Testing FASB’s goodwill impairment model through a pandemic
Many have started to question the goodwill impairment model under FASB ASC 350-20 and whether it paints the most accurate financial picture in light of the COVID-19 pandemic. In September, the Private Company Council, the American Institute of CPAs’ Technical Issues Committee and Financial Accounting Standards Advisory Council raised issues with the Financial Accounting Standards Board related to the current goodwill impairment model and whether we need an alternative solution or practical expedient.
FASB ASC 350-20-35-30 requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. These events are also known as “triggering events.”
Many accounting practitioners and financial statement preparers likely agree that a sequence of events during the COVID-19 pandemic — for example the news of the spread of COVID-19 to the U.S., the government declaration of the pandemic, the stay-at-home orders issues at the state level, and the decline of the stock market — could be considered triggering events at some point in 2020 for reporting units with little to no headroom (that is, a reporting unit’s carrying value is close to or approximates its fair value), and therefore would require an impairment assessment.
The issue for private companies that only obtain audited financial statements annually and that have subsequently rebounded later in 2020 is whether taking a hefty impairment charge makes sense. Unfortunately, the FASB guidance does not allow for hindsight in performing the goodwill impairment analysis; the test is a point-in-time fair value assessment as of the date of the triggering event. This could cause private companies to record large goodwill impairment charges in their 2020 financial statements, even in cases where those entities are now financially strong and have substantially recovered from the pandemic.
For public companies that are required to report quarterly using U.S. GAAP, this resulted in some companies reporting hefty impairment charges in their first or second quarter financial statements. One example is Del Taco, a public company that saw its stock price bottom out on March 18, 2020, down nearly 68 percent for the year. For the 12 weeks ending March 24, 2020, Del Taco recorded a goodwill impairment charge of more than $87 million. Unfortunately, many public companies across different sectors incurred similar charges in 2020. However, Del Taco (along with many other companies both public and private) has substantially recovered from the pandemic when considering its same-store sales and share price have made gains on a year-to-date (as of early September) basis for 2020.
The conundrum for private companies that only obtain an audit report on their annual financial statements, and therefore typically record GAAP adjustments for items such as goodwill impairment and amortization only at year-end, is whether this trigger-based impairment model is the best alternative. As a reminder, starting in 2014 with the issuance of ASU 2014-02, “Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill,” private companies were granted the ability to elect to amortize goodwill over a 10-year period (or less) and test goodwill for impairment at either the entity level or the reporting unit level whereby goodwill should be tested for impairment when a triggering event occurs. For some private companies that had elected this alternative in 2014, it may not be a big issue. However, if a company recently acquired a business or impaired its goodwill, it is at much higher risk of goodwill impairment in 2020 — even for companies that have fully recovered from their lowest points in 2020.
The Basis for Conclusions of ASU 2014-02 states that, “The triggering event is the event that makes an entity stop and think about impairment.” Many would argue that economic issues related to the pandemic would make a lot of entities stop and think about many things related to their business, impairment being a key one.
Is the model worth it?
Another question we need to ask is whether users of private company financial statements find the current goodwill impairment model to be decision-useful. Many practitioners and preparers believe users of private company financial statements focus on adjusted EBTIDA, which usually allows addbacks for goodwill impairment. If users don’t find the current goodwill impairment model to be useful, it would be a shame to spend a lot of time and money on goodwill impairment testing.
If we compare the goodwill impairment test under current GAAP to the impairment test for other long-lived assets, the financial results would be quite different. Under GAAP, an entity with long-lived assets (for example, property, plant and equipment) would be able to perform a recoverability test on those assets and consider undiscounted cash flows and entity-specific cash flow projections. These tests can be performed internally without the cost of engaging a valuation specialist. Since private companies are not traded on an open market, often fair value assessments need to be performed by a specialist, an additional expense for many private companies that are already under some level of cash flow duress.
In its September 22 meeting with the FASB, the AICPA’s Technical Issue Committee proposed alternatives to the current impairment model for private companies. The committee encouraged FASB to look at a short-term solution or practical expedient for private companies in the meantime, and then asked them to consider a more comprehensive solution for the longer-term. FASB is working on a longer-term project to revisit subsequent measurement of goodwill for all entities, both public and private, as part of an existing project are on their agenda.
FASB has noted they will take these ideas into consideration. However, if they are to come up with a solution, it will have to happen fast, as we are quickly approaching year end, when many private companies will be closing their books and preparing to issue annual financial statements.