Given the recent impact of Covid-19 on the economy, unemployment and operations, discussions around potential goodwill impairment – and the related testing – is a hot topic for many financial institutions as the March 31 quarter ended.
Goodwill is defined as an asset representing the future economic benefits arising from other assets acquired in a business combination. Financial institutions record goodwill as a result of a merger or an acquisition. Accounting Standards Codification (ASC) 350, Intangibles – Goodwill and Other, states that entities must evaluate their goodwill for impairment at least annually. However, during interim periods, a goodwill impairment analysis could be necessary if the entity has an indication that the fair value of a reporting unit has fallen below carrying value, defined by the guidance as a triggering event. Determining whether a triggering event has occurred is challenging for many financial institutions.
Under the guidance of ASC 350, impairment testing for goodwill is required annually and upon a triggering event. Private entities electing the accounting alternative are only required to test upon a triggering event. Here are some examples of goodwill triggering events, according to ASC 350-20-35:
Macroeconomic conditions: deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates or other developments in equity and credit markets.
Industry and market considerations: deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (consider in both absolute terms and relative to peers), a change in the market for an entity’s products or services, or a regulatory or political development.
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.
Other entity-specific events: changes in management, key personnel, strategy or customers; contemplation of bankruptcy or litigation.
Events affecting a reporting unit: a change in the composition or carrying amount of its net assets, a highly probable expectation of selling or disposing of all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit.
A sustained decrease in share price: to be considered in both absolute terms and relative to peers.
It is clear that Covid-19 has global impacts on some macroeconomic conditions. Financial institutions may want to assess whether they have experienced a triggering event; if they conclude there has been such an event, they will need to proceed to a goodwill impairment test. Assessing whether there has been a triggering event, as defined by ASC 350, involves judgment.
When it comes to a decline in stock price, the guidance in ASC 350 does not define what “sustained” means. In isolation, a decrease in share price is not an automatic indicator of a triggering event. The guidance suggests comparing the relative decrease to peers – if it is consistent among the industry, one may conclude that the decrease is related to general economic events and not specific to the institution individually. Banks may determine that an overall decline in the market could be indicative of macroeconomic conditions that impact the value of the company. Entities should consider forecasts and projections to determine whether the situation is expected to be temporary, and the reduction in stock price is reflective of short-term market volatility rather than a long-term, sustained decline in fair value.
The guidance does not suggest that the existence of one negative factor results in a triggering event. Rather, the guidance requires companies to assess various factors to determine whether it is probable that the company’s fair value is less than its carrying value. One way to consider the factors mentioned in the guidance is to weight them by their impact on the entity’s fair value. If the company concludes that a triggering event has occurred, then an impairment analysis should be performed to determine if in fact goodwill is impaired.
The determination of a triggering event, or lack thereof, involves judgment; management’s analysis and conclusion should be thoroughly documented. As the economic environment and resulting impacts of Covid-19 continue to shift and evolve, companies should revisit goodwill impairment triggers on a regular basis.