Do Impairment Indicators Exist?

By: Jason Mutarelli

Estimated reading time: 3 minutes

A “triggering event” occurs when there are indicators that the fair value of an entity (or a reporting unit) may be below its carrying amount. One of the changes in events or circumstances that may indicate impairment is a significant decrease in market prices, particularly if it impacts an entire market sector.

In assessing the decrease in market prices, we reviewed the change in the three major U.S. stock market indices – the Dow Jones Industrial Average, the NASDAQ Composite Index, and the S&P 500 – and 11 industry classifications as defined by S&P CapitalIQ (CapIQ). VRC also reviewed the change in the median enterprise value (EV) to next twelve-month (NTM) EBITDA multiple for the 11 industry classifications as defined by CapIQ.

Analyzing the Indices

At the end of the second quarter of this year, the U.S. stock market recorded its worst first half in over 50 years. The S&P 500 had its lowest start to a year since 1970, the Dow had its worst first half in a given year since 1962, and the NASDAQ experienced its worst start to a year ever. In the first chart, we see on a year-to-date (YTD) basis looking from the calendar year 2021 to 2Q 2022, the Dow is down 15.3%, the S&P 500 is down 20.6%, and the NASDAQ is down 29.5%.

Indices Analysis For Goodwill Impairment Indicators

Sector Performance Factors

Next, we see the median change in enterprise value for CapIQ’s 11 industry classifications. We note that the median calculation looks at companies in each industry classification with an enterprise value of at least $1.0 billion as of 2Q 2022 end. Using the same YTD basis from CY 21 to 2Q 2022, nine of the 11 industries experienced a decline in EV, with only the Energy and Utilities industries showing an EV increase. Consumer Discretionary experienced an EV decline of approximately 23%. Information Technology suffered the most significant EV decline of all the industries, with an almost 27% decline in EV.

Sector Performance Analysis For Goodwill Impairment Indicators

Again using the same period and industries, chart three shows the median change in the NTM EBITDA multiple. Here we can see that all 11 industries exhibited a decline in the NTM EBITDA multiple. Utilities experienced a minor decrease in NTM EBITDA multiple of approximately 0.3x, while Information Technology experienced the largest decrease in NTM EBITDA multiple of over 5.0x.

Sector Performance Analysis 2 For Impairment Indicator

Company Financial Performance Indicators

Another event or circumstance to consider in evaluating a potential impairment triggering event is a company’s financial performance decline. The first half of 2022 was plagued by supply chain constraints stemming from China lockdowns, congested ports, and other transit issues. This, coupled with the war in Ukraine, rampant inflation, rising interest rates, and tightening monetary policy, have many anticipating a near-term recession. Given the current market environment challenges, there is an anticipation of disappointing Q2 sales and profits and lower earnings estimates for the near term.

In assessing a decline in the financial performance of companies, our fourth chart reviews the change in forecasted CY 2022, and our fifth the forecasted CY 2023 EBITDA. Energy has seen the largest increase in forecasted EBITDA, while Financials has seen the largest decrease in forecasted EBITDA from CY 2021 to 2Q 2022. The EBITDA forecasts for the remaining industries have not changed significantly (less 5%).Company Performance Analysis For Goodwill Impairment IndicatorsCompany Performance Analysis 2 For Impairment IndicatorsAs companies announce second quarter 2022 results and more up-to-date information and guidance is presented about how the macroeconomic factors mentioned above are impacting sales and earnings, these CY 2022 and CY 2023 EBITDA forecasts may change materially.

Seek and Find?

So, do impairment indicators exist? By illustration and limited analysis for this article, we show that the combination of several factors needs considering:

  1. Falling stock prices during the first half of 2022
  2. Reduced earnings due to inflationary pressures on input costs, including but not limited to (i) wages and transportation costs, (ii) increased energy costs, and (iii) the Russia/Ukraine conflict.
  3. The Federal Reserve has been pushing interest rates up, directly impacting companies’ borrowing costs and increasing the discount rate used to present value company cash flow streams.
  4. Many of the acquisitions in 2020 and 2021 involved transaction multiples higher than those prevailing in the markets today.

These four factors will likely incur increased audit scrutiny around impairment testing, especially for companies that closed material acquisitions over the last two years.

VRC can help your organization address impairment issues accurately and help mitigate inevitable balance sheet scrutiny from auditors, the SEC, and the PCAOB. We welcome you to contact the article author, Jason Mutarelli, or any VRC professional for further expert views on market and valuation considerations surrounding potential interim impairment testing requirements and other questions you may have.