Financial Reporting Reminder: Assess Triggering Events Due to COVID-19

  • 5/18/2020
Stark Office Discussion Review

During this period of uncertainty, be mindful of asset impairment and the associated triggering events.

Key insights

  • Companies that have been affected by the COVID-19 pandemic should be aware of how that could impact their financial reporting.
  • Conduct a thorough evaluation of potential impairment triggering events, including cost factors, macroeconomic conditions, industry conditions, and overall financial performance.
  • If a triggering event has occurred, you may need to perform impairment testing.

On February 12, 2020, the Dow Jones Industrial Average (DJIA) hit an all-time high of 29,551.42. The bull market that started in 2009 was still roaring despite increasing global concerns about the coronavirus (COVID-19). Twelve days later, on February 24, the DJIA began its rapid descent into a bear market at an unprecedented rate, hitting a floor about a month later. Countries around the world began shuttering their economies, and only businesses deemed “essential” remained open. Fear of the viral pandemic and financial catastrophe dominated market sentiment.

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At the end of March, federal aid arrived in the U.S. by way of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, representing a $2.2 trillion relief package. This was followed by additional legislation offering assistance to businesses. Financial markets responded positively to the stimulus, leading to a rebound of more than 25% for the DJIA from the trough established on March 24 (Dow market data as of May 4, 2020).

Realities of coronavirus could bring a triggering event

Most companies have been impacted by COVID-19 in some form, with certain industries more affected than others. In these uncertain times, it is important to determine whether an impairment event has occurred. Be mindful of potential triggering events and what may have occurred with your or your client’s business to determine if asset impairment potentially exists.

Impairment events can occur under either Financial Accounting Standards Board (FASB); Accounting Standards Codification (ASC) 350, Goodwill and Indefinite-Lived Intangibles; or ASC 360, Long-Lived Assets, including Finite-Lived Intangibles.

Consider these examples of triggering events for your financial reporting purposes:

  • Macroeconomic conditions, such as 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, such as a 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.
  • Cost factors, such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows.
  • Overall financial performance, such as negative or declining cash flows or a decline in actual or planned revenue or earnings when compared with actual and projected results of relevant prior periods.
  • Other relevant entity-specific events, such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation.
  • Events affecting a reporting unit, such as a change in the composition or carrying amount of its net assets; a more-likely-than-not 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.
  • (If applicable) A sustained decrease in share price or market capitalization, which should be considered in both absolute terms and relative to peers.

Start by looking at these potential triggering events

Let’s take a closer look at a few of the potential triggering events that are particularly relevant in the current economic climate.

Macroeconomic conditions

This is the most obvious of the factors listed above in the wake of COVID-19. The sharp and widespread downturn in economic activity affected virtually all businesses. However, in evaluating the macroeconomic impact on potential impairment, it is important to consider the market decline, business closures, and widespread unemployment alongside the prospect of reopening local and state economies and the rise of the stock market. It remains to be seen how the economy will respond going into the summer months and beyond. As such, this factor should be tracked continuously.

Cost factors

Supply chains and labor markets were initially disrupted and continue to impact the operations of businesses that are still open, as well as those still incurring costs while temporarily closed. Some raw materials are becoming scarce and more expensive, due to work stoppages and supply chain issues. Other raw materials, such as oil, are much cheaper as a result of the reduced demand and international factors.

Labor costs are another major consideration. Companies are managing the issue in a variety of ways, including furloughs, layoffs, or pay cuts in adversely affected industries, or through pay increases and hazard pay in essential businesses that carry increased personal risk for employees. While it appears these cost management measures could resolve as economies reopen and cost structures return to normal, the impact could be considered a triggering event and should be evaluated in the context of your particular situation.

Industry and market considerations

The economic impact of business closures and social distancing restrictions varies greatly across industries, which can be a leading indicator when assessing impairment triggering events. Industries such as air travel and cruise lines could feel long-lasting effects, even in scenarios where the economy reopens and restrictions are lifted. Cruises are a highly discretionary expense, indicating it could be among the last places people will spend money when the economy starts up again.

Similarly, a large portion of air travel is connected to leisure time and discretionary income, both of which are likely to be in short supply in the near future. Additionally, there could be a significant reduction in business travel as employers are realizing the benefits of video conferencing and telecommuting. These two examples indicate a high likelihood that COVID-19 could contribute to an impairment triggering event. Analyze the industry-specific impact the COVID-19 pandemic may have on your organization, combined with a consideration of your organization’s specific risk factors.

A sustained decrease in share price

Virtually all public companies experienced at least some share price reduction at the onset of panic selling as the COVID-19 pandemic progressed. The key consideration in this factor is that the share price reduction is considered to be “sustained,” which is a term open to interpretation based on the guidance. As mentioned at the beginning of this article, the initial drop in February preceded a historically quick rally for a large portion of the public markets. Despite the rally, nearly all stocks are substantially below prices quoted in early February.

When analyzing a triggering event using this factor, consider a wider range of price performance than the typical 10- to 15-day period on either side of an impairment testing date. Periods of 30 – 60 days could provide a more representative indication of whether the negative impact has staying power. For instance, stocks that did not increase meaningfully after stimulus packages rolled out are likely in for a tougher road to recovery.

How we can help

When analyzing impairment triggering events, consider these factors and discuss the state of your business with your leadership team. With the volatility in markets and uncertainty surrounding the future economic implications of COVID-19, conduct a thorough evaluation to identify potential impairment triggering events. At a minimum, assess qualitative indications of impairment that could affect your long- and short-term performance.

At CLA, our team can assist you with these evaluations or conducting an impairment test. Regardless of the approach you take in identifying an impairment triggering event due to COVID-19, continue to monitor the situation closely and involve your external audit teams. We’re here to help.

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