The year 2020 saw many restaurants go out of business or struggle to remain open. As 2021 draws to a close, some of these businesses are back on their feet, but their status as a going concern may be uncertain. At year-end, their management must evaluate business conditions, 2022 plans and the funding necessary to continue operations.
Let’s review critical year-end accounting considerations for these restauranteurs: impairment testing for goodwill, intangible and fixed assets, and a going concern assessment.
Impairment Testing for Goodwill
Accounting Standards Update (ASU) 2021-03, issued by the Financial Accounting Standards Board (FASB) in March 2021, allows private companies to use an accounting alternative to evaluate goodwill impairment triggering events. Per the ASU and required by Accounting Standards Codification (ASC) 350-20, management can perform this evaluation and any resulting goodwill impairment test at the end of the business’s interim or annual reporting period versus when as triggering events occur under legacy guidance. Goodwill must be tested for impairment annually or more frequently when events or circumstances indicate asset impairment is more likely than not (>50 percent). Measurements of goodwill, such as customer loyalty and trademark values, require supporting data. When an impairment indicator triggers an interim impairment test, a qualitative assessment is required.
ASC 350-20-35-66 states, “Goodwill of an entity (or a reporting unit) shall be tested for impairment if an event occurs or circumstances change that indicate that the fair value of the entity (or the reporting unit) may be below its carrying amount (a triggering event). Paragraph 350-20-35-3C(a) through (g) includes examples of those events or circumstances. Those examples are not all-inclusive, and an entity shall consider other relevant events and circumstances that affect the fair value or carrying amount of the entity (or of a reporting unit) in determining whether to perform the goodwill impairment test. If an entity determines that there are no triggering events, then further testing is unnecessary.”
If COVID-19 didn’t affect Q1 2021, then Q2 wouldn’t require a quantitative impairment test due to a qualitative assessment. This qualitative assessment for a hypothetical regional chain might show the following:
- COVID-related downturns didn’t trigger any store closures (permanent or temporary).
- There were no significant workforce-related issues.
- There was a resurgence in consumer demand during the spring and summer.
- There were no shortages in supply which had a material impact on the company.
- Earnings and cash flow were steady.
- The company doesn’t anticipate selling or disposing of any assets as a result of COVID-19.
- The company pivoted its operations to emphasize takeout and local delivery.
- Web enhancements have driven increases in online traffic.
- Expenses, vendor terms and capex have been tightly managed to retain cash flow and liquidity.
It’s important to remember that the simplification of the triggering event evaluation process applies only to goodwill impairment — not long-lived or intangible asset impairment.
Impairment Testing for Intangible Assets
The guidance requires testing intangible assets, such as acquired franchise rights and trademarks, for impairment at least once a year. When events or changes in circumstances indicate a likely impairment of the intangible asset or reporting unit, testing must be more frequent. During interim periods, ASC 350 requires companies to focus on the events and circumstances affecting the fair value of the asset, asset group or reporting unit. These are the inputs used to determine the need for an interim quantitative impairment test. The guidance lists several relevant events and circumstances to indicate impairment as part of a qualitative assessment in ASC 350-30-35-18A – 18F.
Generally, when a business continues to be profitable and there are no significant changes to operations affecting the utility or expected life of indefinite-lived assets, an annual, high-level qualitative analysis will suffice. This test allows management to conclude that no events or changes in circumstances indicate impairment of these assets.
COVID-19 May Cause Revenue to Decline Over Time
Consider the example of a hypothetical restaurant chain, where 2021 sales have risen compared to the previous year. Stores stayed open with limited operational disruptions. The chain pivoted to meet customer needs during the pandemic, focusing on takeout and limited-area delivery. The continued use and expected value of intangible and long-lived assets appear unaffected.
Given current economic and market conditions, management should consider whether any events or changes in circumstances have occurred in the current period. This determines if an interim quantitative impairment test of an indefinite-lived intangible asset, reporting unit, or both, is necessary. When an impairment indicator triggers an interim impairment test, a quantitative test is required.
However, as COVID-19 infections rose and fell during the current year, management should evaluate whether there were periods where facts and circumstances indicate impairment. The exact timing of a potential triggering event depends on the nature of the events and circumstances. Discrete events that significantly affect the fair value or carrying value, such as the release of unforeseen government regulation or weather event, may be traced to a particular day. Yet, broad-based declines in economic conditions are more common. These unfold over time without a discrete event to mark their start, meaning the COVID-19 triggering event and a resulting decline in business activity can’t be traced to a particular day. The decline is therefore evident when seen over weeks or months. Given the circumstances of the COVID-19 economic decline, we have some flexibility to determine the exact trigger date for COVID-related goodwill impairment. This would be a short-term period, such as a few weeks or months. After this, a business would still need to monitor for another triggering event.
Step-By-Step Analysis of Triggering Events
Management’s analysis should look for events or changes in circumstances indicating a need for impairment testing during an interim period:
1. Was there a triggering event in the fiscal year 2021 due to the COVID-19 pandemic?
a) Management doesn’t see a triggering event. As defined, a triggering event causes the fair value of an enterprise to fall below its carrying value.
2. Should management review entity-level detail to support the above conclusion?
a) Long-lived assets are kept at a consolidated level, not at the entity level, in all cases. Therefore, attributing specific asset values to entities (e.g., store level) would require numerous assumptions and artful application.
b) The company doesn’t report at store levels. Goodwill impairment evaluations should be performed at a reporting level only.
3. Why wasn’t an interim impairment performed in 2021?
a) An “interim” period would be defined by quarters. COVID-19 had a reduced impact on 2021 compared to 2020.
b) Goodwill must be tested for impairment annually, and more frequently, if events or circumstances indicate that asset impairment is more likely than not (>50 percent). A qualitative assessment is required when an impairment indicator triggers an interim impairment test. COVID didn’t affect Q1 2021. Therefore, Q2 2021 didn’t require a quantitative impairment test because of the following qualitative assessment. This qualitative assessment would apply for Q3, Q4 and in total:
§ COVID-19-related shutdowns didn’t trigger any store closures (permanent or temporary).
§ There were no significant workforce-related issues.
§ There was a surge in demand during the height of COVID-19 infections.
§ There were no supply shortages that had a material impact on the company.
§ Earnings and cash flow were steady.
§ The company doesn’t anticipate selling or disposing of any assets as a result of COVID-19.
§ The company revamped operations to emphasize takeout and local delivery.
§ It launched website enhancements to drive more online traffic.
§ It managed expenses, vendor terms and capex to retain cash flow and liquidity.
Impairment of Fixed Assets
Our hypothetical restaurant chain has a broad range of fixed assets, including commercial foodservice equipment, furniture and fixtures, and leasehold improvements. It holds and uses these assets in ongoing operations, depreciating them over their estimated useful lives.
ASC 360-10-35-17 states, “An impairment loss shall be recognized only if the carrying amount of a long-lived asset (asset group) is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset (asset group) is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset (asset group).”
ASC 360-10-35-21 provides guidance to assess a long-lived asset or asset group for recoverability: “A long-lived asset (asset group) shall be tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable.
Assessment of Events or Changes in Circumstances
The following are examples of possible events or changes in circumstances, plus management’s hypothetical assessments in italics:
1. Is there a significant decrease in the market price of a long-lived asset (asset group)?
No
2. Is there a significant adverse change in the extent or way a long-lived asset, or asset group, is being used or in its physical condition?
Stores have remained open to customers, and the business office continues to operate normally. There have been no changes in the physical condition of these assets.
3. Has there been a significant adverse change in legal factors or the business climate that could affect the value of a long-lived asset (asset group), including an adverse action or assessment by a regulator?
With the business climate changing, the company has adapted operations to meet new COVID-driven consumer needs. The business remains profitable, and its fixed assets remain in use. Consumer demand has spiked compared to prior years, as shown by current year revenues. While there have been shortages to the supply of produce and proteins, our menus have adapted and prevented any extended supply chain issues.
4. Have costs accumulated significantly, in excess of the amount originally expected for the acquisition or construction of a long-lived asset or asset group?
No.
5. Does the current operating period show a cash flow loss, combined with a history operating or cash flow losses? Is there a forecast that shows continuing losses associated with the use of a long-lived asset or asset group?
No. The company remains profitable.
6. Does management expect that it is more likely than not to sell or dispose of a long-lived asset or asset group before the end of its previously estimated useful life?
There have been no plans to sell or dispose of any assets as a result of COVID-19.
Going Concern Assessment
Given the level of uncertainty resulting from the pandemic, restauranteurs must demonstrate their ability to meet financial obligations when they become due. This requires an assessment covering current and potential adverse conditions, as well as management plans for mitigation.
If management sees material uncertainties about the company’s ability to continue as a going concern, it is obligated to disclose these facts in its financial statements. These statements offer an early warning of potential financial difficulties to creditors and shareholders.
Management’s assessment of the company’s ability to continue as a going concern will be more visible than ever in 2022 as a result of the Auditing Standards Board (ASB) of the American Institute of Certified Public Accountants (AICPA) new Statement on Auditing Standards (SAS) No. 134. The statement, “Auditor Reporting and Amendments, including Amendments Addressing Disclosures in the Audit of Financial Statements” is effective Dec. 15, 2021. SAS 134 reconciles Generally Accepted Auditing Standards (GAAS) with the auditor reporting standards of the International Auditing and Assurance Standards Board (IAASB). These changes increase the value of audited financial statements by providing more transparency. They also now require disclosure of management and the auditor’s responsibility for going concern issues in the auditor’s opinion.
Management’s assessment, in its going concern analysis, is to provide its directors, shareholders and creditors with a complete and accurate report of its current financial condition. This includes:
- Liquidity sources.
- All obligations, due or expected within a year of the date of the financial statement’s publication.
- Funds required to maintain operations. Any conditions or events, actual or anticipated, that could adversely affect the company’s ability to meet its obligations within a year of the date of the financial statement’s publication.
Restauranters will need to consider any adverse conditions, which could include any of the following:
- Loss of significant franchisee(s).
- Significant supply chain or labor shortages.
- Operating losses or negative financial ratios.
- Store closures (temporary or permanent).
- Aging stores in need of remodeling or capital infusion to maintain operations.
If initial substantial doubt is raised, management must move on to Step 2 in accordance with the guidance in ASC 205-40-50-6. Step 2 requires management to consider all plans intended to mitigate those relevant conditions or events that, when implemented, alleviate the substantial doubt. Management’s plans are considered only to the extent that they meet both of the following criteria: (1) it is probable that such plans will be effectively implemented within one year after the date that the financial statements are issued, and (2) it is probable that the plans, when implemented, will mitigate the relevant conditions or events within one year after the financial statements are issued. Restauranters may consider mitigating factors such as the following if substantial doubt is raised:
Food costs reductions/menu price increases.
Closure of under-performing stores.
Adjusted hours to accommodate labor shortage and raising wages.
New or modified financing agreements.
Waivers of debt covenant violations.
Rent abatement or deferrals from landlords.
Government assistance through various programs such as loans under the Restaurant Revitalization Fund (RRF) or Paycheck Protection Program (PPP), Employee Retention Credit (ERC) or the deferral of employer FICA taxes.
The Value of Complete, Accurate Financial Statements
COVID-19 has introduced record uncertainty to the hospitality industry. This makes it critical for restauranteurs to test assets for impairment at year-end — or more often, depending on events and circumstances. Impairment testing helps to ensure complete, accurate financial statements, which will be of critical importance to shareholders, creditors and vendors.
If you have restaurant operations and are ready for experienced impairment testing, please contact Windham Brannon principal, Maggie Wise, who leads the firm’s restaurants practice.
