Asset Impairment Testing – Just When You Thought You Were Done…
As of the date of the publication of this article, virtually all calendar year-end based companies will have completed their 2008 fiscal year audits. Due to the ongoing recession and negative macro and micro economic factors, too numerous to mention, several companies have had to directly address asset impairment issues under Statement of Financial Accounting Standard (SFAS) No. 142, Goodwill and Other Intangible Assets, and SFAS No. 144, Impairment and Disposal of Long-lived Assets. While financial executives are breathing a sigh of relief now that they can move onto other important duties, the fact remains that the accounting rules still require constant monitoring for “trigger events” that could necessitate the completion of additional impairment testing at any point during the current fiscal year.
Long-lived asset impairment (SFAS 144)
Although SFAS 144 became effective June 30, 2001 (the same date as SFAS 141, Business Combinations and SFAS 142), most companies were able to avoid the Step 1 test due to the economic expansion between 2003 and 2007 that afforded them the benefit of believing their assets were worth at least their net book value. Unfortunately, 2008 became the first fiscal year in which many companies realized that their current basis may not be recoverable should they have to dispose of the assets. This recognition occurs due to some of the “trigger events” spelled out in the SFAS 144 literature which we would be happy to provide to you upon request. Do any of the following circumstances sound familiar?
- A significant decrease in the market price of a long-lived asset (asset group).
- A significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an adverse action or assessment by a regulator.
- A current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset (asset group).
If so, the company was required to complete an “undiscounted cash flow” test to determine at a macro level if the earnings of the business can support the assets in place over the expected remaining useful life of the subject asset group. Only those companies in highly distressed situations are likely to fail this test (which triggers a revaluation of finite-lived fixed and intangible assets). Unfortunately, this has come true for the first time for some companies.
As the economic crisis continues, companies will need to revise their 2009 budgets and short-term forecasts, and many will continue to experience operating losses and project the same for the immediate future. As market values of property, plant and equipment continue to decline, more financial executives will be forced to face the recognition of one or more trigger events that may lead to book write-downs of finite-lived assets. This may now occur in advance of fiscal year-end.
Goodwill impairment (SFAS 142)
Companies have been dealing with the requirements of SFAS 142 for years as the most recent M&A boom created goodwill on the balance sheet of many private and public companies. However, many have been able to get by with completing the impairment testing exercise only very close to, or after, the fiscal year end date. Paragraph 28 of SFAS 142 requires that the goodwill of a reporting unit shall be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Examples of such events or circumstances include:
- A significant adverse change in legal factors or in the business climate.
- An adverse action or assessment by a regulator.
- Unanticipated competition.
- A loss of key personnel.
- A more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of.
- The testing for recoverability under SFAS 144 of a significant asset group within a reporting unit.
- Recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit.
In regards to the correlation with a SFAS 144 test, paragraph 29 of SFAS 142 states that if goodwill and another asset (or asset group) of a reporting unit are tested for impairment at the same time, the other asset (or asset group) shall be tested for impairment before goodwill. For example, if a significant asset group is to be tested for impairment under SFAS 144 (thus potentially requiring a goodwill impairment test), the impairment test for the significant asset group would be performed before the goodwill impairment test. If the asset group was impaired, the impairment loss would be recognized prior to goodwill being tested.
While companies will certainly obtain a great deal of guidance from their external auditors on these matters, it is in their best interest during these challenging economic times to keep a keen eye on the trigger events that may cause them to require valuation assistance during the fiscal year. By so doing, companies not only stay on top of important financial reporting requirements, but strategically position themselves to proactively consider actions that will address business challenge and improve financial performance, enabling them to achieve business goals.