Preparing for a Goodwill Impairment Assessment

Reassess reporting units

The goodwill impairment guidance requires entities to test goodwill for impairment at the reporting unit level, which is where discrete financial information is available and segment management regularly reviews the operating results.

With the economic environment changing at a rapid pace, executives are faced with the challenge of keeping their business ahead of the curve. Addressing this challenge means the business often looks different when compared to the previous year, sometimes undergoing a change in structure, product mix, or geographies. As a result, management must determine whether changes to the business affect the nature and number of reporting units at which goodwill is assessed.

Examine results of a qualitative assessment

Once a business’s reporting units have been established, the first step in the goodwill impairment assessment is the qualitative assessment. During this optional but time-saving process, management assesses relevant events and circumstances, such as macroeconomic conditions, overall performance of the company, and changes in key personnel to assess whether the fair value of a reporting unit is less than its carrying amount.

This assessment often yields both positive and negative indicators. For instance, increasing stock prices for the company and its competitors may reveal a healthy macroeconomic environment. At the same time, certain revenue streams may not be on pace to hit targets. Decision makers may be left with the dreadful thought that continuing with the quantitative assessment, in which an entity must calculate the fair value of its reporting units, may be a necessary fate.

Fortunately, one negative result does not indicate that the qualitative assessment has been tripped. The impairment guidance states that companies should evaluate the results of the qualitative assessment to determine whether it is likely that goodwill is impaired (i.e., a likelihood of greater than 50%). As such, companies should analyze the results of all qualitative factors considered and use judgement in determining the significance of each factor to come to a final conclusion.

Expect private company relief, but at a cost

While public companies are required to perform an annual assessment for goodwill, including that which was newly recognized during the year, private companies have another option. In 2014, the FASB issued guidance for private companies, which, if elected, eliminates the requirement to test for goodwill impairment on an annual basis.

This all-or-nothing election, however, requires entities to amortize goodwill on a straight-line basis over ten years—or less if the entity demonstrates that another useful life is more appropriate—forcing management to take a hit to its bottom line even in favorable economic conditions.

Equally important, electing the private company alternative results in financial statements that are inherently different than those required for public companies. If a company anticipates a potential liquidity event someday—such as a public offering or a sale to a private equity or venture capital firm that would require public company financial statements—the entity would be required to restate its prior period as if it had not elected the private company alternative.

When private companies use this accounting alternative, goodwill must be tested for impairment when a triggering event indicates that goodwill may be impaired. In this case, management has the option to test at the entity or reporting unit level, which can save companies the hassle of determining the reporting units to test.

Understand measurement period adjustments after an assessment

Under the business combination guidance, entities have a year after the close of a business combination to adjust the purchase price allocation to the assets and liabilities acquired (i.e., the “measurement period”). If new information is acquired, the balance of goodwill tested for impairment can change in the subsequent months. The accounting guidance does not specify the accounting treatment in this situation, but it should be noted that adjustments made to goodwill relate to facts and circumstances as of the acquisition date. Companies should consider whether potential changes to its purchase price allocation are imminent and how this can affect its goodwill impairment assessment.

Whether a company has recently acquired goodwill in a business acquisition or has had it on the books for years, impairment testing can be difficult—especially when going through the assessment for the first time. Acting early to understand the factors affecting this assessment will avoid costly mistakes down the road.