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Generally, a bankruptcy filing is not the first triggering event for an impairment assessment. Asset impairments usually precede a bankruptcy filing given the financial decline that a reporting entity typically faces, which may also be experienced throughout the industry in which it operates. Impairments are usually associated with declines in the reporting entity's cash flows from operating activities and a corresponding decline in the fair values of underlying assets. See BLG 2.2.1 through BLG 2.2.9 for important considerations regarding asset impairments in advance of a bankruptcy filing.

2.2.1 Goodwill (pre-bankruptcy)

A reporting entity is required to assign goodwill to its reporting units and test for impairment annually. Private companies may apply an alternative accounting model for goodwill. This section only addresses the goodwill accounting model for entities not following the private company alternative. See BCG 9.11 for more information on the private company accounting alternative.
In addition, a reporting entity tests goodwill for impairment between annual tests if an event occurs or circumstances change (i.e., a triggering event) that would “more likely than not” reduce the fair value of a reporting unit below its carrying amount.
A triggering event usually precedes a bankruptcy filing because of prolonged operating losses. Accordingly, interim goodwill impairment triggers should be closely monitored, as it is common for goodwill to be impaired prior to the bankruptcy filing. If an interim goodwill impairment test is necessary, the guidance in ASC 350, Intangibles—Goodwill and Other, is applicable. The indicators of impairment listed in ASC 350 are examples, and do not comprise an exhaustive list. ASC 350 indicates the following:

Excerpt from ASC 350-20-35-3F

An entity shall consider other relevant events and circumstances that affect the fair value or carrying amount of a reporting unit in determining whether to perform the first step of the goodwill impairment test.

The SEC staff has provided the following additional examples of events that may indicate that an interim impairment test is necessary:
  • Impairments of other assets or the establishment of valuation allowances on deferred tax assets
  • Cash flow declines or operating losses at the reporting unit level (the greater the significance and duration of losses, the more likely it is that a triggering event has occurred)
  • Negative current events or long-term outlooks for specific industries impacting the reporting entity as a whole or specific reporting units
  • Failure to meet analyst expectations or internal forecasts in consecutive periods or downward adjustments to future forecasts
  • Planned or announced plant closures, layoffs, or asset dispositions
  • Market capitalization of the reporting entity below its book value
In addition, the AICPA Accounting and Valuation Guide, Testing Goodwill for Impairment, provides specific examples of events and circumstances that should be considered in determining if a goodwill impairment test should be performed:
  • Market reaction to a new product or services
  • Technological obsolescence
  • A significant legal development
  • Contemplation of a bankruptcy proceeding
  • An expectation of a change in the risk factors or risk environment influencing the assumptions used to calculate the fair value of a reporting unit, such as discount rates or market multiples
The goodwill impairment standard includes a qualitative assessment option commonly referred to as “step zero.” Step zero is an assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount (that is, a likelihood of more than 50 percent). ASC 350 provides a series of indicators that should be considered in making the more-likely-than-not evaluation. If the assessment concludes that the fair value of a reporting unit is greater than its carrying value, then testing goodwill for impairment is not necessary. However, if the assessment indicates a reporting unit’s fair value is less than the carrying value, impairment testing must be performed.
An entity can apply the step zero approach on a reporting unit by reporting unit basis. For any reporting unit, the reporting entity can decide to directly test goodwill for impairment, even if it applied the step zero approach in a prior period. When an entity elects to bypass the qualitative assessment or determines that based on its qualitative assessment that further testing is required, either the one-step or two-step goodwill impairment test must be followed, depending on whether the reporting entity has adopted ASU 2017-04, Intangibles–Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. Generally, an entity in financial decline and considering a bankruptcy filing would not apply the qualitative assessment to its reporting units. Accordingly, this section focuses primarily on the quantitative impairment tests.

2.2.2 ASU 2017-04 Quantitative goodwill impairment testing (pre-bankruptcy)

In January 2017, the FASB issued ASU 2017-04. The revised guidance eliminates step two of the goodwill impairment test. All other goodwill impairment guidance will remain largely unchanged. Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary.
The revised guidance is effective for public business entities that are SEC filers, excluding entities eligible to be smaller reporting companies as defined by the SEC, for annual and interim goodwill impairment tests in fiscal years beginning after December 15, 2019. An entity that adopts ASU 2017-04 must apply the revised impairment model for all goodwill impairment tests within that fiscal year. For example, a calendar year-end public business entity that is an SEC filer must apply the revised guidance effective January 1, 2020 even if the company’s annual goodwill impairment testing date is not until later in the calendar year (e.g., October 1). All other entities will be required to apply the guidance in fiscal years beginning after December 15, 2022. Early adoption is permitted. Early adoption in a fiscal year is precluded if an impairment test earlier in that fiscal year applied the former impairment guidance. See BCG 9.8 for further discussion on the application of ASU 2017-04.
ASU 2017-04 also amends the testing for reporting units with zero or negative carrying amounts. See BCG for the consideration of goodwill impairment testing for these reporting units.
Figure BLG 2-1 illustrates the revised goodwill impairment model.
Figure BLG 2-1
Revised goodwill impairment model

2.2.3 Other goodwill impairment testing considerations (pre-bankruptcy)

There are important considerations for the goodwill impairment test, many of which relate to the assignment of assets and liabilities to a reporting unit to determine the carrying value. When the entire reporting entity represents a single reporting unit, generally all assets and liabilities would be considered. When the reporting entity consists of multiple reporting units, some of the common items to consider include:
  • Working capital is generally included in the valuation of reporting units. When comparing a reporting unit's carrying amount to its fair value, it is important to understand the working capital assumptions used in the fair value measurement and whether they are consistent with the reporting entity's assignment of working capital to the reporting unit when determining the carrying amount. Similarly, intercompany accounts may impact the working capital of a reporting unit and may need to be considered when determining the fair value and carrying amount of a reporting unit.
  • Cash and cash equivalents that are maintained at a corporate-level generally would neither be assigned to a reporting unit nor considered when determining its fair value. On the other hand, a reporting entity would assign cash to the related reporting unit if the reporting entity considered the cash in determining the fair value of the reporting unit.
  • Investments maintained at a corporate level generally would not be employed in the operations of a reporting unit and therefore would not be assigned to a reporting unit. In some cases, however, investments may be an integral part of the operations of a reporting unit. In those cases, if a reporting entity demonstrates that its investments would likely be transferred to a market participant if a reporting unit were sold, it may be appropriate to assign investments to a reporting unit and consider them in determining the reporting unit's fair value.
  • Debt is assigned to a reporting unit if that debt relates directly to the operations of the reporting unit and is likely to be transferred to a market participant if the reporting unit were to be sold. On the other hand, a reporting entity would not typically assign general corporate debt to its reporting units. Intercompany debt should be evaluated to determine if it should be treated in a manner similar to external debt.
  • Tax considerations affect the goodwill impairment analysis. The determination of the reporting unit's assumed disposal structure can impact the fair value of the reporting unit. Management's assumption of the disposal as a taxable or nontaxable transaction, and the ability to benefit from tax credit or net operating loss carryforwards, should be considered when determining the fair value of the reporting unit. Further, deferred taxes originating from temporary differences related to the reporting unit's assets and liabilities should be included in the carrying amount of the reporting unit, regardless of whether the fair value of the reporting unit is determined assuming disposal in either a taxable or nontaxable transaction. Deferred tax assets arising from NOLs and credit carryforwards would generally not be assigned to a reporting unit in a taxable transaction because a market participant would not be able to benefit from the pre-existing carryforwards.

A reporting entity facing financial difficulties should consider the adequacy and robustness of its financial statement disclosures related to annual or interim goodwill impairment tests. In addition to the required GAAP disclosures, the reporting entity should consider expanding disclosures to cover a reporting unit with a reasonable likelihood of a material goodwill impairment. Disclosures related to reporting units most at risk for goodwill impairment should also include the amount of goodwill assigned, the relationship between fair value and carrying value of the reporting unit, a qualitative discussion of key assumptions, significant uncertainties surrounding those assumptions, and events that could negatively affect a reporting unit’s fair value.
When a goodwill impairment charge is recorded, a reporting entity should be able to support the timing of the impairment charge. Often, events or circumstances during the reporting period cause impairment of a reporting unit's goodwill. In other instances, a specific event has not occurred, but a goodwill impairment charge may be necessary after a steady decline in the reporting entity's financial position and results of operations. In either case, a reporting entity should also consider disclosure regarding the future implications to the business of the conditions leading to the impairment.
If a goodwill impairment charge has not been recorded in advance of a bankruptcy filing, a reporting entity should consider contemporaneously documenting why an earlier charge was not necessary. Such documentation would include an assessment of whether any impairment triggers occurred or whether the impairment test was performed and indicated that goodwill was not previously impaired.
See BCG 9 for further discussion of the goodwill impairment model.

2.2.4 Indefinite-lived intangible assets (pre-bankruptcy)

An indefinite-lived intangible asset is considered to be impaired when the asset’s carrying amount exceeds its fair value. Like goodwill, an indefinite-lived intangible asset should be assessed for impairment at least annually, and a reporting entity may first assess qualitative factors to determine whether it is necessary to perform a quantitative impairment test. If a reporting entity bypasses the qualitative assessment or determines from its qualitative assessment that an indefinite-lived intangible asset is more likely than not impaired, a quantitative impairment test must be performed. A reporting entity nearing bankruptcy generally should not perform the qualitative impairment test for its indefinite-lived intangible assets and instead should proceed directly to the quantitative test. As discussed in ASC 350-30-35-18, the quantitative impairment test compares the fair value of an indefinite-lived intangible asset with the asset’s carrying amount. If the fair value of the indefinite-lived intangible asset is less than the carrying amount, an impairment loss should be recognized in an amount equal to the difference. 
See BCG 8.3 for further discussion of the indefinite-lived intangible asset impairment model.

2.2.5 Long-lived assets to be held and used (pre-bankruptcy)

ASC 360, Property, Plant, and Equipment, indicates that long-lived assets within an asset group should be tested for recoverability whenever events or circumstances indicate that the carrying amount of the long-lived assets may not be recoverable. An asset or asset group is considered to be recoverable when the sum of the undiscounted cash flows expected to be generated from the asset or asset group is greater than its carrying amount. This analysis is the first step of the impairment test of long-lived assets. If an asset group is not recoverable based on the results of step one, the second step determines the extent of impairment, if any, by comparing the fair value of the asset group to its carrying amount. If the carrying amount of an asset group is recoverable (i.e., passes step one), the reporting entity is precluded from recognizing an impairment charge, even if the fair value of the asset group, or any individual asset within the group, is less than its carrying amount.
Companies should evaluate whether a bankruptcy filing impacts management’s intended use of such assets (e.g., will they continue to be operated for their remaining useful lives or sold during bankruptcy to provide liquidity). But even before the filing, significant operating or cash flow losses that typically precede a bankruptcy filing would often trigger an impairment assessment of the long-lived assets. The cash flow forecasts used to test for recoverability would consider the likelihood of various outcomes, including whether a bankruptcy filing would occur and, if so, how that filing might impact the future cash flows and operations of the asset group. If a reporting entity is having difficulty financing its operations and if customers are unwilling to purchase from, or suppliers are unwilling to sell to, the reporting entity because it is considering bankruptcy, these factors would impact the cash flow projections used in the recoverability test for long-lived assets in most scenarios. A probability-weighted cash flow analysis is often used to assess recoverability when various outcomes, such as continued operation, sale, liquidation, or operating and emerging from bankruptcy, are considered.
The method of depreciation and the remaining useful lives of a reporting entity’s long-lived assets should also be evaluated when impairment tests are performed even if the asset (asset group) is determined to be recoverable. For example, this evaluation may indicate that the anticipated life of a manufacturing facility should be shortened in light of reduced production volumes, resulting in increased depreciation over the remaining term.
If goodwill is included in an asset group (i.e., an asset group is the same as a reporting unit for impairment testing) to be held and used, the impairment testing should be performed in the following order:
  • Test other assets (e.g., accounts receivable, inventory) under applicable guidance, and indefinite-lived intangible asset(s), other than goodwill, under ASC 350
  • Test long-lived assets (asset group) under ASC 360-10
  • Test goodwill of the reporting unit that includes the aforementioned assets under ASC 350
The carrying values are adjusted, if necessary, for the result of each test prior to the next test. This order differs from the held-for-sale approach, which prescribes that goodwill be tested for impairment prior to the asset disposal group. The order of assessment may impact the recorded amount of any impairment losses.
See PPE 5 for further discussion of the long-lived asset impairment model.

2.2.6 Long-lived assets to be disposed of by sale (pre-bankruptcy)

Companies progressing toward bankruptcy often sell assets or dispose of noncore operations to increase liquidity. The primary guidance applicable to the disposal of long-lived assets is ASC 360, which addresses the determination of the disposal group, whether the disposal group should be reported as held for sale, and whether the operations of the disposal group should be classified as discontinued operations.
The six criteria that must be met to classify a disposal group as held for sale are:
  • Management having the authority to approve the disposal action commits to a plan to sell the asset or disposal group. However, bankruptcy court approval may be required in order for management to commit to such a plan.
  • The asset or disposal group is available for immediate sale in its present condition
  • An active program to locate a buyer has been initiated
  • The sale of the asset or disposal group is probable, and transfer of the asset is expected to occur within the next year
  • The asset or disposal group is being actively marketed
  • Actions to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn
If these criteria are met, the asset or disposal group should be measured at the lower of its carrying amount or fair value less costs to sell. Depreciation or amortization of long-lived assets included in the disposal group is suspended once held-for-sale classification has been met. Further, consideration should be given to the criteria in ASC 205-20, Discontinued Operations, to determine whether discontinued operations classification is appropriate. See FSP 27.3 for further discussion.
See PPE 5.3.1 for further discussion of the held-for-sale accounting model and PPE 6 for asset dispositions.

2.2.7  Inventories (pre-bankruptcy)

A bankruptcy filing is typically preceded by reduced sales volume, declining gross margins, and reduced operating profits. Entities should consider the impact of these declining operating results on inventories and whether any inventory reserves are needed. For example, a decline in product gross margin resulting from reduced sales prices or higher costs may indicate that an inventory reserve is necessary to reduce the carrying value of inventory to net realizable value. Inventory quantities might also be in excess of forecasted sales volumes given the overall sales pipeline and projections. This could result in the need for a reserve for excess or obsolete quantities. Consistent with the view of the SEC staff, the impact of write-downs on inventory should be classified as cost of goods sold on the statement of operations, even when the inventory reserves are directly associated with a reporting entity’s restructuring activities.
Another important area for companies to consider prior to a bankruptcy filing is whether underabsorbed overhead or production costs should be expensed when production volumes decrease due to reduced demand or unplanned facility downtime. When production levels are determined to be abnormally low, the portion of the fixed production overhead attributable to the underutilized capacity should not be allocated to and capitalized as a cost of inventory. Rather, it should be recognized as an expense (within cost of goods sold) in the period in which it is incurred. Judgment is required to determine when a production level is abnormally low—that is, outside the range of the expected variation in production. See IV 1.4 and IV 1.5.7 for further discussion.

2.2.8 Accounts receivable (pre-bankruptcy)

Entities proceeding toward a bankruptcy filing may find it increasingly difficult to collect outstanding receivables. As customers become aware of the financial difficulties of a reporting entity, they may have concerns that certain support or warranty obligations may not be performed, and therefore delay or withhold payments until the financial viability of the reporting entity is more certain. This could result in the need to increase the level of allowance for doubtful accounts.
Furthermore, financial difficulties are often not isolated to specific companies. Rather, they may affect entire industries. Historical examples of industry-wide financial difficulties include the airline and automotive industries. Entities proceeding to bankruptcy should consider the impact that a downturn in the industry might have on outstanding receivable balances from customers within their industry (e.g., an automotive parts supplier with receivables from a car manufacturer). If a customer files for bankruptcy protection and there is an outstanding receivable, the amount likely would become an unsecured claim and be settled for less than its carrying amount. An allowance should be considered in these instances.

2.2.9 Investments (pre-bankruptcy)

Companies should periodically assess their investments for declines in value. Companies in troubled industries with investments within that industry are more likely to experience declines in investment values, which may result in the recognition of impairment charges. Circumstances leading to an investee considering a bankruptcy filing would likely trigger an impairment assessment by the investor.
See LI 7 and LI 8 for discussion of the impairment model for investments in debt securities, LI 2 for impairments of investments in equity securities and EM 4.8 for impairments of equity method investments.

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