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With a new year and a fresh slate, it is the perfect time to set goals, make resolutions, and plan for the year ahead. From a valuation perspective, companies should consider the following topics as part of their agenda:
- Purchase Price Allocations (ASC Topic 805)
Any acquisitions that executives have planned for 2022 will lead to a need for a purchase price allocation. This analysis consists of taking the transaction price or “purchase price” and allocating it to the acquired assets (and liabilities). Purchase price allocations are performed under the guidelines of ASC Topic 805 – Business Combinations. Assets and liabilities are estimated based on the fair value (as defined in ASC Topic 820 – Fair Value Measurements and Disclosures) as of the transaction close date.
When a transaction occurs, executives should consider whether the acquisition is an asset acquisition or business combination. In an asset acquisition, substantially all the purchase consideration is booked to the single (or similar) identifiable asset (i.e., proved or unproved reserves) and, as such, there are no other assets to allocate value to, including goodwill (or a bargain purchase). In a business combination, all the assets acquired must be measured at fair value and the sum of the assets equates to the purchase price. If the sum of the fair values is lower than the purchase price then the transaction implies goodwill, which the acquiring company will have to add as an asset to their balance sheet.
- Asset Impairments (ASC Topic 360)
On November 3rd, Reuters reported that a super major, “for the first time in a securities filing that some of its oil and gas properties may face impairment due to climate change.” Planning for 2022 should consist of whether a company may experience any triggering events over the course of the year, which could signal a need for asset impairment testing. Like this super major, “certain assets could be at risk for impairment,” according to the Reuters report. I expect other integrated oil companies and energy companies to experience similar triggering events related to climate change in 2022.
Examples of triggering events include a change in the way an asset or asset group is being used or a change in its physical condition, loss of a significant customer, an adverse change in legal factors, regulation, or business environment, or a significant decrease in the market price of a long-lived asset, among other things.
Asset impairment tests are a two-step test performed under the guidelines of ASC Topic 360 – Property, Plant, and Equipment, which tests the recoverability of depreciable, amortizable and/or depletable asset groups, and if the recoverability test is failed, the impairment is then measured.
Executives should note that there is an appropriate order in which to perform impairment tests. The asset impairment should be performed before the goodwill impairment. You can remember this by thinking about a balance sheet and how the long-lived assets appear before goodwill.
- Goodwill & Indefinite-Lived Intangible Impairments (ASC Topic 350)
We see a lot of goodwill impairment testing done this time of year as companies typically test at year-end. Goodwill impairment tests are a one-step test performed at a reporting unit level under the guidelines of ASC Topic 350 – Intangibles – Goodwill and Other. A company has the option to first perform a qualitative assessment to determine whether its fair value is less than the carrying amount (including goodwill). The company can bypass the qualitative assessment and proceed directly to a quantitative assessment as of the test date or in the instance of a triggering event. If the carrying amount is higher than the fair value, then the goodwill is impaired by the amount of the difference (limited by the amount of goodwill on the books).
Executives should note that an impairment of goodwill or indefinite-lived intangibles can be considered a triggering event for asset impairments.
Fair Value Guidance
The standard of value for financial reporting is fair value, which is defined under Accounting Standards Codification (ASC) 820 – Fair Value Measurements and Disclosures, as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”
Market Observations
The global pandemic due to COVID-19 adversely impacted companies of all shapes and sizes. As a result, there had been an uptick in a company’s need to perform asset impairments and assess whether goodwill and indefinite-lived intangible assets should be written down. Some companies saw the events in 2020 and 2021 as an opportune time to make downward adjustments to their balance sheets, alongside their competitors. For companies that continued to experience downward effects from the pandemic, it may have even been reasonable to take more than one impairment in a given year.
Final Remarks
Arriving at fair value conclusions is a subjective process and involves significant judgment in inputs. As reporting becomes more rigorous, documentation that’s clear, robust, and thorough for each of these valuation topics is required so companies can properly withstand reporting requirements. Where possible, valuation assumptions and conclusions should be backed by qualitative and/or quantitative support.
Planning for these valuation topics with the turning of a calendar will help companies experience a smooth transition heading into the new year.
Lauren Clyburn is a Director within the Valuation practice of Opportune LLP.