Management Accounting

What’s So Simple about New Goodwill-Impairment Tests?

FASB says its revised goodwill-impairment testing rule will ease the cost and time burden for preparers, especially private-company accountants. Bu...
Marie LeoneAugust 12, 2011

This article was updated on August 17, to include additional comments by FASB.

The Financial Accounting Standards Board has approved a rule revision that reportedly makes its less complicated for companies to test for goodwill impairment. In practical terms, that means companies have the option of using a qualitative — rather than quantitative — assessment to determine whether they overpaid for an acquisition, and therefore must post a loss to their financial statements.

Goodwill is the amount paid for an acquisition in excess of its fair value, and FASB requires, with few exceptions, that companies test for goodwill impairment at least once on an annual basis. The rule rework, which goes into effect December 15, 2011, was championed by majny private-company CFOs and controllers who complained about the mandatory fair-value calculation required as the first step of a two-step testing process. In essence, executives said such quantitative tests were a costly and cumbersome way of determining the likelihood that an impairment had occurred and therefore required further analysis.

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Goodwill-impairment testing affects a large number of public companies, as well. A study released last year by research outfit Duff & Phelps found that 5,200 U.S. publicly traded companies reported an aggregate $26 billion in goodwill impairments in 2009. The year before, total impairments reached $118 billion. Despite the 80% drop in recognized impairments year over year, the volume still represents a measure of how much impairment testing takes place in the course of a year.

According to FASB project manager Kevin Catalano, approximately 80% of all comment letter respondents expressed support for the proposed revision, and many stated that the rule will meet the expected goals of reducing costs and complexity associated with impairment testing. In fact, Catalano says that many respondents were in favor of the FASB’s proposal to allow preparers of financial statements to exercise more judgment and to avoid unnecessary costs.What’s more, he points out that substantially all of the companies that responded indicated that they intend to use the optional qualitative assessment if their circumstances allow.

Nevertheless, some comment letters — about 20% —  were not convinced that the rule revision would slash costs or complexity. For example, the in its comment letter to FASB, the CFA Institute noted that current impairment write-downs indicate the “market appears to be able to perform the [quantitative] analysis in a timely manner.” Furthermore, the trade group rejected the claim that a qualitative test reduce costs associated with impairment testing, and went on to emphasize that the more-subjective test allows for increased management discretion and judgment in determining whether it is likely impairments exist. “Any change to the requirements that would allow management to postpone the rigor of performing a regular and thorough quantitative analysis will surely lead to an even longer delay in the reporting of impairment losses, to the detriment of investors,” wrote the group.

Under the new rules, management may first assess a list of qualitative factors to determine whether a quantitative analysis is needed. The list of qualitative indicators is wide-ranging, and includes such factors as macroeconomic conditions (e.g., access to capital constrains and foreign-exchange-rate volatility), increases in raw materials and labor, declining cash flows, changes in key personnel and customers, a decline in stock price, and the specter of bankruptcy or litigation.

In contrast, a quantitative assessment, which is still allowed under the rule rewrite, is typically done using an income or market approach. For example, using a discounted cash-flow calculation to assess company value is considered an income approach, while a market approach might involve applying a multiple to the company’s operating income that is based on peer company operating income.

The full impact of the qualitative option won’t be clear until FASB releases the final rule — ASC 350 (formerly FAS 142) — in September, says Brad Pursel of Brown Smith Wallace, a tax and accounting firm and part of the Moore Stephens association. While the effects are sure to vary from company to company, he believes some industries may be more easily subjected to a qualitative assessment than others; for instance, industries that have access to relevant economic data that correlates to value, such as those in, or closely tied to, the commodities industry.

But Pursel is not convinced that companies will derive any time-saving or cost benefits from switching to a qualitative test. According to him, the ease of analysis depends on management’s skill to perform “a credible, convincing qualitative assessment” while also providing the documentation required by auditors to support the more-subjective position. “Although at first glance a qualitative assessment may appear to be easier than a quantitative assessment, this may not be the case,” contends Pursel. “Management may find that auditors set the bar fairly high,” mainly because there may be concerns about the “auditability” of a qualitative assessment.

In addition, he says that for companies currently outsourcing their quantitative impairment assessments, any savings in fees they expect to gain using a qualitative assessment “may be more than offset by higher audit fees.”

In all, while the rule revision will require management and auditors to use more professional judgment than in the past, financial statements will still be “auditable,” according to participants that attended FASB’s July workshops on implementing the new testing rules. In the workshops accounting firms, corporate accountants, and regulators also noted that cost and complexity would be reduced for some companies. 

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