Client Alert: FASB Introduces Qualitative Screen for Goodwill Impairment Testing
On September 15, 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (“Update”) No. 2011-8, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment. The objective of the Update is to simplify the requirement to test goodwill for impairment. Under the amendments, an entity has the option, but is not required, to first assess qualitative factors (“Qualitative Assessment” or “QA”) to determine whether it is more-likely-than-not (greater than 50% likelihood) that the fair value of a reporting unit is less than its carrying amount. If, after assessing facts and circumstances in the aggregate, an entity determines it does not fail the QA, then performing the traditional two-step impairment test is unnecessary. Otherwise, an entity is required to proceed to the first step of the goodwill impairment test as currently outlined in ASC 350. Under the Update, however, an entity has the unconditional option to bypass the QA and proceed to the usual quantitative test at each reporting date, and can resume performing the QA in any subsequent period. The amendments in this Update do not affect how the first and second steps of the goodwill impairment test are performed.
Click here for a complete summary of the ASU which includes our views on implementation considerations.
Click here to view the FASB ASU No. 2011-08, Intangibles-Goodwill and Other (Topic 350).
Factors to Consider in the Qualitative Assessment
Examples of events and circumstances provided in the Update that an entity should consider in a QA include, but are not limited to:
- Macroeconomic conditions
- Industry and market considerations
- Cost factors
- Overall financial performance
- 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
- If applicable, a sustained decrease in share price (consider in both absolute terms and relative to peers).
These and other relevant factors are to be evaluated based on the weight of the evidence. None of the individual examples are intended to represent standalone factors that would require the first step of the goodwill impairment test to be performed. The FASB intends for an entity to make a positive assertion about its conclusion reached and the events and circumstances taken into consideration if it passes the QA.
This Update applies to both public and private companies which have recorded goodwill on the balance sheet. While this project was originally undertaken in response to private company preparers' concerns about the cost and complexity of performing the first step of the two-step goodwill impairment test, FASB decided to expand the scope to public companies as well.
QAs under this Update can be applied for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Earlier adoption is permitted and would include impairment tests performed as of a date before September 15, 2011 if an entity’s financial statements for the most recent annual or interim period have not been issued.
Our Take on the Update
As practice has shown, it is difficult to attain the same level of comfort in a conclusion based on an array of qualitative factors considered in their totality, compared to the one provided by a quantitative analysis encapsulating the impact of such multiple factors. Entities taking the QA option should be prepared to adequately address issues such as reconciliation of aggregate reporting unit fair values to market capitalization for public entities; making a “positive assertion” as part of the qualitative assessment; reporting unit dynamics, such as impact of shared resources and synergies on reporting unit fair value; and the level of documentation required to withstand auditor and regulatory scrutiny.
Entities employing the qualitative assessment option need to be able to manage the following risks:
- Perception risk: avoiding the perception of delaying the recognition of a goodwill impairment.
- Execution risk: risk of suboptimal documentation, leading to increased costs in rectifying the issue upon external review. Or, alternatively, arriving at judgments in the QA step which differ from those of the auditor or regulator, and having to resolve the disparity via a quantitative approach.
On balance, we believe that the QA option may be better suited to fulfill its objective of reducing costs and complexity under a combination of circumstances including a favorable economic environment, single - or simple reporting unit structures, and consistent entity operating performance. In many other circumstances, we view a periodic quantitative Step 1 test as a potential practical fallback substantiating current and future QAs. Further, some form of quantification would be needed to perform an adequate reconciliation to total market capitalization for public entities. We expect that initially, upon implementation of this Update, the documentation would rely on a quantitative benchmark, e.g., the fair value of the reporting unit indicated by the most recent impairment test, and a process to bridge this valuation to a current assessment date.
How Duff & Phelps Can Help
To assist entities seeking to perform a QA, we can provide a variety of empirical data points which can be leveraged into the more-likely-than-not determination. For example, we can provide a periodic analysis of market inputs, including market multiples, discount rates, macroeconomic indicators and other data that can be incorporated in the documentation supporting the QA.
From an implementation standpoint, entities should establish a framework for performing QAs, which might include building a matrix which reflects the pertinent events and circumstances listed in this Update and any additional relevant factors, such as value drivers of the various reporting units. Entities should be able to transparently track changes in these factors overtime, while possibly bridging periodic quantitative tests, where needed. We can provide such benchmark value assessments and sensitivities as well as assistance both in the identification and dynamic tracking of various market-based inputs impacting value.
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