The Financial Accounting Standards Board (“FASB”) in the U.S. has issued a few Accounting Standard Updates (“ASUs”) over the past several months that could impact various areas of accounting such as acquisitions, disposals, goodwill impairment and consolidation under U.S. GAAP; this, in turn, may affect a company’s valuation requirements. In the following sections, we have summarized the key features and potential valuation impact from two FASB updates:
FASB Simplifies the Goodwill Impairment Test by Eliminating Step 2 under ASC 350
In January 2017, FASB issued ASU 2017-04 which eliminates Step 2 of the current goodwill impairment test under ASC 350. Under the simplified model, a goodwill impairment is calculated as the difference between the carrying amount of the reporting unit and its fair value, but not to exceed the carrying amount of goodwill allocated to that reporting unit.
Additionally, there are three notable changes:
- The same impairment testing methodology applies to all reporting units, even those with a zero or negative carrying amount of net assets
- An entity is required to disclose the amount of goodwill allocated to such reporting units with a zero or negative carrying amount
- An entity still has the option to perform the qualitative assessment (“Step 0 “) for a reporting unit to determine if the quantitative impairment test is necessary
Step 0 was introduced in September 2011 when the FASB issued ASU 2011-08, Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment, providing public and private companies with the option to first assess qualitative factors to determine whether it is "more likely than not" (i.e., greater than a 50 percent likelihood) that the fair value of a reporting unit is less than its carrying amount, inclusive of goodwill. In evaluating this likelihood, an entity is to assess certain events and circumstances, including but not limited to macroeconomic conditions, industry and market conditions, cost factors, overall financial performance, entity-specific events, a sustained decrease in share price (if applicable), etc.
What is the Impact?
- Failing Step 1 will always result in a goodwill impairment under the new one-step test, which was not always the case under the previous impairment model.
- A higher impairment may result under the new one-step test when the fair value of long-lived assets is below their carrying amount; or,
- A lower impairment may result under the new one-step test when there are significant unrecognized or appreciated intangible assets.
Who is affected?
- Public business entities and other entities that have goodwill reported in their financial statements and have not elected to apply the private company alternative for the subsequent measurement of goodwill.
- Private companies that have elected to amortize goodwill (but continue to separately recognize customer related assets and non-competition agreements) have the option to adopt ASU 2017-04. However, if the company has elected to subsume customers and non-competition agreements into goodwill, adoption is not permitted, unless the company follows additional accounting guidance.
When is it effective?
- For public business entities that are U.S. Securities and Exchange Commission (SEC) filers, the guidance is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Apart from that, the guidance is effective for annual or any interim goodwill impairment tests:
- In fiscal years beginning after December 15, 2020 for public business entities that are not SEC filers; and
- In fiscal years beginning after December 15, 2021 for all other entities.
- Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.
Click here to read the full ASU.
FASB Revises the Definition of a "Business" under ASC 805
Earlier this year, FASB issued ASU 2017-01 which clarifies the definition of a business and introduces a framework for determining when a set of assets and activities constitutes a business. In general, the definition of a business has a significant impact on how an entity treats acquisitions and disposals of an asset (or group of assets), and how it accounts for goodwill and consolidation.
The new guidance includes an initial screen, which specifies that when substantially all the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset (or a group of similar identifiable assets), the set is not a business, and no further assessment is required.
If the initial screen is not met, to be considered a business, a set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create an output. On the other hand, the ASU removes the evaluation of whether a market participant could replace missing elements. In essence, this ASU lays out a framework for evaluating whether both an input and a substantive process are present, while introducing more stringent criteria for sets without outputs. Finally, the ASU narrows the definition of the term ‘output’ so that it is consistent with how outputs are described in Topic 606 – Revenue from Contracts with Customers.
The IASB has added a project on the definition of a business to its agenda under IFRS and issued an Exposure Draft, Definition of a Business and Accounting for Previously Held Interests – Proposed amendments to IFRS 3 and IFRS 11, which proposes similar amendments to those in ASU 2017-01. However, this project is not yet complete, and as such, there is no change in the current application of the definition of a business under IFRS.
What is the Impact?
- The ASU is likely to result in fewer sets of assets and activities qualifying as a business; and therefore, more acquisitions would be accounted for as asset acquisitions.
- The amendments are aimed to provide more consistency in applying the guidance, reduce the costs of application, and make the definition of a business more operable.
Who is Affected?
- All reporting entities that must determine whether they have acquired or sold a business.
- The definition of a business affects many areas of accounting, for example acquisitions, disposals, goodwill impairment and consolidation.
- The effect of the ASU is pervasive, with the real estate, pharma, and oil & gas industries being most affected.
When is it Effective?
- For public business entities, the guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019.
- Early adoption is permitted for covered transactions – such as acquisitions and derecognition of assets, or deconsolidation of subsidiaries – that have occurred on a date prior to the ASU’s issuance date or effective date, provided the specific transaction has not yet been reported in financial statements.
Click here to read the full ASU, with examples for various industries.
Any positions presented in this article are those of the authors and do not represent the official position of Duff & Phelps, LLC. This material is offered for educational purposes with the understanding that neither the authors nor Duff & Phelps, LLC or its affiliates are engaged in rendering legal, accounting or any other professional service through presentation of this material.
The information presented in this article has been obtained with the greatest of care from sources believed to be reliable, but is not guaranteed to be complete, accurate or timely. The authors and Duff & Phelps, LLC or its affiliates expressly disclaim any liability, including incidental or consequential damages, arising from the use of this material or any errors or omissions that may be contained in it.
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