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Goodwill Impairment
New Treatment of Goodwill and Intangibles
Goodwill and intangible assets often represent a considerable portion of an enterprise's net worth, and recent changes to Financial Accounting Standards Board (FASB) rules for treating goodwill and intangibles may have an important effect on the valuation of some companies. The implications for past, pending and future mergers, acquisitions and other deals are significant, so it is important that business owners be familiar with these new rules, FASB Statements 141, Business Combinations, and 142, Goodwill and Intangible Assets.
FASB 141 requires all business combinations to be evaluated using the purchase method of accounting, and it specifically prohibits use of the pooling-of-interests method. It also provides recognition criteria for intangible assets other than goodwill, along with general guidelines for assigning values to assets acquired and liabilities assumed. FASB 141 defines an intangible asset apart from goodwill as:
An asset arising from a contractual or legal right, such as a patent, trademark or copyright.
An asset other than contractual that can be sold, transferred, licensed, rented or exchanged individually or in combination with a related contract, asset or liability.
Under FASB 141, parties to a business combination are required to estimate the fair value of acquired intangible assets in the following manner. First, intangible assets must be categorized by type, such as customer lists, trademarks, patents, software, intellectual property, etc. Second, intangible assets with an identifiable remaining useful life must be separated from those with an indefinite useful life. The latter are then classified as goodwill and must be subject to a two-step test for impairment under FASB 142, which companies were required to adopt by January 1, 2002.
Amortization Eliminated
The major change of FASB 142 is that amortization of goodwill will no longer be permitted, although it will still be recognized as an asset. Instead, goodwill and other intangibles will be subject to an annual test for impairment of value. Not only will the change affect goodwill related to acquisitions completed after the effective date, it will also affect any balance of goodwill from previous deals that has not already been amortized. In the past, goodwill has been amortized over its useful life, up to a period not to exceed 40 years.
Instead of amortizing goodwill, companies will now have to test goodwill at least once a year for impairment. Businesses must perform this testing in new reporting units, develop valuation methodologies for those units and subjectively value identifiable intangible assets. FASB 142 requires businesses to perform a Transitional Impairment Test on all goodwill within six months. The calculated amounts should be measured as of the first of the year. If this first step indicates that goodwill is impaired, any impairment loss should be calculated and recorded as soon as possible prior to year-end.
Two-Step Process
After the initial Transitional Impairment Test is conducted, businesses must perform the Goodwill Impairment Test on an annual basis (with certain exceptions) under FASB 142. This process must be conducted at the reporting unit level, defined as the lowest level of an entity, i.e., business units, subsidiaries, operating units, divisions, etc. There are two steps to the process:
1. Identify potential impairments by comparing the fair value of a reporting unit to its carrying amount, including goodwill. Goodwill is not considered impaired as long as the fair value of the unit is greater than its carrying value. The second step is only required if an impairment to goodwill is identified in step one.
2. Compare the implied fair market value of goodwill to its carrying amount. If the carrying amount of goodwill exceeds its implied fair market value, an impairment loss is recognized. That loss is equal to the carrying amount of goodwill that is in excess of its implied fair market value, and it must be presented as a separate line item on financial statements.
Historically, accounting for business combinations has been one of the most controversial issues in financial reporting. With the rapid pace of change in today's marketplace-driven by technological advances, new business models and other factors-the role of financial reporting in maintaining stability of capital markets will only increase. FASB 141 and 142 are intended to address critical issues of currency and accuracy in financial reporting.
Experts expect the Securities & Exchange Commission to put a magnifying glass to the new subjective valuations that will arise from FASB 141 and 142, and the agency is likely to pay particularly close attention to how those valuations are allocated in the purchase price in merger and acquisition deals. That being the case, it is critical that companies hire a reputable firm to provide expert valuations and impairment opinions under the new statements. Appraisal Economics has the personnel, expertise and research resources required to provide the kind of 141/142 valuations that will stand up to SEC scrutiny. We are highly experienced in mergers, acquisitions, divestitures and related services and have worked on many such transactions, both domestically and internationally. A goodwill valuation and impairment opinion from Appraisal Economics is the product of a comprehensive analysis that takes into account all areas of concern to the SEC.
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