Impact of COVID-19 on goodwill impairment analysis (ASC 350)

We continue to live in unprecedented times. The COVID-19 pandemic’s impact on society, the economy and businesses has been rapid, severe and complex. Earnings of companies in the S&P 500 index are expected to have fallen by 44% in the three months to June 2020, compared with last year.[1] Privately held companies, which generally are smaller, less diversified and have less ready access to capital than publicly traded companies are likely to fare no better. Financial markets have experienced extreme levels of volatility, with the S&P at one point having fallen nearly 30% from its February high. While the S&P subsequently rebounded sharply, segments of the market have seen varied degrees of recovery—e.g., restaurants, airlines and hospitality have been particularly hard hit, while segments of the tech sector and logistics companies have fared better. With the ultimate duration and depth of the impact to businesses uncertain, it is clear it has been and will continue to be drastic.

Among many critical repercussions of the pandemic, management teams and their auditors will need to consider implications for their assessments of the fair value of assets, particularly with respect to potential impairment to goodwill (ASC 350). While, with a few exceptions, it is difficult to think of a business that has not been affected by the pandemic, the extent of impact to each company must be specifically considered and analyzed.

Businesses are experiencing the impact to revenue and profitability in real time. But, even after the pandemic has subsided, its long-term impacts are likely to be profound. There is a very real possibility that consumers, businesses and governments—weighed down by lost income/earnings/tax revenue and increased debt burden, as well as the fear of a second wave of COVID-19—will spend at a reduced rate post-pandemic relative to the pre-pandemic era. This will result in lower growth trajectory and profitability for businesses which will impact valuations.

Of course, the pandemic’s legacy to businesses will likely not be universally negative. Often cited is the acceleration of the virtualization of commercial and other activities, already underway pre-pandemic. This will almost certainly result in reduced costs and increased productivity for many businesses in the long run. Management teams and valuation analysts will need to carefully consider these impacts in their models, including thorough, rigorous stress testing. The unprecedented nature of the current environment likely requires additional attention be paid to downside scenarios, including the possibility of a “W-shaped” or “L-shaped” economic recovery and the specific implications such outcomes might have for the subject business.