ASC 805 also requires that contingent consideration, for example, earn-out amounts that are dependent on the future financial performance of the acquired business, be recorded at fair value at the acquisition date. When measuring a goodwill impairment loss, a company should consider the income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit. The ASU contains an illustration of the simultaneous equations method to demonstrate this, which reflects a deferred tax benefit from reducing the carrying amount of tax-deductible goodwill relative to the tax basis. In addition to the considerations around an entity’s assets, the fair value of its liabilities, relative to their carrying amounts, may also influence the goodwill impairment analysis.
Instead of automatically testing for impairment every year, private companies are required to test only when there’s a triggering event. This indicates the company has evidence that the fair value of the acquired business is less than the carrying amount on the balance sheet. If, after assessing all relevant events or circumstances, an entity determines that the fair value of a reporting unit is less than its carrying amount, then the first and second steps of the goodwill impairment test are unnecessary. While bull markets previously overlooked goodwill and similar manipulations, the accounting scandals and change in rules forced companies to report goodwill at realistic levels. The proposal resulted from Phase 1 of a project that was added to FASB’s agenda after the board issued a standard to allow private companies an alternative accounting treatment for subsequently measuring goodwill. The board considered whether similar amendments should be considered for other entities, including public companies and not-for-profits.
Examples of triggering events include the loss of a key customer, unanticipated competition or negative cash flows from operations. Impairment may also occur if, after an acquisition has been completed, there’s an economic downturn that causes the parent company or the acquired business to lose value. FASB eliminated Step 2 from the goodwill impairment test in an effort to simplify accounting in a new standard issued Thursday. We apply these tools to help unlock unrecognized value through the strategic optimization of assets and operations.
On the other hand, the ASU removes the evaluation of whether a market participant could replace missing elements. In essence, this ASU lays out a framework for evaluating whether both an input and a substantive process are present, while introducing more stringent criteria for sets without outputs. Finally, the ASU narrows the definition of the term ‘output’ so that it is consistent with how outputs are described in Topic 606 – Revenue from Contracts with Customers. a The carrying value and fair value are presented on an enterprise basis (i.e., inclusive of debt and equity). Understand how the proper distinction between personal and enterprise goodwill can create tax savings. The extent and applicability of these disclosures are oftentimes an area of judgment and based on company-specific facts and circumstances.
Navigating goodwill impairment testing guidance
If the fair value is less than the carrying amount, the entity will record an impairment charge equal to the difference (not to exceed the carrying amount of goodwill). This change also applies to reporting units with zero or negative carrying amounts, which will always pass Step 1 as the fair value of a reporting unit cannot be lower than zero. Previously, reporting units with zero or negative carrying amounts had to perform a qualitative assessment to determine whether to proceed to Step 2.
- In rising interest rate environments, the fair value of these financial assets will often be significantly less than the carrying value, which consequently could lead to the impairment of goodwill to reflect the decrease in the fair value of the reporting unit.
- The proposal resulted from Phase 1 of a project that was added to FASB’s agenda after the board issued a standard to allow private companies an alternative accounting treatment for subsequently measuring goodwill.
- An entity still would have the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary.
FASB proposes simplifying goodwill impairment testing
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Goodwill is an intangible asset that accounts for the excess purchase price of another company based on its proprietary or intellectual property, brand recognition, patents, etc., which is not easily quantifiable. Company BB acquires the assets of company CC for $15M, valuing its assets at $10M and recognizing goodwill of $5M on its balance sheet. After a year, company BB tests its assets for impairment and finds out that company CC’s revenue has been declining significantly. As a result, the current value of company CC’s assets has decreased from $10M to $7M, having an impairment to the assets of $3M. Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows.
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- Under the current guidance, if the equity value approach is used for a reporting unit with a negative carrying amount, the reporting unit generally will not have an impairment since the reporting unit’s fair value will always be greater than its carrying value.
- While many companies may not have had to work through a Step 1 quantitative assessment, there are nuances in how the current impairment guidance interacts with the subsequent measurement of other assets (not goodwill) governed by other accounting standards.
This is a signal that the value of the asset has fallen below the amount that the company originally paid for it. The Company is currently evaluating the impact of this standard on its consolidated financial statements depending on the outcomes of future goodwill impairment tests. Although the effect of this limitation could be mitigated by employing an enterprise value approach, there are still factors (including corporate level debt that usually does not get pushed down to the reporting unit level) that could impact the calculation and valuation results. It is highly recommended that entities consult with their technical accounting advisors and valuation professionals when assessing the potential effects of a choice in valuation methodology. Companies should take a fresh look at existing processes and controls for assessing asset impairment, as proper identification of triggering events is integral to appropriately measuring goodwill impairment.
FASB Drops Step 2 From Goodwill Impairment Test
The excess of the fair value of a reporting unit over the amount assigned to its assets and liabilities is the implied fair value of goodwill. SFAS 142 further notes that the allocation process should be performed only for purposes of testing goodwill for impairment. An entity should not write up or write down a recognized asset or liability, nor should it recognize a previously unrecognized intangible asset because of the Step 2 allocation process. Another consideration for companies is the income tax effect from any tax-deductible goodwill on the carrying amount of the entity (or the reporting unit). Specifically, if an entity has tax-deductible goodwill, there is the possibility of running into a cycle of impairment due to the decreasing book value of its goodwill as a result of an impairment charge increasing its deferred tax asset.
With the elimination of Step 2, an entity that has created intangible value that is not recorded on the balance sheet will find a lower measurement of impairment than would have been indicated in Step 2. David Kindness is a Certified Public Accountant and an expert in the fields of financial accounting, corporate and individual tax planning and preparation, and investing and retirement planning. David has helped thousands of clients improve their accounting and financial systems, create budgets, and minimize their taxes. Learn accounting fundamentals and how to read financial statements with CFI’s free online accounting classes. Non cash expenses appear on an income statement because accounting principles require them to be recorded despite not actually being paid for with cash.
FASB Simplifies Goodwill Impairment Test and Clarifies Definition of “Business”
On June 15, the Financial Accounting Standards Board (FASB) unanimously voted to drop its project on the subsequent accounting of goodwill and other identifiable intangible assets — for now. In the meantime, the FASB plans to keep an eye on changes to the disclosure model that are being considered by the International Accounting Standards Board. If the goodwill asset becomes impaired by a decline in the value of the asset below the purchase price, the company would record a goodwill impairment.
They must still assign goodwill to reporting units, and if they make a business combination, allocate goodwill to the appropriate units. Entities can also use the optional Step 0 to minimize the need to get a fair value of a reporting unit if an impairment is not evident. Entities can also use the optional Step 0 to minimize the need fasb drops step 2 from goodwill impairment test to get a fair value of a reporting unit if impairment is not evident. Under the amendments issued, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. Under recently issued amendments, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount.
An entity shall consider the extent to which each of the adverse events and circumstances identified could affect the comparison of a reporting unit’s fair value with its carrying amount. An entity should place more weight on the events and circumstances that most affect a reporting unit’s fair value or the carrying amount of its net assets. An entity should also consider positive and mitigating events and circumstances that may affect whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity has a recent fair value calculation for a reporting unit, it should also consider the difference between the fair value and the carrying amount when reaching its conclusion about whether to perform the first step of the goodwill impairment test.
The qualitative assessment is eliminated and entities with reporting units with zero or negative carrying amounts will simply be required to disclose the amount of goodwill allocated to each reporting unit. Furthermore, the structure of an acquisition can also dictate whether an acquirer can benefit from the existing tax attributes (e.g., tax credit carryforwards and net operating loss) of an acquiree. The impairment test for indefinite-lived intangible assets compares the fair value of the asset to its carrying value.
In a future phase of the project, FASB expects to consider additional changes to the subsequent accounting for goodwill, including possibly permitting or requiring amortization of goodwill and/or further changes to impairment testing methods. As presented in the third column of Figure 1, Step II indicated that the fair value of Company A’s other intangible assets is $10 million less than its book value, while the fair value of Company A’s property plant and equipment is $5 million more than its book value. If the assessment of the quantitative and qualitative factors indicates that it is more likely than not that the fair value of a reporting unit is less than its carrying value, then the entity must perform Step I. In the second step, the fair value of the asset group is determined and compared to its carrying amount to determine the impairment loss. If the fair value of the asset group is less than its carrying amount, the difference is recognized as an impairment loss and the carrying value of the subject long-lived asset is adjusted and depreciated or amortized over its remaining useful life.
In fact, we expect some to measure goodwill impairment both ways to see which creates a better outcome. While we expect many to adopt this in 2017, there will be others who will take their time transitioning to this new approach. In fact, we expect some to measure goodwill impairment both ways to see which creates the better outcome. In recent years, many companies have not had to scrutinize the impairment framework at great length given the state of the equity markets and — with the exception of brief periods of volatility — overall increase in prices.
These include white papers, government data, original reporting, and interviews with industry experts. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy. An impairment in accounting is a permanent reduction in the value of an asset to less than its carrying value. Macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets. The impairment test is done to find out if the carrying amount of the asset exceeds the recoverable value. Since most long-lived assets do not independently generate cash flows, testing is generally performed on an asset group.