Given the recent challenges and changes brought by COVID-19, many companies have faced varying forms of economic disruption. As a result, the COVID-19 pandemic will require many common assets to be tested for impairment. Companies should consider the following relating to potential impairments:
- Accounts receivable: Collection of certain accounts receivable may no longer be probable in the current environment and thus need to be evaluated for impairment. Companies should review the accounts receivable aging regularly and establish specific reserves for any amounts where it is probable that the company will not collect the contractual amount that is due. Companies should also set reserves for homogenous balances with probable incurred losses, known as pool reserves. These reserves are established when collectability of receivables are in doubt and can be reversed if the environment or facts change.
- Inventory: Inventory should be analyzed for impairment as companies may have reduced sales prices, closed production plants, and/or have seen an increase in production costs. Under FASB ASC 330-10, Inventory, inventory measured using any method other than LIFO or the retail inventory method, should be reported at the lower of cost or net realizable value. When evidence exists that the net realizable value is lower than its cost, the difference should be recognized in earnings. To determine the impairment, management should consider the following: slow moving inventory, obsolete inventory, and fixed overhead cost absorption practices. Inventory reserves cannot be subsequently reversed after the close of a fiscal year.
- Deferred tax assets: A deferred tax asset or DTA is recognized for deductible temporary differences and unused tax losses carried forward to the extent that it is probable that future taxable profits will be available. The COVID-19 pandemic may affect the realizability of DTA’s and an allowance may be necessary. A DTA allowance should be established when realizability is not expected and the allowance can be reversed if facts or circumstances change.
- Long-lived assets: The impairment guidance in FASB ASC 360, Property, Plant, and Equipment, applies to long-lived assets including land, buildings, equipment, capital leases, finite-lived intangibles, and real estate projects. The impairment analysis for long-lived assets begins when events or changes in circumstances indicate that an asset’s (or asset group’s) carrying amount may not be recoverable. Many companies will conclude that a triggering event has occurred in 2020 due to the COVID-19 pandemic. The exact date of the triggering event may vary within a few weeks or months; however, companies may not bypass the impairment test analysis if economic conditions improve by the end of the fiscal year. If undiscounted cash flows is less than the carrying value of the asset, impairment exists. The impairment loss is equal to the fair value of the asset less the carrying value. Once an impairment loss is recognized it may not be reversed.
- Goodwill: Private companies can use three different accounting models to test for goodwill impairment – (a) one-step traditional model; (b) two-step approach to the traditional model; or (c) the Private Company Council (PCC) alternative. The traditional models (one-step and two-step) require an annual impairment test as well as a trigger-based impairment test. The PPC alternative which allows companies to amortize goodwill over a period not to exceed 10 years only tests for impairment upon a triggering event. In evaluating whether the fair value of a reporting unit is less than its carrying amount, a company should consider events and circumstances, including: deterioration in general economic conditions, industry and market considerations, cost factors, overall financial performance such as negative or declining cash flows, etc. Under all three models, goodwill impairment cannot be reversed once recognized.
In accordance with FASB ASC 360-10, Property, Plant, and Equipment, the impairment testing order is as follows:
- Assets outside the scope of FASB ASC 360-10 (other than goodwill) such as inventory, indefinite-lived intangible assets;
- Long-lived assets to be held and used in accordance with FASB ASC 360-10;
- Goodwill in accordance with FASB ASC 350-20
Many ambiguous impairment scenarios remain, and we are here to help you navigate the various challenges presented this audit season.