On September 15, 2011, Financial Accounting Standard Board (FASB) issued Accounting Standards Update (ASU) No. 2011-08, Testing Goodwill for Impairment. This update is intended to reduce the cost and complexity of the annual goodwill impairment test by simplifying how an entity tests goodwill for impairment.
Prior guidance required an entity to perform the two-step goodwill impairment test on at least an annual basis, by comparing the fair value of a reporting unit with its carrying value including goodwill (step one). If the fair value of a reporting unit is less than its carrying amount, then a test must be performed to measure the amount of the impairment loss to be recognized, if any (step two).
The revised standard allows an entity to first qualitatively assess whether it is necessary to perform the first step of the two-step annual goodwill impairment test. This initial assessment has earned the catch phrase "Step Zero". An entity is required to perform Step One only if the entity concludes that it is more likely than not (i.e., more than a 50% likelihood) that a reporting unit's fair value is less than its carrying amount. An entity has an option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step process, and may resume performing the qualitative assessment in any subsequent period.
The revised standard also includes examples of events and circumstances to be considered in conducting the qualitative assessment. These include macroeconomic conditions such as a deterioration in general economic conditions; industry and market considerations such as increased competition; cost factors such as increases in labor, raw materials or other costs that impact cash flows negatively; entity specific events such as declining financial performance; and other events such as an expectation that a reporting unit will be sold. These examples are not all-inclusive and the company should consider other relevant events or circumstances specific to its reporting units when determining whether to perform step one of the impairment test. Positive and mitigating factors are included in the qualitative assessment.
In performing the qualitative assessment of reporting units with a zero or negative carrying amount, an entity still needs to perform the second step of the goodwill impairment if it concludes that it is more likely than not that goodwill impairment exists. The previous examples of events and circumstances an entity should evaluate in this determination have been replaced with the factors in the previous paragraph. An entity should also consider whether there are significant differences between the carrying amount and the estimated fair value of its assets and liabilities, as well as the existence of significant unrecognized intangible assets. Performance of Step Two requires the calculation of the current fair value of a reporting unit (among other items).
In addition, under the revised standard, an entity is no longer permitted to carry forward its detailed calculation of a reporting unit's fair value from a prior year. Therefore, entities that need to proceed to step one of the impairment test will need to calculate current fair value of the reporting unit. The amendments do not change the current guidance for testing other indefinite-lived assets for impairment, but these have been added to FASB's short-term agenda.
The revised standard is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. A non-public entity that has not yet issued its fiscal 2011 financial statements can adopt the revised standard.
If an entity can support that Step One of the impairment testing process is unnecessary, it can avoid the cost and complexity of determining the reporting unit's current fair value. We suggest that a company that seeks to benefit from the revised standard develop a clear plan for interim and annual goodwill testing. The plan – which should be discussed with the company's auditors and external valuation specialists – should identify the key drivers that would affect each reporting unit's fair value and the documentation that will be necessary to support the company's qualitative assessment of factors used to determine if Step One of the goodwill impairment testing is necessary.
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