Considerations for Acquisition Accounting During COVID-19 [How to Know When a Triggering Event Has Occurred Which Requires Impairment Testing]

Written by Jeff Plank, Lyle Simons on May 4, 2021

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The global pandemic has severely impacted companies’ business operations in a wide range of industries across the country, resulting in stagnant or declining profits or even insolvency.

As a business manager, you must deal with the coronavirus’s more immediate operational and financial concerns while simultaneously considering the accounting consequences of this unprecedented event.

Although companies may not have to test goodwill annually, if they have past merger or acquisition activity they still need to determine whether events or circumstances, such as the disruptive influence of COVID-19, constitute a “triggering event” for potential asset impairment.

Here, we’ll discuss how to know when a “triggering event” has occurred that would require the company to test impairment, as well as what to do after you’ve identified one.

What is a Triggering Event?

In the simplest terms, a triggering event is an event that instigates another event. In our specific conversation here, the triggering event we are referring to is one created as a result of the COVID-19 pandemic that would, in turn, instigate the need for a company to test impairment.

How to Determine if a Triggering Event Occurred

To determine if a triggering event occurred, you must assess whether business or economic conditions are such that it is “more likely than not” that an asset’s fair value has declined to an amount below book value.

The Financial Accounting Standards Board (FASB) outlines the various factors companies should consider when making this determination, which range from macroeconomic conditions (such as a decline in the debt or equity markets) to an almost unlimited number of company-specific factors (such as a notable decline in customers, supply chain disruptions or the loss of key personnel).

Companies experiencing a sustained period of reduced revenue and profit are at higher risk for a triggering event that requires goodwill impairment testing. However, that does not in itself constitute potential impairment. The amount of goodwill “cushion” (i.e., the difference between the fair value and carrying value) is particularly important.

Public companies may base this analysis on market capitalization or, in the case of multiple reporting units, some apportioned amount. This greatly simplifies the estimate.

For private companies, management should review the last fair value estimate and compare it to carrying value. A valuation that is two or more years old may not be very useful in this type of analysis. Transactions occurring within the past 12 months or so may be helpful. However, note that at the time of the transaction, the acquisition price would be exactly equal to carrying value, resulting in zero fair value cushion—likely an unhelpful answer for purposes of current impairment testing.

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Ultimately, you may be able to claim that the difference between fair value and carrying value is large enough that the potential for impairment due to COVID-19 is low, thereby avoiding the need to test goodwill for impairment. Alternatively, a thin cushion, or no cushion at all, will almost certainly necessitate a test.

What to do After a Triggering Event Has Been Determined

If you determine that a triggering event has occurred, the next step is to follow a prescribed order of impairment testing.

A practical question concerning asset impairment occurs when the business moves temporally through the COVID-19 cycle: has a triggering event occurred if, after the initial downturn, business conditions improve? For example, as of the date of this article, market pricing of the major stock exchanges has rebounded significantly from March lows, and unemployment statistics have also improved.

Do you still need to test? In most cases, the answer is yes.

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Under existing FASB rules, impairment testing is required at the time of the triggering event regardless of subsequent changes to business or market circumstances. However, you should consult with your audit team regarding the nature of the changes. The question of whether improved conditions were foreseeable or not requires substantive discussion and consideration.

Identifying a Triggering Event and Moving Forward with Asset Impairment Testing

As always, if you have questions about triggering events or determining if your business should move forward with asset impairment testing, contact your Warren Averett advisor or ask a member of our team to reach out to you.

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