On September 15, 2011, the FASB issued Accounting Standards Update 2011-08, Testing Goodwill for Impairment. Based on the guidance in the ASU, companies have the option to qualitatively determine whether they can bypass the two-step goodwill impairment test under FASB Accounting Standards Codification Topic (“ASC”) 350-20,Intangibles – Goodwill and Other: Goodwill.
The new standard allows an entity first to assess qualitatively whether it is necessary to perform Step 1 of the two-step annual goodwill impairment test. An entity is required to perform Step 1 only if the entity concludes that it is more likely than not that a reporting unit’s fair value is less than its carrying amount (that is, a likelihood of more than 50%). This is different than the previous guidance, which required entities to perform Step 1 of the test at least annually by calculating and comparing the fair value of a reporting unit to its carrying amount.
Qualitative Assessment Factors
ASC 350-20-35-3C (added by the ASU) provides the following examples of events and circumstances that may be considered in the qualitative assessment:
- Macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets
- Industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (in both absolute terms and relative to peers), a change in the market for an entity’s products or services, or a regulatory or political development
- Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows
- Overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods
- 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, a more-likely-than-not expectation of selling or disposing all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit
- If applicable, a sustained decrease in share price (in both absolute terms and relative to peers)
Companies should also consider:
- The extent to which each of the adverse events and circumstances identified could affect the comparison of a reporting unit’s fair value with its carrying amount. An entity should place more weight on the events and circumstances that most affect a reporting unit’s fair value or the carrying amount of its net assets.
- Any positive and mitigating events and circumstances that may affect the analysis. However, positive and mitigating evidence should not be viewed as a “rebuttable presumption” that an entity does not need to perform the quantitative calculation under Step 1.
- If an entity has a recent fair value calculation for a reporting unit, it also should include this as a factor in its consideration of the difference between the reporting unit’s fair value and carrying amount.
ASU 2011-08 also included the following amendments and considerations:
- Evaluating Goodwill for Impairment on an Interim Basis
- ASC 350-20-35-30 states that goodwill should be tested for impairment annually and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
- However, the ASU removes from this paragraph the previous examples of such events and circumstances and replaces them with the qualitative assessment factors in ASC 350-20-35-3C (a through g cited above).
- Reporting Units With Zero or Negative Carrying Value
- ASU 2010-28 modified Step 1 of the goodwill impairment test for reporting units with a zero or negative carrying value, stating that under such circumstances an entity should perform Step 2 of the impairment analysis when it is more likely than not that goodwill is impaired. In performing this step, the entity should consider the events and circumstances outlined above. In addition, ASC 350-20-35-8A (as amended by ASU 2011-08) states that an entity should consider whether there are significant differences between the carrying amount and the estimated fair value of [the reporting unit’s] assets and liabilities, and the existence of significant unrecognized intangible assets.
- If the carrying amount of a reporting unit is zero or negative and the entity determines, on the basis of the qualitative assessment, that it is more likely than not that a goodwill impairment exists, the entity would proceed directly to step 2 to measure the goodwill impairment loss.
- Carry Forward Option Removed
- ASU 2011-08 eliminates the previous option for entities to carry forward a reporting unit’s Step 1 fair value measurement from one year to the next if certain criteria are met.
- Entities currently using the carry forward option will need to assess whether to perform the qualitative assessment or move straight to the quantitative Step 1 calculation.
- Qualitative Assessment Is Optional
- An entity is not required to perform the qualitative assessment described in ASU 2011-08 and can proceed directly to Step 1 of the goodwill impairment test without evaluating any of the factors listed in the ASU.
The revised standard is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. However, an entity can choose to early-adopt the revised standard even if its annual test date is before September 15, 2011 (the date on which the revised standard was issued), provided that the entity has not yet issued its financial statements for the period that includes its annual test date.