Goodwill: hunting for consistency one step at a time.

• Author: Franceschi, Greg
• Position: Research Forum

In the following, Duff & Phelps managing director Greg Franceschi provides new developments in goodwill accounting since FERF and Duff & Phelps conducted their 2010 Goodwill Impairment Study.

Goodwill impairment testing, in particular Step 1, has long been a source of debate between those who think U.S. GAAP calls for an equity level test and others who believe the enterprise premise provides a more substantive economic perspective.

Goodwill is tested for impairment at the reporting-unit level based on a two-step test stipulated in Topic 350: Intangibles-Goodwill and Other. The first step compares the carrying amount of the reporting unit--including goodwill, with its fair value. Current guidance refers to the reporting unit's carrying amount as "net assets," interpreted by some as allowing the test to be performed at either an enterprise level or at the equity level.

In the FERF research study authored by Duff & Phelps, FEI members were asked whether their Step 1 goodwill impairment test was performed by comparing the fair value of the equity or enterprise value to their carrying amounts. Fifty-eight percent of the respondents indicated that enterprise value was used.

This diversity in practice led the Emerging Issues Task Force (EITF) to consider addressing the matter as part of Issue No. 10-A, How the Carrying Amount of a Reporting Unit Should Be Calculated When Performing Step 1 of the Goodwill Impairment Test.

At first EITF considered stipulating an equity level test. However, at its November 2010 meeting, it decided to not be prescriptive, so that both an enterprise and equity premise would be acceptable.

It is practical to have the flexibility of choosing the level of the Step 1 test based on the facts and circumstances. Ultimately, the goodwill impairment test measures the operating performance of the assets in the business, net of operating liabilities.

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Companies use a variety of corporate structures with varying amounts and types of debt at the reporting-unit level. An equity-level test requires an estimate of the fair value of debt for each reporting unit, increasing the scope and cost of the impairment analysis, and introduces another step that could be prone to diversity in practice (i.e., fair value of debt in the public market versus the M&A market).

On the other hand, with an enterprise-level test, a fair value of debt analysis would be limited to Step 1 in a market capitalization reconciliation for...