Goodwill – Simplifying the Test for Impairment
By Jenny Deloy, Partner, Assurance Services
The Financial Accounting Standards Board’s (“FASB”) new Accounting Standards Update (“ASU”) No. 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”), allows public and private companies an alternative treatment for subsequent measurement of goodwill.
Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized. Under accounting principles generally accepted in the United States of America (“US GAAP”), goodwill is not amortized. Instead, goodwill is tested at least annually for impairment at a reporting unit level. Goodwill is considered to be impaired when the carrying amount of the reporting unit that includes the goodwill exceeds its implied fair value. In this situation, an impairment loss is recognized for the amount that the carrying amount exceeds its fair value, up to the goodwill amount for the reporting unit.
Over the years, private companies and their stakeholders have expressed concern about the cost and complexity of the impairment testing. In response to these concerns, in 2014 the FASB amended the FASB Accounting Standards Codification in ASU No. 2014-02 to allow private companies an alternative accounting treatment for subsequently measuring goodwill. The amendment allows private companies to elect to amortize goodwill over a period of 10 years, or less than 10 years if the entity demonstrates that another useful life is more appropriate, and forgo annual impairment testing unless impairment indicators are present.
When ASU No. 2014-02 was issued, the FASB added a project to its agenda to determine whether similar amendments should be considered for public business entities and not-for-profit entities. The first of two phases of the FASB project was to simplify how an entity is required to test goodwill for impairment, resulting in this amendment. The second phase, which was added to the FASB research agenda, will evaluate the effectiveness of the guidance in this update, monitor the International Accounting Standards Board’s projects on goodwill and impairment, and consider whether further changes to subsequent measurement of goodwill are needed.
Prior to ASU 2017-04, private companies that did not elect the alternative to amortize goodwill, and public companies for which the alternative was not available, were required to test goodwill for impairment using a two-step quantitative assessment to identify the existence of impairment and, if applicable, the amount of impairment loss. An entity could choose to perform a qualitative assessment first to determine whether it is more likely than not (likelihood greater than 50%) that the fair value of a reporting unit is less than the carrying amount, or could proceed directly to the quantitative impairment test.
Step One of the quantitative test is to compare the carrying amount of the reporting unit to its fair value. If the carrying amount exceeds the fair value of the reporting unit, it is more likely than not that an impairment of goodwill exists, and the entity will be required to complete Step Two of the quantitative assessment. The second step of the impairment test measures the amount of the impairment loss by comparing the implied fair value of reporting unit goodwill to its carrying amount. Determining the implied fair value of the reporting unit goodwill requires a hypothetical application of the acquisition method, after measuring the reporting unit’s identifiable assets and liabilities in accordance with Topic 805, Business Combinations. If the carrying amount of the reporting unit goodwill is greater than the implied fair value, an impairment loss equal to the difference should be recognized and goodwill should be written down.
To simplify the subsequent measurement of goodwill, ASU 2017-04 eliminated Step Two from the quantitative assessment. Instead, an impairment charge is recorded for the amount the carrying value of the reporting unit exceeds its fair value, not to exceed the total goodwill allocated to that reporting unit.
This ASU is effective on a prospective basis for annual or interim goodwill impairment tests in years beginning after December 15, 2019 for public business entities that are U.S. Securities and Exchange Commission (SEC) filers. Public business entities that are not SEC filers should adopt this ASU in years beginning after December 15, 2020, and all other entities should adopt in years beginning after December 15, 2021. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.