Oh goodwill; your definition is relatively straightforward, but your subsequent accounting rules continue to remain complex, subjective, and costly despite numerous accounting updates over the last several years. Goodwill is what’s left over in a business combination after you allocate the purchase price to the assets acquired and liabilities assumed based on their fair values. While doing research for this blog post, I discovered that before 2001, goodwill was amortized over a period of no more than 40 years (20 years for SEC registrants). But in my defense, I was a sophomore in college in 2001 and the only residual amount left over after any purchases went into my “bar money” jar. And after I graduated and entered the working world as an auditor, all of my public companies did not amortize goodwill; so, it’s hard for me to imagine public companies amortizing goodwill, but this may be a possibility in the near future. But first, let’s recap current accounting guidance for goodwill.
Public company guidance
Currently, goodwill is not amortized. ASC 350, Intangibles – Goodwill and Other, requires goodwill to be measured at the reporting unit level and tested for impairment on (at least) an annual basis. Prior to testing for impairment, a company must first determine its reporting units, defined as an operating segment or one level below an operating segment based on certain criteria. Then the company must allocate its assets, including goodwill, and liabilities to each of the reporting units based on the guidance within ASC 350.
A company is permitted to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the quantitative goodwill impairment test. This qualitative assessment is an optional test that would be performed before the quantitative test. You also might hear people refer to the quantitative impairment test as the 2-step impairment test, but as of January 1, 2020 there will only be one step (thank you ASU 2017-04)! This quantitative test is essentially the “old” Step 1, but the goodwill impairment amount is now determined within the first step (rather than moving on to the second step). A company will compare the fair value of each reporting unit to its carrying amount, which is the book value of the assets and liabilities allocated to it by the company, and an impairment loss will be recognized for the amount by which the reporting unit’s carrying amount exceeds its fair value, not to exceed the carrying amount of goodwill in that reporting unit. If the fair value of the reporting unit is higher than its carrying amount, goodwill within that reporting unit is not impaired!
Private company guidance
The Private Company Council (PCC) provided an alternative accounting treatment for private companies as it relates to goodwill, which went into effect in 2015. Private companies can elect to amortize goodwill on a straight-line basis over 10 years (or less than 10 years if a company can support that another useful life is more appropriate). This modification essentially changed goodwill to a definite-lived intangible asset and set incremental amortization over this expected useful life.
This alternative standard also simplified the impairment testing model for goodwill in three ways:
- Annual impairment testing is no longer required, as it is for public companies. It is only assessed when a triggering event occurs.
- There is an option to test for impairment at the entity level or at the reporting unit level. Assessing impairment at an entity level can reduce the time and effort that was previously needed to document the required identification of reporting units.
- Step 2 of the impairment test was eliminated (just like the new public company impairment testing steps described above).
This PCC alternative guidance was just extended to not-for-profit entities in May 2019, so public companies are the only companies that do not have an option to amortize goodwill!
In July 2019, the FASB provided an invitation to comment on whether the accounting for goodwill should be changed. This early-stage proposal included a number of questions for entities to respond to by October 7, 2019. Some of the questions included:
- On a cost-benefit basis, relative to the current impairment-only model, do you support (or oppose) goodwill amortization with impairment testing?
- If the Board were to decide to amortize goodwill, which amortization period characteristics would you support?
- A default period
- A cap (or maximum) on the amortization period
- A floor (or minimum) on the amortization period
- Justification of an alternative amortization period other than a default period
- Amortization based on the useful life of the primary identifiable asset acquired
- Amortization based on the weighted-average useful lives of identifiable asset(s) acquired
- Management’s reasonable estimate (based on expected synergies or cash flows as a result of the business combination, the useful life of acquired processes, or other management judgments)
- Do your views on amortization versus impairment of goodwill depend on the amortization method and/or period?
It’s an interesting debate: some stakeholders have expressed that amortizing goodwill over the expected life of the synergies acquired in a business combination would be more informative because it would better reflect the timing of the benefit derived from a business combination. However, some users expressed concern about the subjectivity of amortizing goodwill, noting that it would not produce meaningful information. Hans Hoogervorst, IASB Chairman, has called the amortization of goodwill “ugly as sin”.
The AICPA recently submitted their comments on the proposal and stated that they “generally support goodwill amortization with impairment testing. However, it also recommends making certain changes to the goodwill impairment test to reduce its costs, such as making it a trigger-based test, provided the amortization period is fairly short, and elevating it from the reporting unit level to the operating segment level.”
What do you think about this potential change? Let us know in the comments below, or feel free to contact us to discuss!
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