Ongoing market volatility and uncertainty can result in a material impact on the outlook and valuation of businesses and whether any associated goodwill recorded on the books is still supportable. Kroll advises companies to consider performing an assessment of whether the current environment constitutes a triggering event to their business that would require goodwill impairment testing.
Triggering Events
A temporary drop in stock price may not be representative of a more permanent decline in a business. Accounting guidance focuses on a more sustained decrease in the stock price in both absolute terms and relative to peers.
Determining if a stock price decline will be sustained is a critical element in assessing whether a triggering event has occurred. Factors to consider include:
- Whether a stock price decline reflects fundamental shifts in their business and industry, and if this affects the entities where goodwill resides;
- Prices from orderly transactions should be considered with additional focus placed on market volatility up to the measurement date. Sensitivities should be performed when analyzing market prices and market multiples.
- The market may hold a more pessimistic or optimistic view than what a company’s fundamentals indicate. A discounted cash flow analysis (DCF) is a helpful corroborating analysis to perform given the volatile state of equity markets.
Some other examples of potential triggering events may include (but are not limited to) the following:
- Macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets;
- 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 (consider in both absolute terms and relative to peers), a change in the market for an entity's products or services, or a regulatory or political development;
- Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows; and
- Overall 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.
Disclosure
If a company concludes that no triggering event or impairment has occurred, this conclusion should be supported with documentation. For disclosure purposes, companies may need to make goodwill-at-risk disclosures for which fair value is not substantially in excess of carrying amount. This could require estimates of fair value.
Expected Case Cash Flows and Scenarios
In highly volatile environments, the importance of explicit consideration of the impact of risk on value is magnified. When assessing cash flows, the traditional method using only a single cash flow projection may not be sufficient. Rather, a probability-weighted cash flow model considering multiple scenarios may be a more effective measurement tool.
Measuring the economic impacts of changes in tariff and tax policy may be best performed by developing discrete scenarios. Improved methods identify, quantify, and communicate not only the immediate effects that such policies have on important financial parameters including revenue (such as pricing changes and associated impacts on volume or effects on competition) and costs (such as impacts on COGS, transportation expenses, or taxes), but also the ability for management to respond by making decisions to maximize value given the changed environment (through, for example, supply chain management or facility relocation). The value of a reporting unit or cash generating unit is driven not only by risk, but also how that risk is managed.
Kroll’s Guidance
Kroll leads companies through the quantitative impairment testing process, including initial qualitative assessments and scenario planning. In the event an impairment analysis is required, our experts perform fair/recoverable valuations of reporting units, cash generating units, indefinite-lived intangibles and long-lived assets for impairment testing purposes.
Please contact your Kroll partner or a member of our team to discuss the potential impact of the current volatility on your business and any needs for impairment testing.
