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Goodwill hunting

Early this year, the Financial Accounting Standards Board (FASB) eliminated Step 2 of the goodwill impairment test in an effort to simplify the process for financial reporting units. The change allows companies to adopt the new guidance early as well as an ability to transition to the new rule over several years. While some companies have begun to transition, others have not because they recognize significant considerations still needed before full implementation.

FASB has sought to simplify goodwill impairment accounting for several years. In 2014, a FASB update simplified private company goodwill impairment by providing an alternative to amortize goodwill over 10 years and testing by using a one-step process at the entity or reporting unit level only when there is a triggering event.

In contrast, the elimination of Step 2 for public companies does not allow amortization of goodwill, requires at least annual testing, as well as more frequent testing in the case of financial duress, changed circumstances or another triggering event. Goodwill is assigned to reporting units, and in the case of a business combination, allocated to the appropriate units. The optional Step 0 can be used to minimize obtaining fair value of a reporting unit if impairment is not evident.

With the elimination of Step 2, entities will record impairment based solely on Step 1, which compares the fair value of a reporting unit with the carrying amount. If fair value is greater than the carrying amount, there is no impairment. If 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. This eliminates the qualitative assessment. Reporting units with zero or negative carrying amounts simply must disclose the amount of goodwill allocated to each.

For entities with tax-deductible goodwill, FASB requires consideration of the deferred tax effect when measuring the goodwill loss. When goodwill is tax-deductible, a goodwill impairment charge increases a deferred tax asset or decreases a deferred tax liability, causing a subsequent change in the carrying amount. To avoid a continuous cycle of impairment charges, consider the impact on deferred taxes concurrent with the impairment charge.

The elimination of Step 2 may result in more frequent reporting of impairment, as well as a change in the magnitude of the impairment charge. Previously, an entity could fail Step 1, proceed to Step 2 and determine that there was no goodwill impairment. Now if you fail Step 1, you must report an impairment charge.

Some public companies may initially embrace the simplification, but others may recognize their fair value will now be equal to the carrying amount post impairment. In fact, some may measure goodwill impairment both ways to see which creates the better outcome.

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Bryan Browning, CFA, ASA, is a managing director with Valuation Research Corporation. Qualified in both real estate valuations and value-related financial analysis, he devotes most of his time to valuations of intellectual property, capital stock and business enterprises. He also develops opinions concerning solvency, fairness and capital adequacy.

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