#1 – Plan Ahead
Everything but travel-time is taking longer in Covid-time. This includes your annual impairment testing. For financial reporting, this includes the amount of time to: (1) prepare prospective financial information (the “PFI”), (2) review and approve the PFI, (3) perform and document impairment testing, and (4) conduct the audit review of the impairment testing. Therefore, plan ahead and build in extra time to your plan.
#2 – Expect Quantitative Impairment Testing and Consider Using a Third-Party Valuation Specialist
While qualitative impairment tests may have sufficed in the past, the prospects of sufficing this year are likely much lower due to the Covid-19 pandemic. Charges for impairment are a bit like accounting restatements, in that they occur infrequently and viewed unfavorably. But when they occur, they must be arrived at after following a rigorous process. Management and auditors will seek a third-party valuation specialist to provide additional rigor.
#3 – Prioritize Communication between Management and Auditors
Financial statement audits may be quite different this year. In addition to all the changes occurring company-side, public accounting firms are adjusting their practices to work-from-home (“WFH”) arrangements. This may have implications on your auditor’s: planning process; training & staffing; timing of field work; and site visits. Auditors and management should communicate early and often.
#4 – Acknowledge Preparing the PFI Will Require Deeper Thinking and More Resources
Preparing a forecast of financial and/or operational results has never been an easy process and in the current environment, the process has only gotten harder. For example, what time horizon are you implicitly or explicitly assuming until the Covid-19 pandemic becomes a minor consideration? How is the company expected to fund operations during this time? What does the PFI indicate for compliance with any debt covenants?
#5 – Prepare for Implications of a Charge for Impairment
Assuming the results of impairment testing is the recognition of a charge for impairment, what does this mean for the subject company? Will this result in a technical default of a debt covenant? Is the auditor going to add more scrutiny in assessing whether or not the company is indeed a going-concern?
#6 – Estimate EBITDAC, i.e., Historical Financial Results Normalized for Covid
Normalization for one-time items and other “addbacks” requires significant analysis and judgment. Buyers and sellers, as well as management and auditors, often have different views. This is even more the case for Covid-specific adjustments. That being said, normalizing historical results to remove the impact of any government-mandated shutdowns on your operations will likely be quite useful, especially if done so thoughtfully and documented in a well-supported manner.
#7 –Review Valuation Specialist’s Work-Product More Carefully
There is more for you look out for in the work product of your valuation specialist. For example, if a merger & acquisition method is applied, have any of the precedent transactions closed since the March 2020 WHO declaration of the Covid-19 global pandemic. When reviewing the income approach, consider how the pandemic has impacted the company’s: cost of capital/WACC; long-term growth rate; and working capital needs.
#8 – Don’t Forget Impairment Testing of Long-Lived Assets Under ASC 360
Due to the nature of the first step of impairment testing under ASC Topic 360, impairment testing of a company’s long-lived assets, such as tradenames and machinery & equipment, is often overlooked. For companies experiencing financial distress, this is typically a bad supposition. Impairment testing under ASC 360 is complicated work and must be completed before impairment testing of goodwill under ASC Topic 350.
#9 – Document Assumptions Regarding the Treatment of PPP Loan in Impairment Testing
Companies with loans from the Paycheck Protection Program of the CARES Act will likely not have certainty on whether or not the loan will be forgiven until after impairment testing is complete. Despite the uncertainty, it can be appropriate to assume forgiveness in the impairment test, based on the facts and circumstances. Management, auditors, and valuation specialists should engage on this complexity.
#10 – Don’t Forget About Non-Operating Assets & Liabilities
When the cushion of fair value in excess of carrying value of the reporting unit is significant, spending time carving out and valuing non-operating assets and liabilities is often moot, which can mean not considered or not audited. When that cushion though is much less, non-ops can be the difference between passing or a charge. Non-ops should be considered and appropriately incorporated into goodwill impairment test.