Impairment testing on goodwill is one of the least common accounting issues. However, it’s important to understand when it might be required of your organization and how to conduct the testing when necessary.
Trigger-based impairment testing is required “when an event occurs or circumstances change” that indicate a “more likely than not” possibility that the fair value is below carrying value. This trigger-based impairment testing can take place at any point during the calendar year.
It can be difficult to determine:
- Whether an occurrence qualifies as a triggering event that requires impairment testing on goodwill.
- The time period that defines the event for such an assessment if required.
- Whether certain circumstances mitigate the requirement, such as recovery from an economic decline.
Evaluating Trigger-Based Goodwill Impairment Testing
Privately held companies can currently be under any one of three different accounting models for goodwill impairment:
- The traditional model one-step approach (no amortization, required impairment test at least annually)
- The traditional model two-step approach
- The Private Company Council (PCC) alternative (amortization with trigger-based impairment test)
In evaluating whether a trigger-based goodwill impairment test is needed, all three accounting models reference the following qualitative factors (as noted in FASB ASC 350-20-35-3C) to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount.
- 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.
- Industry and market considerations, such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (consider in both absolute terms and relative to peers), a change in the market for an entity’s products or services, or a regulatory or political development.
- Cost factors, such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows.
- Overall financial performance, such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods.
- Other relevant entity-specific events, such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation.
- Events affecting a reporting unit, such as a change in the composition or carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing of all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit.
- If applicable, a sustained decrease in share price (consider in both absolute terms and relative to peers).
In addition, the following qualitative factors should be considered in determining whether a trigger-based goodwill impairment test is needed (as noted in FASB ASC 350-20-35-3F, FASB ASC 350-20-35-3G, FASB ASC 350-20-35-68 and FASB ASC 350-20-35-69):
- 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 also should consider positive and mitigating events and circumstances that may affect its determination of 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 also should include as a factor in its consideration the difference between the fair value and the carrying amount in reaching its conclusion about whether to perform the first step of the goodwill impairment test.
- An entity shall evaluate, on the basis of the weight of evidence, the significance of all identified events and circumstances in the context of determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The existence of positive and mitigating events and circumstances is not intended to represent a rebuttable presumption that an entity should not perform the first step of the goodwill impairment test.
Timing Related to Triggering Events
In assessing the qualitative factors, it’s important to understand the timing related to events and circumstances. For example, the COVID-19 triggering-event was a broad decline in economic conditions that unfolded over a period of time without a distinct beginning and end. Due to the nature of the pandemic, it seems there is some flexibility in the exact triggering date.
In March 2021, FASB issued ASU 2021-03, Intangibles - Goodwill and Other (Topic 350): Accounting Alternative for Evaluating Triggering Events, which established an accounting alternative for private companies and not-for-profit entities to evaluate goodwill triggering events at their reporting date, whether the reporting period is an interim or annual period, instead of monitoring for triggering events within the reporting period. However, this flexibility does not extend to other entities.
Entities not included within the scope of the ASU 2021-03 accounting alternative are not able to deem that the flexibility in exact triggering date extends to an entire annual reporting period (thus, it is not appropriate to conclude that impairment occurred in March 2020 but economic circumstances improved in the same year and goodwill recovered).
It’s also important to remember that assets like goodwill with fair value-based impairment tests cannot be recovered once impaired. In addition, impairment has not been limited to any certain industry or geographic location.
Get the help you need when it comes to trigger based impairment testing on goodwill.