Simple vs Precise—A Hard Call for Goodwill Impairment Test

Goodwill arises when one company purchases another for a premium. Companies report impairment losses when they believe there is a deterioration in the goodwill’s ability to generate future cash flows--usually when the fair value of the goodwill falls below its book value.


The process of testing whether an impairment has occurred is one of the most time-consuming financial reporting activities. Companies are required to test goodwill for impairment at least annually. And, for many years, companies have complained that the costs of conducting impairment testing under the current two-step rule outweighs the benefits.


The Financial Accounting Standards Board’s journey to simplify the accounting for goodwill impairment has come a long way. In 2011, the Board developed an optional qualitative impairment test (Step 0) as a screen for companies to assess whether it is more likely than not that goodwill is impaired, before performing the quantitative two-step impairment test.


Early this year, FASB issued an Accounting Standards Update (ASU 2017-04) to eliminate Step 2 of the current impairment test. Under the new guidance, companies would follow a one-step goodwill impairment test to compare the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount exceeds the reporting unit’s fair value, an impairment charge would be recognized for the difference.


That means companies no longer have to calculate the implied fair value of goodwill under Step 2, to determine the fair value at the testing date of its assets and liabilities (including unrecognized assets and liabilities).


The amendment makes impairment testing simpler; but it is controversial. Many companies have said that the new single-step rule may be less precise.


Duff & Phelps and the Financial Executives Research Foundation issued a report on the goodwill impairment trends of 8,400+ U.S. publicly-traded companies through December 2016 and the usage of the optional Step 0 of the goodwill impairment test.


Bloomberg Tax interviewed Duff & Phelps managing director Gary Roland to discuss the survey results and the impact of ASU 2017-04 on goodwill impairment testing.


Bloomberg Tax: Were there any surprises in the results of the report? Is there anything that didn’t turn out to be the way you expected it to be? 


Roland: I was expecting more companies to apply Step 0. Last year, 52 percent public companies, and 45 percent private companies, used Step 0. Although compared to 2013 when only 29 percent public companies and 22 percent of private companies applied the qualitative test, companies seem to have more appetite for conducting Step 0. Half of the companies we surveyed still find [Step 0] over-burdening and prefer quantitative testing.


However, Step 0 is a screen. When an entity bypasses or fails Step 0, the two-step goodwill impairment test is performed. 


I was expecting more companies would take advantage of the Step 0 because it reduces costs. 


Bloomberg Tax: What do you think of the controversies surrounding the amendments to ASU 2017-04? Will the ASU reduce costs? 


Roland: Step 2 [of the impairment test] is a revaluation of the underlying assets. It is the justification of how impairment is quantified. The precision of the measurement would be impacted. You may get different outcomes by eliminating the second step.  

There were dissenting opinions on this ASU. A few FASB members pointed out that “in a rising interest rate environment, there is a significant possibility that the fair value of reporting units of financial institutions and other entities with significant financial assets could fall below their carrying amounts.”


Having said that, by eliminating the second step, financial service institutes may record more impairment losses simply because of the drop in value of financial instruments.


So the financial service industry could be impacted the most. 


Blomberg Tax: What is your view on the possibility of expanding the private company alternatives--allowing amortization of goodwill--to all companies?  


Roland: There are still debates on that issue. It is currently on FASB’s research agenda. The Board decided to proceed the accounting for goodwill project under two phases. The first phase is to simplify the impairment test. The board eliminated the second step of the test. And the second phase is to consider other amendments, including allowing amortization of goodwill.  


Investors favor an approach that would provide them the most useful information to make decisions. They want to know if the value of the goodwill on a company’s financial statement truly reflects the value of the goodwill in that company. They want to know how an event is going to be recorded, and how that record is going to be carried forward. 


Amortization of goodwill simply allocates the cost over time. The CFA institute also said that amortizing goodwill doesn't tell you much, amortization doesn’t provide enough information of the real value of the goodwill that investors would find useful.

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