COVID-19: Impairment test considerations COVID-19: Impairment test considerations
It seems hard to imagine that the COVID-19 outbreak has not had a significant adverse effect on the economic environment as well as on the value of equities and assets worldwide. However, a misalignment between stock market performance and earnings expectations has been observed over the past few months. This misalignment has led to a significant challenge in assessing the value of equities and assets as well as concluding whether or not an asset may be impaired.
Nevertheless, if an indicator of impairment has been identified at the (interim) reporting date, an impairment test must be performed. Accounting standards are prescriptive on how to conduct an impairment test, but in light of the COVID-19 pandemic, there are a number of significant challenges in properly applying these standards.
Is there an impairment indication?
Over the past few months, we have witnessed exceptional developments in equity capital markets. Shortly after the global COVID-19 outbreak in mid-February, the MSCI Europe stock index, for example, dropped by 35%. More surprisingly, though, is the stark increase of this index of 28% towards the end of May. These swings, in combination, equate to a drop in the MSCI Europe index of 17% over the period since mid-February to the end of May, which seems like a normal market correction.
The question remains: Does the current state of the MSCI Europe index and these swings accurately reflect the real impact on value, or is this simply the result of market overreactions? A necessary distinction should be made here between ‘price’ and ‘value’. As we know, the market price of any equity security is simply driven by “supply and demand,” which may or may not reflect the reality of the underlying economic fundamentals of the business. Value, on the other hand, is a function of such fundamentals, i.e. cash flows, future growth, and risk (i.e., volatility).
Examining the analyst consensus forecasts in the MCSI Europe index (between December 2019 and May 2020), the plunge in earnings expectations is clearly misaligned with the relatively lower net decrease of the index itself. The chart on the right further illustrates the impact on the various sectors.
This misalignment is combined with a rapidly changing macroeconomic overlay and uncertainty about the long-term economic impact of COVID-19. These considerations make it particularly challenging to assess the ‘value’ of equities and assets as well as concluding whether or not an asset is impaired.
Impairment testing continues to remain a key focus for companies in Switzerland. Activity in this area depends primarily on the industry in which an individual company operates, as well as the characteristics of the company itself. While many companies have been severely affected and have been focused on liquidity and potential going concern issues, many have also shown strong Q1 2020 results with significant cash balances and have even been considering investing in new assets. We anticipate more impairment testing activity to begin starting August once companies seek further clarity around the true impact of COVID-19 on their operations.
