The SEC’s Not-So-Gentle Reminder: Show Your Work

Estimated reading time: 2 minutes

In early March and April, VRC proactively drew reader attention toward focusing on the facts in the face of market disruptions in the COVID-19-impacted economic and business environment. As we now are at the final days of the second quarter, our advised careful consideration in determining if interim impairment tests for goodwill and other assets are needed has likely become mission-critical for many financial reporting professionals.

Fair Warning for Fair Values

The SEC recently shared a public comment letter in response to a public company’s 2019 year-end 10-K filing and March 2020 quarter-end 10-Q filing. In the filings, the disclosures included statements that the company had assessed and concluded that the novel coronavirus did not affect the value of their goodwill and intangible assets. Therefore, an impairment charge was not needed.

The SEC’s response to the company’s public filing was fair and sounded much like every math teacher we’ve all very likely encountered: show your work.

In order to provide investors with information to better assess the probability of future goodwill impairment charges, please disclose, if accurate, that the estimated fair values of the intangible assets you quantitatively tested for impairment substantially exceeded their carrying values. For any asset whose estimated fair value did not substantially exceed its carrying value, please disclose the percentage by which fair value exceeded carrying value at the date of the most recent test.

The SEC is making it a priority to focus on impairments related to COVID-19. While many companies may have concluded (and reported) that in Q1 2020, despite rapid changes in their stock price and uncertainty about the shape and timing of a recovery, it is unlikely that goodwill is impaired. For many companies, their analysis was a simple comparison of their market capitalization and book value of equity without more than a cursory review of individual reporting units given the rapid nature of the downturn, and the potential for varying outcomes. The SEC’s ask for more specifics is appropriate.

Why? Without showing your work, investors have no insight into the potential “cushion” (% fair value over book value) in a reporting unit. If the fair value of a reporting unit is not so robustly above book value as of a prior date (likely Q4 2019), a significant decline in earnings or of the company’s stock price may signal interim impairment testing is needed for Q2 (and possibly future fiscal quarter ends).

The SEC’s response to the company’s public filing was fair and sounded much like every math teacher we’ve all very likely encountered: show your work.

Hindsight is 20/20, in 2020

Resources and guidance have become plentiful. We have focused more deeply than ever on helping clients manage through a wide swath of financial reporting questions and challenges that have come as a result of the H1 2020 market disruptions. VRC remains of the opinion that more than likely, Q2 2020 financial evidence will show that interim impairment testing is required for many companies, and the effects on accounting and valuation issues may further evolve before coming to a final resolution.

We strongly encourage companies to seek guidance from trusted partners. Engaging with third-party valuation partners to analyze the impacts of market disruptions on company assets, including potential goodwill impairment, is critical. VRC can help you address impairment issues accurately and help mitigate inevitable balance sheet scrutiny from auditors, the SEC, and the PCAOB.

VRC has developed several resources for your immediate access shared below and within our COVID-19 Resource Center:

  • COVID-19 Event Timeline: Identify key events of the health and financial crises to determine the information that can be considered “known or knowable” as of a particular valuation date.
  • How Do Control Premiums Change: VRC’s analysis of control premium data vs. the DJIA over the 24-year period from 1996 through 2019 provides insight as to the impact of sharp market changes on control premiums.
  • Measuring Triggering Event Impacts and Subsequent Impairment Testing: Accurately identifying potential triggering events for the impairment of goodwill and other assets is necessary, particularly in light of COVID-19. Here we highlight the most relevant factors companies should consider in determining if goodwill is impaired.
  • Professional Guidance: VRC has extensive experience working with public and privately-held companies to develop supportable impairment studies. We welcome you to contact any member of VRC’s professional staff or reach out using our Contact Us portal.