The new goodwill impairment guidance eliminates time and effort by removing step 2 of what was previously a two-step impairment test. In this video we discuss:
Hi, I’m Drew Cummings, a senior manager in PwC’s national office. Today, I’m going to discuss the new, simplified goodwill impairment test, which is effective for calendar year-end public companies beginning January 1, 2020.
Specifically, I’ll cover three topics:
First, let’s begin with a brief overview of what’s changing. The revised guidance simplifies the goodwill impairment test to address concerns relating to the existing tests cost and complexity. The most significant change is the elimination of Step 2 of the current goodwill impairment test, which requires a hypothetical purchase price allocation to measure the amount of a goodwill impairment.
Under the revised guidance, the optional qualitative assessment (or Step 0) and Step 1 of the quantitative assessment remain unchanged. However, as a result of eliminating Step 2, a goodwill impairment loss will instead be measured as the amount by which a reporting unit’s carrying amount exceeds its fair value, not to exceed the carrying amount of goodwill.
In addition, the same one-step impairment test will now be applied to all reporting units, including those with zero or negative carrying amounts. As such, goodwill allocated to these reporting units generally will not be impaired since the fair value of a reporting unit is rarely negative. However, the revised guidance includes a new requirement to disclose the amount of goodwill allocated to reporting units with zero or negative carrying amounts.
All of that being said, the new guidance will not change the timing of, or the unit of account (that is, the reporting unit), for testing goodwill impairment. So, that’s what’s changing. Now let’s cover a few of the financial reporting consequences of the new guidance.
Although we expect that preparers will find the new, single-step test easier and less costly, there are specific considerations companies should keep in mind as they transition to the new guidance. For instance, because of the complexity involved in completing Step 2, current guidance permitted an entity to record a preliminary impairment in one period and determine the final amount of the impairment in a later period. This will no longer be allowed under the revised guidance.
Further, the amount of goodwill impairment recognized under the revised guidance could be larger or smaller than under the current guidance, largely depending on the difference between the carrying amounts and fair values of the other assets and liabilities in the reporting unit.
For example, when the fair value of a reporting unit is less than its carrying value, there will be a goodwill impairment charge under the new test, even if the impairment is attributable to other assets in the reporting unit for which an impairment cannot otherwise be recognized based on the guidance for those assets.
Of course, on the other side, when there is an unrecognized appreciation in the fair value of other assets in the reporting unit, the amount of the impairment charge would be less than under the current guidance. In fact, it’s possible that other appreciated assets could shelter the entire goodwill impairment.
Additionally, while some companies may not recognize an impairment of goodwill under the current guidance, even if they fail Step 1, under the revised guidance, failing Step 1 will always result in some goodwill impairment.
Now, let’s discuss topic two, considerations for companies planning to early adopt the new guidance. Companies that plan to adopt the guidance for their annual impairment test must also apply it to any interim testing in that same year.
For example, assume a calendar year-end company expects to early adopt the new goodwill impairment test in the fourth quarter of 2019 for its annual test. In that case, the company must also apply the new guidance if there’s a triggering event in any interim periods in 2019. Conversely, if the company performs a trigger-based impairment test under the current guidance, it cannot use the revised guidance for its annual test.
Next, let’s cover topic three, where I’ll highlight a few income tax considerations to keep in mind when adopting the new guidance. To determine the fair value of a reporting unit, companies must determine whether a hypothetical sale would be taxable or nontaxable. This determination could impact the existence and amount of a goodwill impairment.
Companies are required to use a market participant perspective in making this determination, whereby the seller would receive the highest economic value, or after tax amount, from the sale. Therefore, the taxable or nontaxable determination should be supported based on the reporting units specific facts and circumstances, especially when there is a change in the determination from prior periods.
Further, taxable business combinations can generate goodwill that is deductible for tax purposes. When such goodwill is impaired for financial reporting purposes, there may be an impact on deferred taxes. In these cases, the goodwill impairment guidance illustrates a simultaneous equation method that should be used to determine the goodwill impairment loss and associated income tax benefits. This is the same method used today to determine the final goodwill and related deferred income tax amount in a nontaxable business combination.
So let’s wrap-up. I’ve highlighted a few of the key changes to and resulting effects of the new goodwill impairment test, including certain tax considerations. Adoption of the new standard will require incremental effort to ensure a smooth transition based on the adoption date, and a shift in mindset from applying the current guidance. But there are many resources available to help.
For more information, please refer to the business combinations page on CFOdirect.com. Thank you.