The Financial Accounting Standards Board (FASB) has released new guidance that simplifies the process for goodwill impairment testing for public companies and not-for-profit organizations (when applicable). Accounting Standards Update (ASU) No. 2017-04, Intangibles — Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, allows those companies to follow the one-step process that private companies have been permitted to use for several years.
Under ASU 2017-04, a goodwill impairment loss is measured as the excess of a reporting unit’s carrying amount (including goodwill) over its fair value. Impairment losses are limited to the total amount of goodwill allocated to the reporting unit. Essentially, the update removes the second step of the goodwill impairment test.
The impairment testing requirement
For accounting purposes, “goodwill” refers to the residual asset recognized in a business combination, such as a merger, after recognizing all other identifiable assets acquired and liabilities assumed. This intangible asset generally includes the reputation of the purchased business and its competitive advantages in the market. U.S. Generally Accepted Accounting Principles (GAAP) require that goodwill be carried on the books at its initial value less any “impairment.”
Goodwill is considered impaired when the implied fair value of goodwill in a company’s “reporting unit” (generally, an operating unit that has its own discrete financial information, separate from the overall company) is less than its carrying amount, or book value, including any deferred income taxes.
Current GAAP generally requires companies to test for impairment annually — and between annual tests in certain circumstances — using a two-step process:
- The company calculates the fair value of the reporting unit and compares that amount with the reporting unit’s carrying amount, including goodwill. If the carrying amount is greater than the fair value, the company also must perform the second step.
- The company measures the amount of goodwill impairment loss, if any, by comparing the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. The implied fair value is generally calculated by deducting the fair value of the reporting unit’s assets and liabilities from the fair value of the reporting unit itself. This is the same procedure required to determine the fair value of assets acquired and liabilities assumed in a business combination.
If the implied fair value of goodwill is less than its carrying amount, the company must recognize the difference as an impairment loss on its income statement, by adjusting the carrying amount of goodwill to its implied fair value.
The move toward simplification
Companies have long protested the costs of impairment testing, asserting they outweighed its benefits. They complained to the FASB that the testing process was too complicated and requested simplified guidance.
In 2011, the FASB responded by issuing ASU 2011-08, Intangibles — Goodwill and Other (Topic 350): Testing Goodwill for Impairment. This standard allows companies to opt to make a qualitative assessment (known as “Step 0”) to determine whether it’s even necessary to perform the quantitative two-step test. A company that opts for this approach must assess whether relevant “events and circumstances” (for example, general economic conditions, regulatory changes and the company’s financial performance) make it more likely than not that the reporting unit’s fair value is less than its carrying amount. If the company determines that it’s not more than 50% likely that fair value is less than the carrying amount, impairment testing isn’t required.
Subsequently, the FASB found some evidence that the use of the qualitative assessment has increased over recent years but recognized that its use may vary depending on overall economic conditions. As a result, many companies would continue to incur the cost and complexity of applying the two-step test.
In 2014 the board provided further relief to private companies in the form of ASU 2014-02, Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill. It allows a private company to amortize goodwill on a straight-line basis over a period of 10 years, or less if the company demonstrates that another useful life is more appropriate. A company that elects this option only considers impairment, when a triggering event occurs — such as a significant adverse change in business climate, legal issues or loss of key personnel —that indicates that the fair value of the company or a reporting unit may be below its carrying amount.
ASU 2014-02 also eliminates the second step of the current impairment test. Under this alternative, the amount of the impairment equals the amount by which the carrying amount of the company or reporting unit exceeds its fair value. The goodwill impairment loss can’t exceed the company’s or reporting unit’s carrying amount of goodwill.
The latest changes
On Jan. 26, 2017, the FASB further simplified goodwill impairment testing, this time for public companies and other entities that report goodwill on their financial statements, as well as for private companies that haven’t elected to amortize goodwill under ASU 2014-02. Under ASU 2017-04, a goodwill impairment loss must be measured as the excess of a reporting unit’s carrying amount (including goodwill) over its fair value. Impairment losses are limited to the total amount of goodwill allocated to the reporting unit. If applicable, a company should consider income tax effects from any tax-deductible goodwill on the carrying amount of the reporting unit when measuring impairment loss. (The FASB also incorporated this guidance into the private company accounting alternative for goodwill.)
The new standard also eliminates the requirement that any reporting unit with a zero or negative carrying amount perform a qualitative assessment and, if it fails the more-than-50% test, perform Step 2. As a result, the same impairment assessment applies to all reporting units, regardless of their carrying amount. A company is, however, required to disclose the amount of goodwill allocated to each reporting unit with a zero or negative carrying amount of net assets. The FASB emphasized that the allocation of assets and liabilities to reporting units shouldn’t be viewed as an opportunity to avoid impairment charges. The allocation, it cautioned, should be changed only in the case of a change in a reporting unit’s facts and circumstances.
Bottom line — the update removes the second step of the goodwill impairment test. These companies will no longer need to go through the burdensome process of calculating the implied fair value of goodwill.
2019: Public companies that are Securities and Exchange Commission (SEC) filers are required to begin applying the updated standard for annual or interim periods in fiscal years beginning after Dec. 15, 2019.
2020: Public companies that aren’t SEC filers should adopt the standard for annual or interim periods in fiscal years beginning after Dec. 15, 2020.
2021: All other organizations, including not-for-profit entities that adopt ASU 2017-04 must do so for the annual or interim periods in fiscal years beginning after Dec. 15, 2021.
Early adoption: The FASB is permitting early adoption for interim or annual periods after Jan. 1, 2017. Early adoption by many companies is likely due to the expected cost savings by implementing the changes.
On the horizon
Notably, ASU 2017-04 differs from the private company reporting alternative in that it doesn’t permit public companies the option to amortize goodwill — not yet, anyway. The FASB has moved its project on subsequent accounting for goodwill for public companies and not-for-profit entities to its research agenda. In the meantime, the FASB will monitor the effectiveness of its latest goodwill reporting update before proposing any additional changes.
If you have questions regarding impairment testing requirements or would like to know if early adoption of the updated standard makes sense for your company, please contact our team.
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