COVID-19: Balance Sheet ‒ Caution Ahead
21 Jul 2020
By Aaron O’Connor, CPA, Managing Director
Since the start of 2020 when COVID-19 began to have a larger and more direct impact in the U.S., companies have been faced with many challenges. To date, the majority of these challenges have been income statement related: costs to acquire PPE or retrofit safer working conditions, temporary closures of businesses, restrictions on operations / capacity, supply chain disruption, and increased operating costs to name a few. All of these challenges resulted in lower revenues and higher costs, directly impacting the day-to-day performance of the company.
Indefinite Lived Intangibles
Sitting on company balance sheets, brought on by COVID-19, in the form of indefinite lived intangibles are potentially other areas of trouble for business owners and managers to confront and manage. Indefinite lived intangibles are items such as goodwill, trademarks, or perpetual franchises. These intangible assets are not amortized and their balances remain unchanged, frozen in essence, on the company’s balance sheet. That is until there is an impairment when these balances are written down to reflect their current fair market value.
Companies have been required to evaluate intangible assets for potential impairment for many years, but in recent years the business conditions in the U.S. were generally favorable and lessened the need for companies to rigorously consider potential impairment. ASC 350-30-35-18 states that an intangible asset that is not subject to amortization shall be tested for impairment annually, and more frequently, if events or changes in circumstances indicate that it is more likely than not that the asset is impaired.
Examples of events that indicate a potential impairment include:
- Cost factors such as increases in raw materials, labor, or other costs
- Declining financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods
- Legal, regulatory, contractual, political, business, or other factors
- Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation
- Industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (in both absolute terms and relative to peers), or a change in the market for an entity’s products or services due to the effects of obsolescence, demand, competition, or other economic factors (such as the stability of the industry, known technological advances, legislative action that results in an uncertain or changing business environment, and expected changes in distribution channels)
- Macroeconomic conditions such as deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets
Key Takeaway: Ongoing Analysis
Most every company has been impacted by at least one, if not more, of these potential indicators of impairment. Companies should develop a robust analysis of their specific considerations of these potential indicators of impairment on their operations. When developing this analysis, companies will benefit from a process that is repeatable and incorporates internal controls over the analysis.
The analysis of these conditions is likely to change on a frequent basis, likely resulting in a need to update this analysis every quarter vs. annually due to the continuing challenges brought about by COVID-19.
As always, if you need any assistance, please reach out to your PKF Advisory client service team. We are here to help.