detailed. To improve the efficiency of the testing process, it is permissible to carry forward this information to the next year, as long as the following criteria have been met:
· There has been no significant change in the assets and liabilities comprising the reporting unit.
· There was a substantial excess of fair value over the carrying amount in the last impairment test.
· The likelihood of the fair value being less than the carrying amount is remote.
Order of testing for assets held and used
Order of testing for assets held and used:
- Test indefinite-lived intangible assets under ASC 350.
- Then test long-lived assets (asset group) under ASC 360, if trigger event occurred.
- Finally, test goodwill of a reporting unit (RU) under ASC 350.
Impairment charges are recorded after each test above before moving to the subsequent test.
Impairment test under ASC 350: Intangibles & Goodwill
Non-amortizable intangibles are tested for impairment (private companies can choose to amortize) at least annually or when a triggering event occurs. Triggering events include but are not limited to the following:
- Macroeconomic conditions: deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, etc.
- Industry and market considerations: deterioration in the entity’s environment, increased competition, change in the market for an entity’s products or services, etc.
- Cost factors: increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows, etc.
- Overall financial performance: negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods, etc.
- Other relevant entity-specific events: contemplation of bankruptcy, litigation, changes in management, key personnel, strategy/customers, etc.
- Events affecting a RU: change in the composition or carrying amount of its net assets, an expectation of divestiture, etc.
- Sustained decrease in share price: consider in both absolute terms and relative to peers.
It should be noted that there are other events not captured within these lists that may be considered as impairment triggers. Companies should be mindful of, and ready to identify, potential impairment indicators as they may occur at any time.
Indefinite-Lived Intangible Asset Impairment Testing: ASC 350
The impairment testing for indefinite-lived intangible assets is similar to goodwill impairment testing, as described below:
Step Zero: GAAP allows for a qualitative Step Zero test to be used in testing indefinite-lived intangible assets for impairment– just as with goodwill. Like Step Zero for goodwill impairment testing, this gives companies the option to bypass a valuation analysis and first assess certain qualitative factors to determine whether it is more likely than not (greater than 50% likelihood) that an indefinite-lived intangible asset is impaired. Impairment occurs when the fair value of an indefinite-lived intangible asset is less than its book value. If this analysis indicates that an indefinite-lived intangible asset may be impaired, the company must proceed with a fair value analysis.
Fair Value Analysis: A fair value analysis determines the fair value of the indefinite-lived intangible asset. If the fair value of the asset is lower than its book value, impairment is indicated and the asset is written down to its newly-determined fair value. It should be noted that indefinite-lived intangible assets are not written up if their value increases after initial recognition or if their value subsequently rebounds after an impairment has been recorded.
Finite-Lived Intangible Asset Impairment Testing: ASC 350
The accounting rules for finite-lived intangible asset impairment testing require a company to compare the undiscounted future cash flows associated with the asset to the asset’s net carrying value on the balance sheet. If the future undiscounted cash flows are greater than the net carrying value of the asset (which is most often the case), then there is no impairment. If the future undiscounted cash flows are less than the net carrying value of the asset, however, then impairment exists and those future cash flows are discounted back to the testing date to determine the new fair value of the asset and an impairment charge is recorded to write down the asset to its fair value. Because finite-lived intangible assets are amortized, they decrease in value on a company’s balance sheet each year. As a result, GAAP allows companies to consider the undiscounted future cash flows associated with finite-lived intangibles in testing for impairment, which makes it much less likely that they will be deemed impaired.
Long-Lived Asset Impairment Testing: ASC 360
ASC 360 (formerly SFAS 144), Accounting for the Impairment or Disposal of Long-Lived Assets, governs the accounting treatment of finite-lived assets. As in ASC 350, a two-step test is required to evaluate goodwill impairment. However, unlike ASC 350, the initial test entails the utilization of undiscounted cash flows associated with the finite-lived asset. An impairment loss is recognized only if the carrying value of the asset is not recoverable and exceeds its fair value. The carrying value is considered unrecoverable if it exceeds the sum of the undiscounted cash flows anticipated from the use and disposition of the asset. Impairment loss is measured as the amount by which the carrying value of an asset exceeds its fair value.
Historically, accounting for business combinations has been one of the most controversial issues in financial reporting. With the rapid pace of change in today’s marketplace-driven by technological advances, new business models and other factors-the role of financial reporting in maintaining stability of capital markets will only increase. ASC 805 and 350 address critical issues of currency and accuracy in financial reporting.
The Securities & Exchange Commission continues to scrutinize the new subjective valuations arising from ASC 805 and 350, and the agency continues to pay particularly close attention to how those valuations are incorporated in purchase price allocations for mergers and acquisitions. That being the case, it is critical that companies hire a reputable firm to provide expert valuations and goodwill impairment opinions under these accounting rules.