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FASB Amends Guidance on Goodwill Impairment Testing

Goodwill is not amortized under current U.S. generally accepted accounting principles (GAAP). However ...

The Financial Accounting Standards Board (FASB) Accounting Standards Codification Topic Number 350 (ASC 350) mandates that goodwill is tested annually, or more frequently under certain circumstances, for impairment at the reporting unit level using a two-step impairment test. If, based on a quantitative testing methodology, it is determined that the carrying value of the reporting unit exceeds its implied fair value, then an impairment exists (Step 1). If it is determined that an impairment does exist, then a second step is required to compare the implied fair value of the reporting unit's goodwill (calculated based on a “memo allocation”) with the carrying value of the goodwill (Step 2). The impairment loss is equal to the difference between the implied fair value of the goodwill and its carrying value.

On September 15, 2011, the FASB issued Accounting Standards Update 2011-08 (ASU 2011-08), which amends goodwill impairment testing procedures. Based on the revised rules, companies now have the option of initially utilizing a qualitative assessment, as opposed to a quantitative testing methodology. However, the quantitative assessment, which is typically performed by employing an income or a market approach to determine the fair value of the reporting unit, is still permitted.

ASU 2011-08 applies to both public and non-public entities that have goodwill on their balance sheets, and is effective for annual periods ending December 15, 2011; however, early adoption is permitted. ASU 2011-08 does not amend the annual testing requirements for other indefinite-lived intangible assets, for example trademarks, although the FASB added the topic to its agenda in September.

The qualitative assessment (commonly known as Step 0) determines whether it is more likely than not (i.e., a likelihood of more than 50%) that the fair value of the reporting unit is less than its carrying value. If, based on an assessment of qualitative factors, it is determined that the tested reporting unit's fair value exceeds its carrying amount, then the reporting unit is deemed to have passed the impairment test and no further testing is necessary. Conversely, if this initial qualitative assessment fails to establish that fair value is greater than carrying value, it then becomes necessary to perform Step 1, and possibly Step 2, of the quantitative assessment.

ASC 350 provides the following examples of factors to consider in the qualitative assessment:

  • macro-economic conditions;
  • industry and market considerations;
  • cost factors including cost of raw materials, labor costs, distribution expense and resulting cash flow;
  • overall financial performance;
  • relevant entity-specific events including changes in management, strategy, customers or litigation;
  • events impacting the reporting unit including changes in carrying value; and
  • a sustained decrease in share price (for public entities).

The stated purpose of ASU 2011-08 is to reduce the cost and complexity of goodwill impairment testing. Although the assessment is termed qualitative, certain quantitative analyses and documentation will likely be required to support the concluded assessment. In addition, the reduced cost associated with the qualitative testing may be offset by increased audit fees associated with reviewing the qualitative analysis and associated documentation. Early involvement of an appraiser who has experience in addressing fair-value issues may ultimately yield savings in terms of overall time and professional fees.

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