ASC Topic 350 Intangibles – Goodwill and Other (ASC 350) currently prescribes a two-step goodwill impairment test based on reporting units. But step 2 is on its way out and to that I say, “Auf Wiedersehen!” As we’ll discuss in this post, after an optional qualitative test, impairment of goodwill is calculated by comparing the carrying value of the reporting unit to its fair value. “Es ist einfach! Prost!”
In a previous post, we discussed goodwill impairment testing under ASC 350, but that was prior to the issuance of ASU 2017-04 Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which eliminated step 2. Before we get into the new rules for goodwill impairment introduced by this ASU, let’s take a brief “die Wanderung” down memory lane to remind you of the time when the FASB added undue complexity to U.S. GAAP.
Reminder of existing guidance
Step 2 was sexy; compare the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of reporting unit goodwill exceeds the implied fair value of goodwill, then an impairment loss is recognized in an amount equal to that excess.
“Was?” How should an entity determine the “implied fair value of reporting unit goodwill?”
This is the “sexy” part. It is determined in the same manner goodwill in a business combination in accordance with ASC 805. That is, an entity assigns the fair value of the reporting unit (determined in step 1) to all the assets and liabilities of that unit. This means entities have to determine the fair value, in accordance with ASC 820, of all the reporting unit’s assets and liabilities, irrespective of whether they are recorded on the balance sheet or not. The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill.
“Wunderbar!” This means performing a hypothetical business combination just to determine the amount of goodwill impairment (as if you didn’t have enough to do)!
Overview of the changes
The flowchart above illustrates the optional qualitative assessment and the quantitative goodwill impairment test described in ASC 350-20-35-3A through 35-13.
It begins with an optional qualitative assessment that is often referred to as “Step 0.” Entities electing to perform it must assess:
Is it more likely than not the fair value of the reporting unit is less than its carrying amount?
- If NO: Stop. No goodwill impairment is recognized.
- If YES: Measure impairment under a quantitative impairment test.
If an entity fails the qualitative assessment (or elects to forego it all together), then the entity must perform a quantitative test. This test previously referred to as “Step 1,” compares the fair value of the reporting unit to its carrying amount including goodwill.
Is the fair value of the reporting unit less than to its carrying value, including goodwill?
- If NO: Stop. No goodwill impairment is recognized.
- If YES: Recognize impairment.
Measuring the impairment loss
If the carrying amount of a reporting unit exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit. Entities must also consider any income tax effects of tax-deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss.
The revised guidance does not change the timing of goodwill impairment assessments (i.e., annually or more frequently if there are indicators of impairment), or the unit of account to which the test is applied (i.e., reporting units).
Will the changes result in more or less goodwill impairment?
Everything comes at a cost! Although the new rules will certainly reduce the cost and complexity of accounting for goodwill, it probably will increase the number of goodwill impairments that are recorded. Why? Because entities have to record a goodwill impairment loss anytime the fair value the fair value of a reporting unit is less than its carrying amount.
That being said, the actual amount of goodwill impairment most likely will be less. Why? Because the fair value of the reporting unit is “boosted” by internally-generated intangible assets within the reporting unit. This reduces the total amount of the impairment loss if one is needed, since the impairment loss is the difference between the fair value of the reporting unit and its carrying amount. Under existing GAAP, internally-generated intangible assets actually “hurt” entities when performing step 2 as they have to allocate a piece of the hypothetical purchase price to them. This reduces the implied fair value of reporting unit goodwill, which increases the amount of the impairment loss.
Transition and effective dates
The new guidance must be applied prospectively. For public business entities that are SEC filers, the amendments are effective for annual and interim goodwill impairment tests in fiscal years beginning after December 15, 2019. The effective dates for other entities are one or two years later.
However, early adoption is permitted. In fact, companies could have early adopted this new guidance last year. But our understanding is that very few companies have elected to early adopt!
Why haven’t you said “Auf Wiedersehen” to step 2? We’d love to hear from you!
This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.