The FASB’s new goodwill impairment testing guidance – ASU 2017-04, required for public SEC filers for periods beginning after December 15, 2019 – while intended as a simplification, could result in less precise goodwill impairments for reporting entities.
Early and ongoing cross-functional coordination between accounting, valuation and tax professionals is critical to effectively navigating financial reporting complexities of the goodwill impairment model.
Companies should take a fresh look at existing processes and controls for assessing asset impairment as proper identification of triggering events is integral to appropriately measuring goodwill impairment.
The revised guidance simplifies the goodwill impairment test to address concerns related to the existing test’s cost and complexity by eliminating Step 2 (see diagram) of the current goodwill impairment test. Step 2 requires a hypothetical purchase price allocation to measure the amount of a goodwill impairment. Upon adoption of the revised guidance, a goodwill impairment loss will 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.
While the approach for measuring the amount of goodwill impairment has been simplified, there are nuances in how the revised impairment guidance will interact with the subsequent measurement of other assets (not goodwill) governed by other accounting standards. These complexities will be important for management and stakeholders to understand when adopting and applying the revised guidance.
The revised goodwill impairment model does not change the sequencing of impairment testing for assets (or asset groups) held and used or held for sale. As with the existing model, getting the sequencing right can help avoid potential errors in assessing impairment. For example, for assets that are held and used, other assets (e.g. inventory, financial assets, etc.) and long-lived assets are assessed for impairment prior to testing goodwill.
The impairment models for assets other than goodwill may not require an impairment charge to be recognized under certain circumstances, even when the fair value is less than carrying value. As the new single-step approach for assessing goodwill impairment compares the fair value and carrying value of the entire reporting unit, the goodwill impairment charge (if any) may capture fair value declines, below their carrying values, for non-goodwill assets.
Consider the example of a company that has long-lived assets that are recoverable under ASC 360-10: Property, Plant and Equipment – but the fair value of its fixed assets or finite-lived intangible assets have fallen below their carrying amounts. Under the new guidance, the goodwill impairment charge would capture the decline in fair value of the long-lived assets. Additionally, recognition of the impairment of the long-lived asset that contributed to the goodwill impairment may occur at a later date. Without the more involved calculation that would have been performed when applying Step 2 (i.e., the implied fair value of goodwill is no longer calculated), there is a higher potential for a less precise amount of goodwill impairment.
Another example often seen is with companies that hold significant portfolios of financial assets which are carried at amortized cost. In rising interest rate environments, the fair value of these financial assets will often be significantly less than the carrying value, which consequently could lead to the impairment of goodwill to reflect the decrease in the fair value of the reporting unit.
Alternatively, when there is unrecognized appreciation in the fair value of other recognized or unrecognized assets in the reporting unit, the amount of the goodwill impairment charge will be less than under the current guidance.
In addition to the considerations around an entity’s assets, the fair value of its liabilities, relative to their carrying amounts, may also influence the goodwill impairment analysis. The effect that debt may have on the analysis will be dependent on the valuation approach selected.
Two valuation approaches are typically employed. Under the equity premise of value, all liabilities (including debt) associated with the reporting unit are assigned to the reporting unit and included in the valuation of the reporting unit. Conversely, under the enterprise premise of value, debt is excluded from the liabilities assigned to the reporting unit. US GAAP does not require the use of an enterprise or equity premise.
The one-step test performed using an equity premise can result in a different amount of goodwill impairment than the enterprise premise. This is specifically relevant in cases where an entity has a zero or negative carrying amount for any of its reporting units. Under the old guidance, a more precise determination of goodwill impairment would have been addressed in Step 2 by determining the implied fair value of the goodwill. Under the new guidance, if the equity premise is used for a reporting unit with a negative carrying amount, the reporting unit cannot have an impairment since the reporting unit’s fair value will always be greater than its carrying value.
Although the effect of this limitation could be mitigated by employing an enterprise premise of value when conducting step one of the impairment test, there are still factors, such as corporate level debt that usually does not get pushed down to the reporting unit level, that could limit the precision of the calculation. It is highly recommended that entities consult with their technical accounting advisors and valuation professionals when assessing the potential effects of a choice in valuation methodology.
Another consideration for companies is the income tax effect from any tax-deductible goodwill on the carrying amount of the entity (or the reporting unit). Specifically, if an entity has tax-deductible goodwill, there is the possibility of running into a cycle of impairment due to the decreasing book value of its goodwill increasing its deferred tax asset (or decreasing its deferred tax liability). This in turn increases the carrying value of the reporting unit and may trigger further goodwill impairment. A simultaneous equation is required to adjust the goodwill impairment and deferred tax impact when tax deductible goodwill is present. Effective coordination between accounting and tax professionals will help appropriately reflect goodwill and deferred tax balances in the financial statements.
Prior to the adoption of the new goodwill impairment model, which is required for public SEC filers for periods beginning after December 15, 2019, companies should consider and prepare for the complexities of the calculation and how information will be digested by stakeholders. Early involvement and coordination between cross-functional teams from accounting, tax and valuation is critical in order to align expectations and evaluate the financial reporting implications. This includes clearly outlining information and data requirements, as well as key decision points to effectively test goodwill for impairment.
PwC’s Accounting Advisory and Valuation specialists can assist with sorting through the details of accounting change impacts your organization. For more insights on the new goodwill impairment testing standard, please contact PwC to request a meeting.
Observations from the front lines provides PwC’s insight on current economic issues, our perspective regarding the financial reporting complexities, and what companies should be thinking about to effectively address those issues.
Partner, PwC Deals, PwC US
Director, PwC Deals, PwC US
Director, PwC Deals, PwC US
Principal, PwC Deals, PwC US