Recently, we have been conferring with many clients and their accounting counsel on the potential for economic impairment and subsequent potential for write-downs as they wrestle with the day-to-day impacts of COVID-19. This is relevant to financial statements for the periods ending after December 31, 2019.
The implications for financial statements include not only the measurement of assets and liabilities but also disclosure and possibly an entity’s ability to continue as a going concern. The implications, including the indirect effects from lower economic activity, should be considered by all entities, not just those in the territories most significantly affected. (1)
Here are some bullet points to consider:
- Asset write-downs and impairments are a big focus. Impairments really put pressure on companies’ balance sheets. They occur in an environment in which the company is distressed, assets are being written down, and at a time when companies really need capital to sustain their operations. (2)
- Whether you are operating under International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP), the relevant accounting associations are providing guidance that businesses should examine.
The Chartered Professional Accountants Canada has provided a valuable alert relative to Accounting Standards for Private Enterprises (ASPE), see https://www.iasplus.com/en-ca/publications/cpa-canada/assessing-potential-covid-19-impacts-on-financial-statements-questions-to-ask-under-aspe/at_download/file/02449-RG-ASPE-Alert-Assessing-COVID-19-Impact-Questions-June-2020.pdf.
The ASPE bulletin provides guidance relative to Property, Plant and Equipment.
Impairment of Assets Other than Financial Instruments
The financial performance of entities may be significantly affected by COVID-19 and related government measures. This may raise impairment concerns for various assets held by an entity including property, plant and equipment, intangible assets, goodwill, investments in other entities, inventories and other assets.
These assets are tested for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. COVID-19 may raise questions, such as:
• Are some items of property, plant or equipment no longer in use due to COVID-19?
• Have certain operations of the business closed down, either temporarily or permanently?
• Is the useful life of any asset likely to be shortened as a result of COVID-19?
The above are examples of indicators of impairment and are not meant to be an exhaustive list. Advice from qualified professionals is essential in assessing the expected significance and duration of COVID-19 impacts and related government measures on the business unit, and when evaluating how quickly that business unit is expected to recover. A short-term reduction in cash flows followed by a rapid return might not be significant enough to be considered an indicator of impairment for some entities. For others, even a relatively short disruption due to COVID-19 may affect recoverability of carrying amounts of certain assets. An impairment loss might not be reversed if the fair value of the asset or group of assets subsequently increases in a future period. (3)
- Under GAAP there is the use of a “triggering event” for restatement purposes. From a financial reporting perspective, the fair value of assets could come under pressure as the economic impact becomes more visible. Impairment testing is required whether in the case of a “triggering event”, as defined in ASC 350 – Intangibles –Goodwill and Other, and in ASC 360 – Plant, Property and Equipment. Triggering event-based impairment testing is an issue even for those who have made accounting elections whereby assets are being amortized rather than tested annually for impairment. (4)
As professional appraisers we are being asked to assist in the quantification of impairment for facilities all over the world. The American Society of Appraisers has offered previous guidance to allocating impairment losses to the value of assets.
If value in use for a single cash generating unit (CGU) is less than the sum of Depreciated Replacement Cost (based on physical and functional depreciation) of the assets comprising the CGU and the difference is recognized as asset impairment (economic obsolescence), the question then arises as to how to allocate these impairment losses among the assets comprising the CGU. IFRS does not include a directive concerning how impairment losses are to be allocated; it is an accounting policy decision taken by a company in consultation with its auditors working with the appraisers. Two opinions are prevalent: (1) losses can be allocated according to the relative value of each asset based on the sum of DRC value for all assets in the CGU: e.g. a single asset representing 15% of total DRC asset value would be allocated 15% of the total impairment loss, or (2) Identify the assets that are the main cause of the economic obsolescence and allocate losses mostly to those assets: e.g. if a certain piece of equipment has a capacity to operate at 100 hours per week but is only used 50 hours per week and all other assets are utilized at capacity, then the underutilized asset be allocated most of the loss. (5)
We would urge our clients to continue to confer with their accounting and appraisal counsel on the potential impairment and impact on their financial statements. This could have a cascade effect on your tax and equity positions.