Goodwill Shortcut Could Spark Auditor Jitters

FASB’s new way to bypass numeric goodwill testing might add to the compliance costs of big, complex companies rather than curb them.
David KatzSeptember 28, 2011

Prompted by private companies, the Financial Accounting Standards Board is offering all corporations a way to sidestep the complex two-step dance required to test for goodwill impairment. But will the new option required to avoid the test spawn added costs for some companies and spur anxieties among their auditors?

Under a FASB update issued September 15, a company would not be required to calculate the fair value of its reporting units if it judges, based on a “qualitative assessment,” that it’s more likely than not that their fair values are more than their book values. (Goodwill impairment occurs when the fair value of goodwill in a company’s reporting unit drops below the unit’s book value, also known as its “carrying amount.”)

Midsize companies with simple corporate structures and wide latitude for estimates could find goodwill testing much simpler under the accounting-standards update. The new option will be effective for annual and interim goodwill impairment tests performed for fiscal years starting after December 15, and early adoption is permitted.

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Previous FASB guidance requires a company to test for goodwill impairment at least once a year using a two-step process. In step one, the entity must figure out the fair value of a reporting unit and compare the fair value with the unit’s carrying amount. If the fair value is less than the carrying amount, then the company must perform a second step to gauge the amount of the impairment loss, if there is any.

In the new guidance, FASB says that a company choosing to make a qualitative assessment must base it on “such events and circumstances” as  macroeconomic conditions, industry and market conditions, raw materials and labor costs, and “[o]verall financial performance such as negative or declining cash flows.”

Beyond that, the standards-setter offers no firm guidance to companies on how to construct their nonnumeric narratives or what documentation to supply in support of them. That, suggests Greg Forsythe, director of business valuation for Deloitte Financial Advisory Services, may set auditors’ teeth on edge. “This is the first time for anything in the fair-value area to have a purely qualitative assessment of what the auditors will be looking at,” he adds. “It’s a new area for them.”

Legal challenges to auditors’ opinions based on estimates “less tangible to audit” may be in the offing, according to the valuation specialist. That may be especially true in a time when the work of auditors is getting tougher scrutiny by the Public Company Accounting Oversight Board.

To be sure, a company with one reporting unit and a large “cushion” between its fair value and carrying value “is definitely going to save money,” Forsythe acknowledges.  

Companies with abundant reporting entities and narrow room for error in their estimates might find the process costly, however. Feeling pressure themselves, auditors might press such clients to provide more and more documentation – adding to the cost of compliance if the companies’ estimates don’t pass muster and have to proceed to the two-step process anyway.

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