An act of goodwill: amendments to simplify goodwill impairment testing.

• Author: Davis, A. Christine
• Position: Regulatoryupdate

Entities that have goodwill reported in their balance sheets are required under U.S. GAAP to test this asset for impairment at the reporting unit level on an annual basis and, in certain circumstances, between annual tests. GAAP prescribes a two-step impairment testing process; however, depending on the outcome of the first step, performing the second step may not be required.

A Brief Refresher

The first step is to determine whether goodwill impairment potentially exists. If the quantitative result of the first step indicates that goodwill impairment potentially exists, the entity is required to perform the second step, which results in the measurement of the impairment loss, if any, that should be recognized in the current reporting period.

If the quantitative result of performing the first step indicates goodwill impairment does not potentially exist, the entity need not perform the second step, and testing is concluded.

In the first step of the goodwill impairment test, the entity compares the carrying amount of the reporting unit containing the subject goodwill and the reporting unit's fair value. Goodwill impairment potentially exists when the carrying amount of that reporting unit carrying the goodwill exceeds that reporting unit's fair value. The presumption is that if the reporting unit is impaired, then it is likely the reporting unit's goodwill is also impaired. Under this scenario, the entity is required to proceed to step two of the impairment test.

Step two of the goodwill impairment test involves additional quantitative procedures that result in the determination of whether goodwill is indeed impaired. Here, the entity estimates the "implied fair value" of the goodwill and then compares that implied fair value to the carrying amount of the goodwill

Goodwill is impaired if the implied fair value of the goodwill exceeds the carrying value, and an impairment loss equivalent to the excess is recognized. Implied fair value of the goodwill is derived from allocating the fair value of the reporting entity -- calculated in step 1 -- to the net assets of the entity and other unreported intangible assets, excluding goodwill. This is similar to the determination of goodwill initially recognized in a business combination. FASB acknowledges goodwill cannot be measured directly, therefore, the residual amount is the implied fair value of goodwill.

The meticulous process required to complete step 1 is time consuming and costly Fair value estimates are subjective, so arriving at a reasonable fair value for the reporting entity requires careful research, evaluation and...