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Changing Goodwill Impairment Rules

By   Paul Sirek

June 30, 2016

As many of you complete your year-end financial statements, if you have goodwill carried on your balance sheet it is, again, time to perform the annual impairment test for this asset. You may be surprised to find out the Financial Accounting Standards Board (FASB) has changed the rules for all fiscal years beginning after Dec. 15, 2011, for this test. While no requirement to change is necessary for fiscal years ending Dec. 31, 2011, early adoption is permitted and encouraged by the FASB.

In April 2011, the FASB issued an exposure draft intended to simplify how businesses are required to test goodwill for impairment. The FASB gathered comments and issued Accounting Standards Update 2011-08 in September 2011 titled “Testing Goodwill for Impairment.”

ASC 350–Formerly a Two-Step Process
Goodwill impairment testing rules, formerly known as Statements on Financial Accounting Positions (SFAS) 142, are now found under Accounting Codification Standards (ASC) Topic 350–Intangibles–Goodwill and Other. The standard has been in place since 2001 and was essentially a two-step process.

The first step is to determine the fair value of the bank (or the reporting unit). If the fair value of the bank is greater than the equity book value (including goodwill) as of the measurement date, no further testing is necessary as no impairment exists. If the fair value of the bank is not greater than the book value, the second step must be completed.

The second step is to allocate the fair value of the bank to all of the assets (excluding goodwill) and liabilities of the bank as if it were acquired by a market participant on the measurement date. The excess fair value is then allocated to goodwill and compared to the book value of goodwill. The amount of write-off (or impairment) is equal to the book value of goodwill over the fair value of goodwill. The loss recognized cannot exceed the book value of goodwill on the measurement date.

Amendments to ASC 350
Topic 350 has been amended to allow businesses the option to first perform a qualitative assessment. Based on the results of the qualitative assessment, an entity would not be required to perform the traditional two-step process unless it determines it is more likely than not (or greater than 50% probability) that the fair value is less than its carrying value.

Factors that should be considered in this qualitative assessment include, but are not limited to, the following:

  • Economic conditions (macro and micro);
  • Industry and market conditions (i.e., competitive environment, market multiples, regulatory changes);
  • Negative changes in costs or financial performance indicators (i.e. negative cash flows or significant declines in revenues); and
  • Entity specific events significantly affecting the management or financial condition of the reporting unit.

A more detailed listing of the qualitative factors can be found at www.fasb.org or by following this link: Topic 350. This qualitative assessment should be documented in a memo and approved by the board of directors for the auditors and regulators. It is also important to understand that if the qualitative assessment is used, an entity is no longer able to carry forward its estimate of fair value from a prior period as previously permitted.

Despite this change, the amendment also allows an entity to opt out of the qualitative assessment in any period and perform the more traditional two-step test. An entity may also elect to perform the qualitative assessment in any future period.

Whichever route one chooses to use in performing its annual impairment testing for goodwill, it remains important to support the assessments or calculations performed with proper documentation. This documentation will allow an entity to efficiently and effectively answer any questions examiners and auditors ask about your goodwill.