The Financial Accounting Standards Board (FASB) recently approved plans to further simplify the test public companies follow to assess goodwill for a drop in value. If the accounting amendment is finalized, it will be the second time since 2011 the board has changed the goodwill impairment test for public companies.
What is impairment testing?
Businesses that acquire other companies typically recognize the part of the purchase cost above the seller’s book value as goodwill. Goodwill is considered an intangible asset and includes things such as the value of the acquired company’s reputation or brand name. Under U.S. Generally Accepted Accounting Principles (GAAP), public companies currently aren’t allowed to amortize goodwill. Instead, they must test goodwill at least once a year for a drop in value.
Testing for impairment is currently a two-step process. In the first step, a reporting entity compares the fair value of its reporting units with their carrying value, including goodwill. If the carrying amount of a reporting unit is greater than its fair value, the company must take a second step and calculate the implied fair value of goodwill by performing a hypothetical application of the acquisition method — similar to the purchase price allocation that’s performed when a company is acquired — as of the date of the impairment test. Impairment equals the excess of the carrying amount of goodwill over its implied fair value.
This two-step process can be costly and complex. So, in 2011, the FASB adopted an optional qualitative impairment test as a screen for companies to assess whether it’s more likely than not that goodwill is impaired before performing the quantitative two-step impairment test. At the time, the FASB said this would remove some of the headaches associated with goodwill impairment testing. For many companies and auditors, however, the qualitative test wasn’t simple enough.
How does the FASB plan to further simplify the process?
In a memo to the board, FASB research staff stated, “Feedback indicates that users are more interested in the existence of an impairment than the amount.” So, on October 28, the FASB voted to start work on a project to eliminate the second step in the two-step impairment test.
Instead, a one-step impairment test would indicate whether there’s impairment, and the write-off would simply equal the amount by which the carrying value of a reporting unit exceeds its fair value. The FASB indicated that, if finalized, the rule would be applied prospectively.
How does the one-step test align with IFRS?
In addition to addressing complaints from business about the cost and relevance of the two-step process, the move to a one-step impairment test would bring U.S. GAAP closer to International Financial Reporting Standards (IFRS).
The current accounting guidance for business combinations in U.S. GAAP is substantially converged with IFRS. The main differences relate to the level at which the goodwill impairment test is performed and the number of steps included in the test. In September, the FASB said it wanted to keep the accounting rules aligned.
The board also said it wanted to work with the International Accounting Standards Board on an effort to improve accounting for customer-related intangible assets, such as customer lists and order backlog. But some board members said they saw no need to change existing U.S. GAAP for acquired intangible assets because public businesses haven’t complained much about the process.
In the meantime, the FASB instructed its research staff to find out more about the differences between domestic and foreign investors when they assess a company’s acquired intangible assets.
When is a proposal expected?
This project is still in the initial deliberations phase. In the coming months, FASB staff will conduct additional research on goodwill testing. No publication date has been announced yet for the FASB to issue an exposure draft.
Sidebar: Will the FASB allow public companies to amortize goodwill?
In 2014, the FASB published a simplification for private companies that have goodwill on their balance sheets. Accounting Standards Update No. 2014-02, Intangibles — Goodwill and Other (Topic 350), Accounting for Goodwill (a consensus of the Private Company Council), lets private companies amortize goodwill for up to 10 years.
The accounting alternative also simplifies the test private businesses have to perform to determine whether the goodwill has lost value. Instead of automatically testing for impairment every year, private companies test only when there’s a “triggering event,” meaning the company has evidence that the fair value of the acquired business is less than the carrying amount on the balance sheet.
Public companies had hoped that this option would be extended to them. However, instead of pursuing a similar alternative for public companies, the FASB favors implementing a one-step goodwill impairment test. (See main article.) So, if the accounting amendment is finalized, public companies will still need to calculate the value of each reporting unit annually and incur write-offs on an “as-needed” basis.