Goodwill impairment testing: tax considerations.

• Author: Barbut, Yosef

In financial accounting, goodwill is an asset representing the future economic benefits arising from other assets acquired in a business acquisition that are not separately recognized. The measurement of goodwill can be generally described as having mixed attributes: it is a residually calculated amount derived both from assets and liabilities that are measured at fair value and others (including income taxes) that are not measured at fair value.

Subsequent to a business acquisition in which goodwill is recorded as an asset, post-acquisition accounting rules (ASC 340, Intangibles--Goodwill and Other) require that goodwill be evaluated to determine whether there has been an impairment loss. Goodwill impairment testing is a two-step process, performed at least annually, on a "reporting unit" basis.

In Step 1 of the testing process, the fair value of the reporting unit (RU) is determined and compared to its book value, including goodwill. If the fair value of the RU exceeds its book value, goodwill of the RU generally is not impaired; if the book value of the RU exceeds its fair value, the testing proceeds to Step 2. In Step 2, the RU's fair value is allocated to its assets and liabilities following acquisition accounting procedures to determine the implied fair value of goodwill. This hypothetical acquisition accounting process is applied only for the purpose of determining whether goodwill must be reduced; it is not used to adjust the book values of other assets or liabilities. There is an impairment if (and to the extent) the carrying value of goodwill exceeds its implied fair value. An impairment loss reduces the recorded goodwill and cannot subsequently be reversed.

Numerous tax law and tax accounting considerations can effect whether there is an impairment of goodwill as well as the amount of impairment. This article discusses five primary tax focal points, beginning at the outset of Step i with the determination of the fair value of the reporting unit.

Tax Focal Point #1: The fair value of the RU is determined from the perspective of appropriate "market participants."

That means giving consideration to the potential buyers likely to consider acquiring a controlling interest in the RU at the time of testing. In other words, the fair value is the price that would be received if the RU were sold in an orderly transaction between market participants at the testing date. Specific market participants need not be identified; the emphasis instead is on identifying the relevant distinguishing characteristics of likely buyers. Market participants might even be identified as a group, such as strategic versus financial buyers, industry, or geographic competitors.

The structure of a hypothetical business disposal, including relevant tax elections and planning, can affect the income taxation of the seller and the buyer. The structure of a disposal can also dictate whether existing tax attributes (e.g., net operating loss or tax credit carry-forwards) of the RU would be transferred to a buyer. As a result, the disposal structure can effect what a market participant would pay to acquire a reporting unit. Indeed, it is not uncommon for a business disposal to attract alternative pricing offers depending upon how the seller and buyer ultimately agree to structure the transaction in order to optimize the associated tax consequences. That can be the case even when a market-based rather than income-based valuation model is used as the primary pricing methodology. Accordingly, the fair value in Step 1 should reflect the assumed effect that tax considerations would have on the price market participants would be willing to pay for the RU.

Generally...