FASB Endorses a Simpler Method for Reporting Impairment

Research by the Financial Accounting Standards Board (FASB) has shown that analysts and investors care more about the existence of goodwill impairment than a precise calculation of what the impairment amount is attributable to. So, on November 30, 2016, the FASB finalized its plan to simplify the measurement of goodwill impairment. This complex calculation sometimes requires businesses to hire valuation experts to calculate an objective measure of fair value. The changes would go live for fiscal periods starting after December 15, 2019, for public companies and for fiscal periods starting after December 15, 2020, for privately held businesses.

Understanding impairment

When one business buys another at a price that’s more than the combined fair value of the acquired business’s tangible assets and identifiable intangibles, the buyer records the premium on its balance sheet as “goodwill.” Goodwill generally includes the reputation of the purchased business or its competitive advantage in the market.

Accounting Standards Codification Topic 350, Intangibles — Goodwill and Other, requires public companies to test for declines in the value of acquired goodwill at least once a year. When there’s a drop in value, companies generally record goodwill impairment. An impairment usually signals to analysts that a company overpaid for a new acquisition, which could lead to problems in the future.

Comparing existing and new rules

Under the existing rules, calculating goodwill impairment is a two-step process. First, businesses must figure out whether an impairment exists, and then they must put a dollar figure on it.

The second step includes determining the implied fair value of goodwill and comparing it with the carrying amount of goodwill on the balance sheet. In computing the implied fair value of goodwill, a business must determine the fair value of its assets and liabilities as of the impairment testing date. This procedure is similar to what would be required in a purchase price allocation for an acquired business.

The FASB has agreed to nix the second step of calculating impairment. Instead, a business will perform its annual goodwill impairment test by simply comparing the fair value of a reporting unit with its carrying amount. Put simply, the impairment charge would equal the difference between the carrying amount and its fair value. Although the new rules simplify the reporting requirements, most companies will still need to hire valuation professionals to estimate fair value.

Debating the issue

The FASB’s vote to approve Proposed Accounting Standards Update (ASU) No. 2016-230, Intangibles — Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment, was split 4-3. Board members who voted in favor of the changes argued that the second step requires a lot of work, but yields little useful information.

FASB member Harold Schroeder voted against approving the proposal, however. “I would emphasize the fact that I don’t think it’s a simplification or an improvement when you run into situations where you could actually misidentify an impairment,” Schroeder said. “By eliminating Step Two you actually increase the cost, collectively to the system, by having misinformation in the marketplace.”

FASB member Lawrence Smith said he would dissent from the update’s issuance because he wants to retain the second step as an option for some companies. Several banks and insurance companies told the FASB that they didn’t feel comfortable scrapping the second step entirely. Specifically, they contend that the second step sometimes offers a more precise measure of the goodwill impairment, particularly in cases where changes in interest rates could give financial statement readers the impression that goodwill impairment was significant.

© 2016