CFOs of post-acquisition companies face the annual task of valuing goodwill on their financial statements. Goodwill is the intangible value of the acquired company over and above the fair market value of its hard assets. After an acquisition, the acquiring company has to report the value of that new reporting unit and then, if that value is impaired, by how much it's been impaired each year.
Thanks to a fierce industry debate about impairment and how it should be charged, goodwill accounting practices continue to evolve, forcing companies to adjust their strategy.
The latest revision to the rules was in 2017, but it just went into effect in December for public companies that file SEC reports. It goes into effect for non-SEC public companies at the end of this year, and in late 2021 for all other entities, including non-profits.
If you're CFO of a public company subject to the new rule this year, you're facing the challenge of incorporating the new guidance into your strategic planning and finding the best path to compliance. If your company or nonprofit isn't required to apply the new rules this year, you might nevertheless start doing so, because the exercise can help you work out the details by the time the requirement applies to you.
A simpler process
Under this latest revision, you no longer calculate the implied fair value of the reporting unit's goodwill. Instead, you record an impairment charge based on the excess of the amount of goodwill the reporting unit is carrying over its fair value.
The update, by the Financial Accounting Standards Board (ASU-2017-04), can actually simplify the process because it eliminates a step.
Previously, the quantitative impairment test had two steps — the first to compare the fair value of the reporting unit to its carrying amount, and the second, to calculate any goodwill impairment by comparing the implied fair value of goodwill to its carrying amount. In response to complaints that the second step amounted to a burdensome pro forma exercise, and was even redundant in some cases, FASB eliminated the requirement.
Under the change, companies record goodwill impairment if the reporting unit's carrying value exceeds its fair value. Impairment is based on the difference between those two amounts, making the second step no longer necessary.
For companies not expecting to take a charge for impairment, that change makes the process easier. For others, it won't be so simple.
"If assets are impaired, then you might have additional work," Phil Ilgenstein, partner at Weaver and Tidwell, LLP, an Austin, Texas, advisory firm, told CFO Dive. "[If they’re not], then you can rip the Band-Aid off and move on, rather than spending time doing an academic exercise on how you allocate impairment across your balance sheet."
That said, there remain some concerns over the one-step process, because it can leave it unclear whether a reporting unit's goodwill impairment is actually the result of losses from other assets such as loan receivables or fixed assets.
Notwithstanding the potentially simpler process, you would do well to start your process early, reporting specialists say.
“You could get into a pattern where you say, 'Well, I don’t have to worry about this until I do my annual impairment test,'" says Ilgenstein. "Start early and don’t underestimate it."
Ilgenstein advises companies to "start adding disclosures to their public financial statements, explaining that they’re adopting the accounting standard and what they think the impact will be."
It’s also smart for finance chiefs to analyze their own firm’s goodwill impairment history. "I would suggest CFOs map backwards over the last several times they had to do the full test," Doug Reynolds, partner at Grant Thornton LLP in Boston, told CFO Dive. "See if the outcome would have been different."
For example, Reynolds said, "if a company did this test two years ago, it should pull the paperwork out, and see if it had an impairment. Would it have been different if the rules had changed?"
Also, you still have the option to limit testing to a qualitative assessment to see if you can amortize goodwill as lived assets. That's a process under the old rules, and kept under the new rules, that lets you do a preliminary assessment, or qualitative test, to see whether the fair value of the acquired company can be treated as lived intangibles.
"It’s a matter of judgment as to whether a company is okay just doing the qualitative test," says Reynolds, "or whether they should also do the full quantitative approach."
Companies that adopted the new guidance in advance can also be a goldmine of valuable information. Reynolds suggests reviewing the EDGAR filings of early adopters. "Just look at their disclosures," he said. "They will describe what they did with the new rule. There you can see the impact of the early adoption."
Finally, Reynolds suggests working closely with your auditor. "Ask that person, would a qualitative assessment be okay or should the company perform the quantitative assessment?" Another risk avoidance tactic is to bring the audit committee into the loop. "Keep your audit committee up to date on all your conversations with auditors," Reynolds said.