Accounting for Intangible Asset Impairment

Intangible assets are non-physical assets, such as goodwill, trademarks, and patents, that provide economic value. Over time, the value of these assets can decrease, a condition known as impairment. Impairment is the process of reducing an asset’s carrying value on the balance sheet to its fair value. This adjustment ensures financial statements accurately reflect that an asset is no longer expected to generate its originally anticipated economic benefits.

Identifying When to Test for Impairment

The timing for impairment testing depends on the type of intangible asset. For indefinite-lived intangible assets, such as goodwill and certain trademarks, U.S. Generally Accepted Accounting Principles (GAAP) require testing for impairment at least annually. For goodwill, this annual test must be performed at the same time each year. Companies must also test these assets more frequently if events suggest that it is “more likely than not” that the asset’s fair value has fallen below its carrying amount.

For finite-lived intangible assets, like patents or customer lists that are amortized over their useful lives, impairment testing is not required annually. Instead, these assets are tested only when a “triggering event” occurs, which is an indicator that the asset’s carrying amount may not be recoverable.

Common triggering events include:

• A significant adverse change in the business climate or in the specific industry in which the company operates.
• Legal factors, like an unfavorable court ruling related to a patent, or the loss of key personnel.
• A history of operating or cash flow losses associated with the asset.
• A forecast that projects continued losses associated with the asset.

The Impairment Testing Process for Intangible Assets (Other Than Goodwill)

For intangible assets other than goodwill, the testing process can begin with an optional qualitative assessment. This initial step allows a company to evaluate relevant events and circumstances to determine if it is more likely than not that the asset’s fair value is less than its carrying amount. Factors considered can include deteriorating market conditions or negative financial performance. If this analysis concludes an impairment is not likely, no further testing is required.

Should the qualitative assessment be skipped or if it indicates a potential impairment, the company must proceed to the quantitative impairment test. This test is a direct comparison of the intangible asset’s fair value with its carrying amount. If the carrying amount is higher than the fair value, the asset is considered impaired, and a loss must be recognized.

Determining the fair value of an intangible asset is a part of the quantitative test and often requires judgment. Common valuation methods include the discounted cash flow (DCF) approach, which projects the future cash flows the asset is expected to generate and discounts them to a present value. Another technique is the relief-from-royalty method, which estimates the royalty payments the company would have to pay if it did not own the asset.

The Goodwill Impairment Test

The process for testing goodwill for impairment is distinct because goodwill cannot be separated and sold from the business that generated it. Consequently, goodwill impairment is evaluated at the “reporting unit” level. A reporting unit is an operating segment of a company or a component one level below an operating segment. All goodwill acquired in a business combination must be assigned to one or more reporting units.

Similar to other indefinite-lived intangibles, the goodwill impairment test starts with an optional qualitative assessment. Management can assess factors like macroeconomic conditions and the financial performance of the reporting unit to determine if it is more likely than not that the unit’s fair value is less than its carrying amount. If an impairment is not likely based on this review, the quantitative test can be bypassed.

If a quantitative test is necessary, it involves a single-step comparison. The fair value of the entire reporting unit is compared to its carrying amount, which includes the allocated goodwill. If the carrying amount of the reporting unit exceeds its fair value, a goodwill impairment loss is recognized for the difference. Determining the fair value of a reporting unit often involves income approaches, like a DCF analysis, or market approaches that look at comparable company transactions.

Measuring and Recording the Impairment Loss

Once an impairment has been identified, the next step is to measure and record the financial impact. For an intangible asset other than goodwill, the impairment loss is the amount by which the asset’s carrying value exceeds its fair value. This difference is recorded as a loss on the income statement, reducing the company’s net income.

For goodwill, the impairment loss is the amount by which the reporting unit’s carrying amount exceeds its fair value. The recognized impairment loss cannot be greater than the total amount of goodwill allocated to that specific reporting unit. After an impairment loss is recognized, the new, lower carrying amount becomes the asset’s new accounting basis. Under U.S. GAAP, impairment losses recorded for intangible assets cannot be reversed in future periods.

The accounting entry to record the loss involves a debit to an “Impairment Loss” account and a credit to the specific intangible asset account. For example, if a trademark with a carrying value of $1 million is found to have a fair value of $700,000, the company would record a $300,000 impairment loss. This entry reduces the asset’s value on the balance sheet and recognizes an expense on the income statement.

Financial Statement Disclosures

After an impairment loss is recorded, companies are required to provide specific information in the notes to their financial statements. These disclosures are mandated by U.S. GAAP, primarily under ASC 350 and ASC 360, to ensure that users of the financial statements understand the impact of the impairment.

The required disclosures include a description of the impaired asset and the specific facts and circumstances that resulted in the impairment. The company must also disclose the total amount of the impairment loss and specify the line item on the income statement where the loss is included.

The notes must explain the method or methods used to determine the asset’s fair value. If a discounted cash flow model was used, for instance, the company should disclose the key assumptions applied, such as the discount rate and growth rates. These disclosures about fair value measurement fall under the requirements of ASC 820.