On July 10th, Kirby Corporation [NYSE: KEX], a tank barge operator in the US, announced that its financial statements for the quarter ending March 31, 2020 could no longer be relied upon. The basis for Kirby’s financial restatement is the Company’s testing of goodwill for impairment. Kirby’s restatement should be a case study for other companies, as we see an increase in goodwill impairments throughout the market turmoil.
On May 8th, Kirby disclosed a $165.3 million impairment of long-lived assets, including property and equipment, customer relationships, trade names, and distributorships. The Company also recorded a $260.0 million impairment of goodwill. Kirby referenced the “uncertainty surrounding the outbreak of COVID-19 and a sharp decline in oil prices during the 2020 first quarter” as factors contributing to the impairment tests.
Kirby notes that the restatement was due to the misapplication of a new accounting standard – ASU 2017-04 – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment – adopted by the company as of January 1, 2020. The new standard was introduced to reduce the complexity of testing goodwill for impairment by eliminating Step 2 of the impairment test, which required companies to compare a hypothetical purchase price allocation to the carrying value of goodwill.
The elimination of Step 2 complicates the testing of goodwill for impairment when the goodwill is tax deductible. As Kirby points out, “the recognition of an impairment of goodwill loss creates a cycle of impairment because the decrease in book value of goodwill increases the deferred tax assets (or decreases the deferred tax liabilities), when tax deductible goodwill is involved.”
The new accounting standard resolves the cycle by applying a calculation which balances the final carrying value and the fair value of the reporting unit. The new calculation increased Kirby’s goodwill impairment by $127.9 million, bringing the total of first quarter impairments to $553.2 million – $387.9 million of which related to goodwill.
Companies should use Kirby as a reminder to evaluate the tax impact of goodwill impairments. As the prevalence of goodwill impairments increases and as companies adopt the new goodwill impairment standard, we are likely to see more companies apply the new standard incorrectly.
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