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Technical Accounting

Goodwill Impairment Testing Guide, Examples, & Accounting Tips

Blog-Hero-GoodwillImpairmentTestingGuideExamples&AccountingTips-02 (2)Goodwill impairment is one of those accounting terms that's more bark than bite. Sure, some of the confusion around the guidancet is valid. After all, goodwill itself isn't the type of asset that you can really sink your teeth into like a good ol' fashioned widget-making machine or stacks of cash.

But just because the fine folks at the Financial Accounting Standards Board (FASB) classify goodwill as an intangible asset doesn't mean it's any less important to your balance sheet as other line items in the same financial reporting neighborhood. Ultimately, goodwill impairment is necessary to provide clarity for stakeholders and an accurate assessment of value. So on that note, let’s dive in.

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Baby Steps: What Is Goodwill?

To state the obvious, any discussion around the impairment of goodwill should begin with a thorough understanding of the underlying concept – goodwill. Per ASC 350, the FASB defines goodwill as:

An asset representing the future economic benefits arising from other assets acquired in a business combination or an acquisition by a not-for-profit entity that are not individually identified and separately recognized.

Quite the mouthful, huh? And somewhat nebulous to boot. Translating that definition into ordinary language, goodwill is an intangible asset that represents the price premium one company pays when acquiring another. Put another way, it's the amount paid above the cumulative net value of the acquired business’s assets.

As a quick aside, the IFRS definition of goodwill is similar to that of US GAAP, just with the latter permitting more intangible assets and, thus, reducing the amount of goodwill a company recognizes. The more you know, right?

Anyway, why would a company ever pay such a premium in the first place, you ask? Well, for starters:

  • Brand reputation, recognition, and loyalty
  • A qualified, assembled workforce
  • Excellent customer service
  • A robust, satisfying corporate culture

All of these items have value, but not in the same way that tangible assets like PP&E, cash & cash equivalents, and the other "traditional" assets do. That's where intangible assets like goodwill come into play. In the case of goodwill, it provides a place for companies to report the value of items like brand reputation, employee relations, and other synergies.

For example, if company A acquires company B for $500 million, but the net value of company B's assets, including identified intangible assets, is only $400 million, then that $100 million paid over the net value is considered goodwill. Further, goodwill is tied to those synergies and the presumption that the acquired business will continue to operate, generate cash flows, and provide value to the investors, owners, and other stakeholders.

 

The Basics of Goodwill Impairment

That brings us to goodwill impairment. Long gone are the days when US GAAP allowed public companies to amortize goodwill like they do long-lived assets and indefinite-lived intangible assets. But if you don't amortize goodwill assets like intellectual property, for instance, or depreciate it like plant equipment, then how do you make sure your recorded goodwill is recoverable? You guessed it – goodwill impairment.

Goodwill impairment exists when the fair value of your reporting unit drops below its carrying value. The topic du jour, goodwill impairment testing, is the mechanism that determines the amount of that accounting charge.

It's important to note that GAAP requires a company to assign all of its goodwill to its reporting units and test each reporting unit’s goodwill for impairment at least on an annual basis. Interim tests for goodwill impairment are required when events or circumstances change – triggering events – that, more likely than not, would reduce the fair value of a reporting unit below its carrying value.  Example of such triggering events could include these, among others:

  • Potential impairment of other assets
  • Cash flow issues or operating losses at the reporting unit level
  • Negative current events or outlooks for industry impacting company holistically or specific reporting units
  • Planned or announced closures, layoffs, restructuring, or dispositions
  • Rising interest rates, valuation reductions, increased costs

Put another way, deteriorating economic conditions – like a pandemic, for instance – have a way of triggering mandatory goodwill impairment testing more often than the annual requirement.

Further, under available private company accounting alternatives, private companies have the choice to test for impairment or amortize goodwill over a useful life no longer than ten years. The FASB provides this accommodation to make life a bit easier and less costly for private companies since they often lack the necessary resources and knowledge to perform such tests without significant costs.

In practice, however, it's not typical to see a private company opt for the amortization route since, amongst other reasons, they would have to unwind any private company alternatives under GAAP for all of their financials if they ever took the company public.

 

Changing Guidance on Goodwill Impairment

From a buyer's perspective, it's critical for you to fully understand the way goodwill works, how you test for impairment, and what it means for your financial statements and stakeholders. And on that front, we have some pretty darn good news – with ASU 2017-04, the FASB simplified the test for goodwill impairment. And while the effective date has already come and gone for public SEC filers – more on deadlines in just a bit – that’s not necessarily the case for private companies, at least if you’re reading this before 2023.

Therefore, to cover all bases, let's take a quick look at some of the key differences between the old guidance and what the standard update brings to companies.

Current Guidance Prior to ASU 2017-04

According to the old standard, companies had the option to begin looking at goodwill impairment from a pretty simple and straightforward qualitative assessment – commonly referred to as step zero – that encompassed different high-level economic factors discussed in ASU 2011-08. If a company failed that test, they proceeded to the quantitative level of testing, which entailed an additional two-step process. Of course, companies could also opt just to skip the qualitative step altogether, as many did.

The two steps involved in the quantitative assessment for goodwill impairment testing were as follows:

  1. The company looked at each of its reporting units individually, gathering information to find both the fair value and carrying value of the reporting unit. If the carrying value was greater than the fair value, an impairment was potentially triggered and you moved on to step two to measure the impairment charge.
  2. You then found the implied fair value of the reporting unit’s goodwill and compared it to its recorded carrying value. As before, if the carrying amount was more than the fair value of the recorded goodwill, you had to record impairment for the excess.

During that first step, keep in mind that just because the carrying value of the reporting unit was greater than the fair value, it doesn't necessarily mean you were to charge an impairment. The only thing that could trigger impairment was when the implied fair value of goodwill was greater than the recorded carrying value of the goodwill.

But if the updated standards have either already kicked in or are about to, why are we even discussing the old guidance? Well, to prove a point. That old assessment process was a little bit on the intense side, right? Even more challenging, for companies with multiple reporting units, they had to apply those two steps to each reporting unit separately.

Long story short, as you’re about to see, the FASB has simplified this process in the standards update, meaning goodwill shouldn’t be a term that still sends shivers down your spine. And for that, we should all smile a bit more.

The New Guidance: ASU 2017-04

The simplified guidance basically eliminates a step from the current assessment process. Companies can still begin with the qualitative assessment if they so choose but, just as before, can also head straight for step one in the quantitative assessment. However, you no longer have to go through the two-step exercise that, before, essentially meant creating a hypothetical purchase price allocation of the reporting unit to determine the implied fair value of goodwill.

Instead, when the carrying value of the reporting unit exceeds its fair value, you simply measure the impairment charge as the difference between those two amounts. Therefore, the biggest difference in the new guidance is that failing step one will now always result in recognition of an impairment charge. No longer does this lead to a more complex and often time-consuming second step to determine if an impairment charge exists and for how much.

Also, take note that your impairment charge is capped at the carrying value of goodwill. In other words, even when there's a significant difference between the carrying value of the reporting unit and the fair value versus the total goodwill recorded, you can only write your goodwill down to zero.

Take note that your impairment charge is capped at the carrying value of goodwill. In other words, even when there's a significant difference between the carrying value of the reporting unit and the fair value versus the total goodwill recorded, you can only write your goodwill down to zero.

Effective Dates

As we said, the updated standard was applied on a prospective basis and became effective for public SEC filers in 2020. For all other entities, including those private companies not electing the private company goodwill alternative, the updated standard must be adopted in fiscal years beginning after December 15, 2022. Tick, tock, tick, tock.

Further, companies failing step one of the assessment are choosing early adoption just because it's less time-consuming and costly to measure the impairment charge.

Private Company Goodwill Alternatives

As we already mentioned, most private companies prefer to adhere to the public company standards on goodwill impairment. We imagine the simplified guidance only extends that dynamic, where a private company no longer faces such a trade-off between simplicity and being prepared for an exit strategy that might include going public or being acquired by a public entity.

Trust us when we say that unwinding those private company goodwill elections in financial statements, just to comply with the public company standard, isn't exactly a walk in the park. It takes quite a bit of time, effort, and resources.

Still, for the sake of being thorough and unbiased, we want to present at least the most common private company goodwill alternatives. The following are already in the accounting standards codification by way of ASU 2014-02:

  • Once again, the simplest alternative gives private companies the option to amortize goodwill up to a maximum of 10 years and avoid any annual goodwill impairment tests altogether.  
  • Nonpublic companies can also elect other alternatives to simplify, including performing their goodwill impairment at an entity-wide level rather than at each reporting unit. This election also permits nonpublic companies to assess for goodwill impairment only when there is a triggering event, as discussed above, rather than conducting a required annual test. Measurement of impairment follows the updated impairment guidance by measuring the excess of the carrying value of the entity – or reporting unit – to its carrying value. 

Looking Down the Goodwill Road

Interestingly, up until recently, accounting for goodwill was an active project on the FASB’s technical agenda. However, in a curveball that few saw coming, the project was essentially given the heave-ho during the Board’s June 15, 2022 meeting. Therefore, while ASU 2017-04 was once essentially considered the first phase of a two-phase project, it now looks as if it’s actually the endpoint, at least for the time being.

 

Goodwill Impairment Testing Example

Now we're going to roll up our sleeves and take a look at an example that demonstrates the difference between the guidance prior to and after applying ASU 2017-04 for goodwill impairment assessment, just for comparison’s sake.

Impairment Testing Prior to ASU 2017-04

Awesome Tots is a dominant force in the competitive tater tot market. And, yes, we made this company up, so feel free to pilfer. Its accounting team sits down to conduct their annual goodwill impairment testing, beginning with the qualitative assessment. For clarity's sake, we're assuming that Awesome Tots has just a single reporting unit as defined by ASC 280-50-10. Remember, this is an optional step for private companies who elect the alternative to assess goodwill impairment at an entity-wide level.

Qualitative Assessment

Is it more likely than not that Awesome Tots' fair value is less than its carrying value? Put another way, is there at least a 50% chance that the fair value is less than its carrying value according to high-level economic factors? For reference, ASC 350-20-35-3C details those economic factors to consider.

  • No – There's no indication of impairment so your work is done
  • Yes – Proceed to step one of the quantitative assessment

Quantitative Assessment, Step On

We begin by determining the carrying amount of the reporting unit for Awesome Tots:

GoodwillImpairmentTestingTables-01 (1)

Next, you compare the carrying value we just computed with Awesome Tots' fair value. For this example, let's assume that the reporting unit fair value is $90,000 as determined under ASC 820.

Is the fair value ≥ $100,000 (the carrying value)

  • Yes – There's no indication of impairment so your work is done
  • No – Proceed to step two of the quantitative assessment

Since our assumed fair value of $90,000 is less than the carrying value we calculated at $100,000, we must proceed to step two of the quantitative assessment.

Quantitative Assessment, Step Two

We start at our assumed fair value of the reporting unit of $90,000. Also, just to keep things interesting, note that the fair values and carrying values for PP&E and Other Intangible Assets differ from one another.

GoodwillImpairmentTestingTables-03 (1)

We can now calculate the goodwill impairment by subtracting the carrying value from the fair value of goodwill:

GoodwillImpairmentTestingTables-04 (1)

Using the old guidance, Awesome Tots has a goodwill impairment charge of $5,000. Now let's look at the same scenario using the updated guidance.

Impairment Testing Applying ASU 2017-04

Once again, companies have the choice to skip the qualitative assessment. Therefore, we're going to head straight into the quantitative impairment test. Since the reporting data is the same between our two scenarios, the Awesome Tots' carrying value will still be $100,000. Likewise, we again assume that the fair value is $90,000.

Thanks to the updated guidance, Awesome Tots no longer has to measure the fair value of each asset and liability to calculate the impairment charge. This eliminates Step Two from the current quantitative assessment, meaning we can directly compare the fair value of a reporting unit with its carrying value to arrive at the impairment charge:

GoodwillImpairmentTestingTables-02 (1)

 When all is said and done, the updated guidance results in a greater impairment charge for Awesome Tots than the guidance prior to ASU 2017-04. However, keep in mind that we used a basic example that only included a single reporting unit.

In reality, even the simplified accounting standards update mandates testing goodwill for each of your reporting units, assuming you're not electing one of the private company goodwill alternatives. In the meantime, you still have a business to run and everyday accounting responsibilities to meet, so unless you have a thoroughly goodwill-tested CPA or two on the team, an experienced partner might be exactly what you need. Therefore, if you'd just prefer to have a squad of experts come in and help with the heavy lifting, Embark is always ready to step in and get to work.

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