Goodwill Impairment Testing

AppId is over the quota
AppId is over the quota

Accounting standard setters face a perpetual challenge in balancing relevance and reliability when establishing generally accepted accounting principles. This tension is especially heightened when the nature of the economic information concerns intangible assets. We know that Goodwill is an "Intangible Asset" resulting from a "Business Combination" and is defined "as the excess cost of an acquired company over the sum of identifiable net assets." Critical issues in accounting for Goodwill involve "Valuation" and "Amortization", the "Purchase Method" vs. "Pooling-of-Interests Method" of accounting for "Business Combinations."

A goodwill valuation and impairment opinion from appraisal economics is the product of a comprehensive analysis that takes into account all areas of concern to the Securities and Exchange Commission (SEC). Both US GAAP (Generally Accepted Accounting Principles in the US) and International Financial Reporting Standards (IFRS) require write-downs of impaired assets and recognition of an impairment loss. With an intangible asset like goodwill, it's hard to find quality rules that govern its measurement. In 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 142, Goodwill and other Intangible Assets. It made major changes to the accounting treatment of goodwill for the first time in over 30 years. These changes occurred concurrently with the issuance of SFAS 141, Business Combinations. Henceforth, all Business Combinations must be accounted for using the purchase method with Goodwill treated as an asset on the balance sheet that must be regularly reviewed for impairment. The pooling-of-interests method, that avoided the goodwill issue entirely, is no longer allowed and Goodwill is not amortized.

The new accounting rules have had a substantial effect on financial statements, as evidenced by an analysis of the 100 public companies with the largest reported goodwill balances. One-third of these 100 companies wrote off about 30% of their goodwill when they transitioned to SFAS 142. Further, with the elimination of the previous goodwill amortization requirements, there will be a likely increase in these 100 companies' reported annual profits of the magnitude of $20 - $25 billions. Changes of this magnitude create difficulties for users of financial statements in estimating trends and forecasting future performance. And the nominal tax-related cash flow effects associated with these changes demand that more attention be paid to operating cash flow when assessing a company's financial performance.

Under IAS 36, Impairment of Assets, requires a comparison of the carrying amount of a cash generating unit to the recoverable amount, as represented by the highest of 'value in use' and 'fair value less cost to sell'. In practice, the 'value in use' methodology is most frequently applied. This, in essence, involves discounting expected future cashflows. With decreased cashflow forecasts, increased discount rates and decreased long-term growth rates. It may seem impossible to avoid a goodwill write-down. Goodwill impairment is a growing threat to many enterprises.

The Financial Accounting Standards Board has finalized a new standard aimed at further simplifying how organizations test goodwill for impairment. The recently released standard - known as Accounting Standards Update No. 201108, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment - includes amendments intended to address concerns expressed by private companies about the cost and complexity of the previous goodwill impairment test.

The amendments allow both public and nonpublic entities the option to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. In the first step, the fair value of the reporting unit is estimated. If this amount is less than the unit's book value, then the second step is to determine the fair value of goodwill by subtracting estimates of the fair value of all other net assets from the initial aggregate estimate. If this residual is less than the book value of goodwill, the difference is written off as impairment. If implemented properly, the fair value test should trigger impairments more quickly than the undiscounted cash flow test. Under that option, an entity no longer would be required to calculate the fair value of a reporting unit unless the entity determines, based on that qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The guidance also includes examples of the types of events and circumstances to consider in conducting the qualitative assessment. The amendments are to be effective for annual and interim goodwill impairment tests performed for fiscal years beginning after Dec. 15, 2011, although early adoption is also permitted.

It is imperative to study goodwill write-offs as it provides us information regarding how a shift towards more relevant accounting information, possibly at the expense of reliability, affects the content of accounting. Since goodwill impairments have been found to be the largest type of long-lived asset write-offs, the study of these charges is important.