Impairment Test Offers Clearer Picture of Goodwill.

• Author: HARPER, STEPHANIE
• Position: Brief Article

In July, the Financial Accounting Standards Board completed its 5-year project on business combinations and intangible assets with the issuance of two separate statements, FASB Statement No. 141, Business Combinations, and FASB Statement No. 142, Goodwill and Other Intangible Assets.

One of the fundamental changes made by Statement 142 is the accounting for goodwill subsequent to an acquisition. As a result of Statement 142, all existing and newly acquired goodwill will no longer be amortized but will be tested for impairment annually and written down only when impaired.

TESTING GOODWILL

Before understanding how the impairment test works, one must first understand that goodwill is not to be tested on an acquisition-by-acquisition basis or at the enterprise level, as it is tested in current practice. Rather, goodwill is to be tested in the aggregate, at a reporting level, referred to as the reporting unit.

The reasoning behind the change is that most of the assets and liabilities of an acquisition, including goodwill, become so integrated with the acquiring company that they are indistinguishable from the company's other assets and liabilities. Thus, goodwill is no longer only associated with the net assets it was acquired with, rather it is associated with a larger part of the acquired company, known as the reporting unit.

THE REPORTING UNIT

A reporting unit is an operating segment or one level below an operating segment (as that term is used in FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information). Existing goodwill and newly acquired goodwill must be assigned to a reporting unit along with other assets and liabilities.

THE FAIR VALUE OF GOODWILL

In general terms, impairment is defined as the condition that exists when the carrying amount of an asset exceeds its fair value. However, because goodwill cannot be sold by itself and does not produce its own cash flows, determining the fair value of goodwill for impairment purposes created a challenge for FASB.

Goodwill is what makes the company as a whole worth more than the sum of its individual parts and is initially measured as a residual. That is, it is the difference between the fair value of the acquired company (the amount paid for the company) and the amounts assigned to the acquired company's assets and liabilities during the purchase price allocation process. In developing the impairment test, FASB concluded that a method similar to the purchase...