The outbreak of COVID-19 and the impact on the wider economy is placing unprecedented pressure on communities and businesses. Near-term business priorities and focus will be on liquidity and potential going concern issues. However, attention also needs to be paid to the value of balance sheet assets and the requirement to consider whether these are impaired. This is an important consideration for all industry sectors, but particular attention should be paid to those entities that have large property, plant and equipment (PP&E) balances or material goodwill and/or intangible assets. Assessments made about the fair value of such assets a few months ago may no longer be valid. At the very least, they will need to be reconsidered in light of the COVID-19 pandemic and the potential impact this will have on all businesses.
Accounting standards are prescriptive as to how to conduct an impairment review, but in the current environment, there are a number of significant challenges in applying these rules.
|1. Consider whether there is a triggering event or indicator of impairment||
2. Revisit cash flow forecasts
|3. Recalculate discount rates||
|4. Determine the disclosure requirements||
There are two questions management should consider to determine whether a triggering event has occurred.
It seems hard to imagine that condition 1 is not met for most companies. COVID-19 has caused a significant deterioration in economic conditions for most companies, and an increase in economic uncertainty for others, which may constitute impairment triggering events. However, such a major economic shock may also trigger events and circumstances not typically assessed as part of the business as usual (BAU) risk and financial reporting process.
For example, COVID-19 may give rise to force majeure events or triggers to material adverse contract clauses which can be the catalyst for asset specific impairments. In our opinion, the cash flows (at least in the near term) of many, if not all, asset classes will be affected by COVID-19. They may also trigger the requirement for impairment tests for PP&E, inventory, financial assets, real estate and investments (including investments in associates and joint ventures). As such, not only will businesses need to accelerate their annual impairment reviews for goodwill and long life intangible assets, but COVID-19 may also trigger impairment events for other balance sheet assets. Not all of these impairment tests are performed under IAS 36 and many asset classes have their own accounting standards which prescribe how the impairment test should be performed. However, the principle that the carrying value cannot exceed the recoverable amount (or fair value) is typically applied.
Similarly the market capitalization of almost every FTSE 250 and BEL 20 listed company has fallen in the first quarter of 2020. Some of these falls have been dramatic, meaning that condition 2 is also (potentially) met.
The graphs below illustrate how significant market value falls, for a selection of FTSE 250 companies, have eroded the headroom and, for some sectors, the market capitalization has declined below net book value (NBV).
Once a high level assessment has been performed, the areas to focus your work will become more apparent.
In summary, you may need to accelerate your normal annual impairment tests, assess other assets for impairment that you would not typically require an assessment for and consider the disclosure implications for reporting in the interim and future accounting periods.
Estimating fair value (or value in use) requires significant informed judgement in the best of times. The current environment requires enhanced consideration of individual facts and circumstances with a rapidly changing macroeconomic overlay. KPMG’s Valuation specialists are happy to talk with you and share their views and experience to help you navigate through these complex times.