I want to start off by saying I hope everybody is staying healthy and navigating through this pandemic as best as possible. I’ve never taken so many online fitness classes in my life, but they say exercise during these uncertain times helps with stress! But while we are all trying to stay active and positive through the COVID-19 pandemic, there are significant impacts to financial reporting which must be considered. We highlighted our top five COVID-19 accounting issues in our vlog last week, and this post will explore the first issue, which relates to non-financial assets that must be assessed for impairment when a triggering event exists.

A triggering event is when an event happens, or a circumstance changes, that would more likely than not reduce the fair value of an asset below its carrying amount. Determining whether a triggering event would cause the need for an interim impairment test involves a significant amount of judgment and careful consideration of current factors such as macroeconomic conditions, industry and market conditions, cost factors, and economic performance.

One of the challenges when assessing assets for impairment is that cash flows are not always available for individual assets, so a company must first determine the lowest level at which information related to identifiable future cash flows can be obtained. In most instances, if an asset is used together with other assets to generate cash flows, it is grouped together with those assets into an “asset group” and cash flows are assessed at the group level. We discuss this challenge and many other challenges of impairment testing withing our bundle of impairment courses. Note that the remainder of this post will be referring to “the asset” for impairment, but keep in mind that a company’s assessment may relate to an “asset group”.

Also, the remainder of the post will discuss the various impairment tests for non-financial assets. Note that they are IN ORDER of how they should be performed!

Indefinite-lived intangible assets

If a company determines that COVID-19 represents an indicator of impairment, it should first assess its indefinite-lived intangible assets. Indefinite-lived intangible assets are accounted for under ASC 350-30 and are required to be tested for impairment on an annual basis, or more frequently if impairment indicators (such as the impacts of COVID-19) exist. Testing for indefinite-lived intangible assets is a one-step process, but a company does have the option to perform an optional, qualitative assessment. This means that a company would consider qualitative factors (the same factors considered when determining whether a triggering event exists) to assess whether it’s more likely than not (i.e., more than 50%) that its intangible asset’s fair value is less than its carrying amount. If a company elects to not perform the qualitative assessment (because it is optional) or if the company “fails” this step, then the company moves on to the one-step test:

• One-step test: The carrying amount of the asset is compared to the fair value of the asset, which is determined in accordance with ASC 820.
  • If the fair value of the asset is greater than the carrying amount, then there is no impairment! However, if the fair value is less than the carrying amount, there is an impairment and the difference between the carrying amount and the fair value represents the impairment loss to be recognized. The company must write-down the asset to its fair value, which becomes the new cost basis.

We cover the impairment of indefinite-lived assets in this course!

Inventory

Inventory is measured at the lower of cost or net realizable value (excluding inventory that uses the LIFO method or retail inventory method – this inventory is measured at the lower of cost or market) and ASC 330, Inventory, requires any declines in net realizable value to be recognized in the period that such declines occur. If a company determines that the carrying value has declined, the company must assess whether this decline is temporary (i.e., the inventory values are expected to be restored by the end of the company’s fiscal year) because temporary losses do not need to be recognized as of an interim date. If the decline is not temporary, then the company should write-down the value of the inventory directly, with a corresponding loss recorded in the income statement. In addition, companies should also be contemplating any purchase commitments they’ve entered into or any excess capacity costs they might be experiencing. For more information on inventory considerations, check out this course!

Long-lived assets

Long-lived assets include land, buildings, machinery and equipment, and intangible assets with finite lives, and are accounted for under ASC 360. ASC 360 requires these assets to be tested for impairment when a triggering event occurs, and the company believes the carrying amount of an asset may not be recoverable (there is no annual impairment testing requirement). After a company tests its indefinite-lived intangible assets (and other assets subject to impairment such as inventory, receivables, etc.), it must move on to assessing its long-lived assets.

Testing long-lived assets for impairment is a two-step process:

• Step 1: Recoverability test – the carrying amount of the asset is compared to the sum of the undiscounted cash flows expected to result from the use (and eventual disposal) of the asset. It’s important to note that the assumptions used to develop the undiscounted cash flows should be the company’s own assumptions (not third-party assumptions) and the cash flow estimation period used should align with the remaining useful life of the asset.
  • If the undiscounted cash flows are greater than the carrying amount, the asset’s carrying amount is recoverable and there is no impairment! However, if the undiscounted cash flows are less than the carrying amount, the company must move on to Step 2 to measure the amount of impairment.
• Step 2: Measuring the impairment – the carrying amount of the asset (as of the date of the recoverability test) is then compared to the fair value of the asset, which is determined in accordance with ASC 820. As such, the cash flows are based on market participant assumptions (irrespective of the entity’s planned use for the asset).
  • If the fair value of the asset is greater than the carrying amount, then there is no impairment! However, if the fair value is less than the carrying amount, there is an impairment and the difference between the carrying amount and the fair value represents the impairment loss to be recognized. The company must write-down the asset to its fair value, which becomes the new cost basis.

For more information on the impairment of long-lived assets, check out this course!

Goodwill

After testing indefinite-lived intangible assets and long-lived assets, a company will then move on to assessing goodwill for impairment. Goodwill is accounted for under ASC 350-20 and, similar to indefinite-lived intangible assets, is required to be tested for impairment on an annual basis, or more frequently if impairment indictors exist. There is also revised guidance for testing goodwill impairment, which aligns impairment testing with the steps described above for testing indefinite-lived intangible assets (optional qualitative assessment and Step 1 comparison of the carrying value to fair value). This revised guidance eliminated a second step to testing goodwill impairment and is effective for public companies in 2020. Early adoption of this revised guidance is allowed and if your company has not yet adopted the one-step impairment approach, check out our course on accounting for goodwill impairment!

Important reminder

The SEC expects that company disclosures surrounding impairments should evolve over time. So, although a company may determine that there are currently no trigger-based impairments of non-financial assets, they should be thinking about disclosures on current (and future) impacts of the COVID-19 pandemic on their business, so that when (or if) a company recognizes an impairment, its financial statement users will have an understanding of what caused the impairment. The SEC recently issued this disclosure guidance, which discusses COVID-19 disclosure considerations.

As always, if you have any questions, we are here to help. Please stay safe and healthy!

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