The spread of the novel coronavirus (Covid-19) around the globe has had grave economic and human costs, including record-breaking drops in equity markets, spikes in unemployment claims, significant reductions in international and domestic travel, nationwide shelter-in-place orders, and nearly unprecedented short-term uncertainty.
Comfort for stakeholders can be found within the traditional confines of corporate financial statements and financial reports for disclosures on how companies expect the virus to affect their operations and future financial performance. These metrics will include enhanced levels of judgment and estimation, but companies should still use existing authoritative guidance as a starting point for the necessary presentation of new quantitative and qualitative information.
One area of corporate financial reports that could see a material impact from the virus is long-term asset impairment. Here are some of the pressing questions companies should be asking:
Will Covid-19 beget impairment of long-term fixed assets?
An impairment loss is defined within ASC 360-10-35-17 as the non-recoverable amount by which the carrying value of a long-lived asset (asset group) exceeds its fair value. Non-recoverable is identified as when the carrying value exceeds the sum of the undiscounted cash flows and eventual disposition of the asset.
The immediate economic effects of the virus are likely to trigger an impairment test for long-lived assets or asset groups at many companies across a variety of industries. As an example, cruise lines are seeing widespread voyage cancellations and disruptions that could lead to sustained falls in the expected undiscounted cash flows from their cruise ships and substantial doubt about the recoverability of the carrying amount of the assets. The ubiquity of these impairments is heavily dependent on factors such as the path of the virus, government restrictions on business operations, government aid, and consumer confidence.
The Securities and Exchange Commission (SEC) has issued several comment letters over the years around how companies assess and disclose the level at which assets are grouped for impairment testing. Companies should expect regulators to place heavy emphasis on this area during periods of material asset impairments.
What guidance should companies follow when considering long-lived asset impairment?
The appropriate U.S. GAAP guidance for companies based in the United States is contained in ASC 360-10. This discussion revolves predominantly around U.S. GAAP material for long-lived asset impairment, but the related discussion for International Accounting Standards can be found within IAS 36.
What are the tests or procedures a company conducts to determine if a fixed asset is impaired?
Companies go through two or three tests or steps to determine fixed asset impairment. First, they must assess if indicators bring rise to potential impairment. If so, they must test the fixed asset for recoverability and/or measure the impairment and record the change. See below for more details of the impairment test.
When does the impairment accounting occur?
Impairment charges should be accounted for during the period they occur.
What needs to be disclosed for an impairment loss?
ASC 360-10-50-2 requires disclosure of:
a description of the impaired long-lived asset, including a description of the events and changes in circumstances that contributed to the impairment;
the amount of the impairment loss and the caption in the statement of activities that includes the loss, if not separately presented on the face of the statement;
the method or methods used to determine the fair value of the impaired long-lived asset; and
the segment in which the impaired long-lived asset is reported under ASC 280, if the company is required to provide segment disclosures.
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Outline of the US GAAP ASC 360-10 impairment steps include:
Step One:Assess impairment indicators: The owner of the long-lived asset considers whether there are events or circumstances that indicate the carrying amount of the asset’s asset group might not be recoverable and thus a potential impairment exists. There are many different events or circumstances that could lead to this conclusion, and assessing these events or circumstances requires significant judgment.
A significant decrease in the market price of the long-lived asset
A significant adverse change in the long-lived asset’s extent or manner of use
A significant adverse change in the long-lived asset’s physical condition
A significant adverse change in legal factors, such as actions or assessments by regulators
A significant adverse change in the business climate
An accumulation of costs significantly in excess of the amount originally expected for the long-lived asset’s acquisition or construction
A current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast predicting continuing losses associated with use of the long-lived asset
A current expectation that, more likely than not, the long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life
In addition to the above indicators, an entity may identify other indicators that are particular to its business or industry.
Step Two:Test for recoverability: If events or circumstances indicate a potential impairment, a recoverability test should be completed by determining the estimated undiscounted cash flows attributable to the asset group and comparing that amount to the carrying amount. The carrying amount is not recoverable if it exceeds the estimated undiscounted future cash flows and eventual disposition from the asset or asset group, and the entity must measure and record the impairment loss.
Step Three:Measurement of impairment: If the asset group’s carrying amount is not recoverable, an impairment loss is recognized if the carrying amount exceeds the asset group’s fair value.The impairment loss is allocated to all the long-lived assets within the asset group.
How do potential future recoveries affect current asset impairment?
According to ASC 360-10-35-20, the reversal of a previously recognized impairment loss of a held-and-used long-lived asset is prohibited. However, paragraphs 110 through 116 of IAS 36 allow an entity to reevaluate the recoverable amount of the asset to determine whether an impairment loss that was previously recognized still exists. Several examples of both external and internal information may indicate an impairment may no longer exist. These examples are provided as follows:
External sources of information:
There are observable indications that the asset’s value has increased significantly during the period.
Significant changes with a favorable effect on the entity have taken place during the period, or will take place in the near future, in the technological, market, economic, or legal environment in which the entity operates or in the market to which the asset is dedicated.
Market interest rates or other market rates of return on investments have decreased during the period, and those decreases are likely to affect the discount rate used in calculating the asset’s value in use and increase the asset’s recoverable amount materially.
Internal sources of information:
Significant changes with a favorable effect on the entity have taken place during the period, or are expected to take place in the near future, in the extent to which, or manner in which, the asset is used or is expected to be used. These changes include costs incurred during the period to improve or enhance the asset’s performance or restructure the operation to which the asset belongs.
Evidence is available from internal reporting that indicates that the economic performance of the asset is, or will be, better than expected.
Are long-term asset impairments from Covid-19 considered to be subsequent events?
The guidance in ASC 855-10-55-20 states that “some nonrecognized subsequent events may be of such a nature that they must be disclosed to keep the financial statements from being misleading.” If it is determined that the nature of the event rises to the level of a non-recognized subsequent event, the nature of the event and an estimate of its financial effect, or a statement that such an estimate cannot be made, must be disclosed.
Companies should consider a variety of factors in whether there are coronavirus-induced subsequent events, including:
Scope of business operations or exposure to countries with high quantities of coronavirus cases, including China, Italy, South Korea, and the United States
The fluid nature of the virus and government restrictions around its movement
Suppliers and customers that have made disclosures around the impact of the virus, including their ability to continue as a going concern
Whether the event would be disclosed as a recognized or non-recognized subsequent event
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