Update to U.S. GAAP scraps second step of goodwill impairment test

The FASB on Jan. 26, 2017, published Accounting Standards Update (ASU) No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, to establish a one-step process for testing goodwill for a drop in value.

The update, published with three FASB members dissenting, calls for a goodwill impairment loss to be measured as the excess of the reporting unit’s carrying amount over its fair value. It scraps a second step that requires the impairment to be measured as the difference between the implied value of a reporting unit’s goodwill with the goodwill’s carrying amount.

“Stakeholders told the FASB that the current impairment test generates unnecessary cost and complexity without adding value to the information provided to their investors and other financial statement users,” the FASB said in a news release.

The new accounting goes into effect for public businesses that file reports with the SEC for annual or interim periods in fiscal years beginning after Dec. 15, 2019. A public business that is not an SEC filer should adopt the amendments for annual or interim periods in fiscal years beginning after Dec. 15, 2020. All other organizations, including not-for-profit groups, should adopt the new accounting for their annual or interim impairment tests in fiscal years beginning after Dec. 15, 2021.

Early adoption is permitted for interim or annual impairment tests after Jan. 1, 2017, the FASB said.

When one business buys another at a price that is more than the purchased business’s market value, the buyer records the premium on its balance sheet as goodwill, which is an intangible asset and generally includes the reputation of the purchased business or its competitive advantage in the market.

U.S. GAAP requires public companies to test for declines in the value of the goodwill at least once a year. When there is a drop in value, companies must record an impairment. Investors and analysts often view the impairment as a sign that an acquired business is less likely to contribute to earnings growth than had been expected at the time of the acquisition.

Calculating goodwill impairment is currently a two-step process. Businesses must determine whether an impairment exists and then value it. The second step includes determining the implied fair value of the goodwill and comparing it with its carrying amount on the balance sheet.

Companies have complained for years that the second step requires complex calculations and sometimes calls for hiring an outside valuation expert. Further, they told the FASB that investors are more interested in the existence of a goodwill impairment as opposed to its amount.

But bankers and insurance companies told the FASB that they wanted to retain the option to apply the second step, because it would offer a more precise measurement of a goodwill impairment in some cases. They also were concerned that a change in the fair value of other assets or liabilities could result in an impairment charge under the one-step test.

Three of the FASB’s seven members, Christine Botosan, Harold Schroeder, and Lawrence Smith, wanted to keep the second step as an option and dissented from issuing the update. In their view the importance of the information to analysts and investors outweighed the complaints companies have had about the work the test’s second-step requires. In some cases, goodwill could be overstated in a one-step test, the dissenters wrote. They would have preferred if the FASB allowed the second step to be optional.

“I would emphasize the fact that I don’t think it’s a simplification or an improvement when you run into situations where you could actually misidentify an impairment,” Schroeder said in a Nov. 30 FASB meeting. “By eliminating Step 2 you actually increase the cost, collectively to the system, by having misinformation in the marketplace.”

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