If the effects of COVID-19 have led to an impairment indication for any of a company’s assets, an impairment test must be performed already at an interim reporting date.
An impairment test requires, at minimum, the following:
- Revisiting cash flow forecasts: the budget and cash flow projections must be updated to reflect the impact of COVID-19. This may include updating the supply of and the demand for products and services affected by restrictions on transport, travel and quarantine; reflecting changes in expectations over exchange rates, commodity prices and other assumptions. As it is unclear as to what is to come after COVID-19, this task remains a considerable challenge. Many analysts expect a global recession despite the current governmental stimulus programs around the globe. In addition, thoughts on the shape and magnitude of the economic impact (V, U, W, or L shaped curves) may vary. We believe it is necessary to consider adjustments to cash flows in light of short-term, medium-term and long-term effects. It is also recommended to develop multiple scenarios and probability-weighted cash flow projections
- Recalculating the discount rates: Discount rates to be used in recent valuations need to be updated to reflect the risk environment at the reporting date. Due to increased volatility and uncertainty in the expected cash flows, discount rates will increase. Many valuation practitioners have already increased their equity risk premium estimates by at least 50 bps. In addition, it is worth mentioning that a specific COVID-19 risk premium (alpha) cannot be quantified. It is preferable to reflect such risks in the cash flows rather than in the discount rate
In any case, to produce robust impairment test results in the current economic environment requires enhanced consideration of individual facts and circumstances as well as a significant informed judgement even in the best of times.
Read the full publication to find more details and considerations on impairment testing in light of COVID-19.