ASC 350-20: Goodwill Impairment and Accounting Rules
Delve into the accounting principles of ASC 350-20, covering how goodwill is valued post-acquisition and managed under different models for public and private entities.
Accounting Standards Codification (ASC) 350-20 provides the guidance for how companies account for goodwill after it is recorded. Goodwill is an asset representing the future economic benefits a company expects from a business acquisition that cannot be attributed to other identifiable assets. It includes synergies, an assembled workforce, and the market position that an acquirer pays for.
ASC 350-20 establishes a model focused on periodic review rather than gradual amortization for most entities. This approach requires companies to regularly assess whether the value of their acquired goodwill has diminished.
Initial Recognition and Measurement of Goodwill
Goodwill is recorded on a company’s balance sheet only through a business combination, a process governed by ASC 805. It represents the premium paid over the fair value of the identifiable net assets of the company being acquired. The calculation is a residual amount. An acquirer must first measure the fair value of all identifiable assets acquired and liabilities assumed.
The aggregate fair value of these net assets is then subtracted from the purchase price. If the purchase price is higher, that excess amount is recorded as goodwill. For example, if a company pays $50 million to acquire a business with identifiable assets valued at $60 million and liabilities of $20 million, the net asset fair value is $40 million. The goodwill recorded would be $10 million, which is the difference between the $50 million purchase price and the $40 million in net assets.
Subsequent Accounting for Goodwill
For public business entities, goodwill is not amortized, meaning it is not systematically expensed over a set period. This is based on the principle that goodwill can have an indefinite useful life, unlike assets such as buildings or machinery that wear out. Instead of amortization, goodwill is subject to impairment testing. Impairment occurs when the carrying value of an asset on the balance sheet exceeds its fair value.
Under ASC 350-20, companies must test goodwill for impairment at least once a year. Companies must also perform an impairment test between annual assessments if a “triggering event” occurs. A triggering event is a change in circumstances suggesting that the fair value of a reporting unit may have fallen below its carrying amount, such as an adverse change in the business climate, new competition, or the loss of key personnel.
The Goodwill Impairment Test
The process of testing goodwill for impairment begins with an optional qualitative assessment, sometimes called “step zero.” This allows a company to evaluate economic and business conditions to determine if a full quantitative test is necessary. The objective is to assess whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If this assessment indicates no likely impairment, no further action is needed until the next testing period.
If the qualitative assessment is skipped or indicates a potential impairment, the company must proceed to the quantitative impairment test. This test is performed at the “reporting unit” level, which is an operating segment or one level below it. The current test is a single-step approach where a company compares the fair value of the reporting unit with its carrying amount.
If the carrying amount of the reporting unit exceeds its fair value, an impairment loss must be recognized for the difference. For instance, if a reporting unit has a carrying amount of $100 million, which includes $15 million of goodwill, and its fair value is $90 million, an impairment loss of $10 million is recorded. The impairment loss cannot exceed the total amount of goodwill allocated to that reporting unit.
Private Company Accounting Alternative
The Financial Accounting Standards Board (FASB) provides an accounting alternative for non-publicly traded entities. This Private Company Council (PCC) alternative is designed to simplify the complexities and reduce the costs of goodwill accounting. Eligible private companies can elect this alternative, which changes how they account for goodwill after its initial recognition.
The most significant change is that private companies can choose to amortize goodwill. The amortization is done on a straight-line basis over a useful life of ten years, or a shorter period if the company can demonstrate another useful life is more appropriate.
This election also simplifies impairment testing. A private company that amortizes goodwill is no longer required to perform the annual impairment test. Instead, testing is only performed when a triggering event occurs, indicating that the fair value of the company or a reporting unit may be below its carrying amount.
Financial Statement Disclosure Requirements
Companies must provide detailed information about their goodwill in the footnotes of their financial statements. These disclosures are mandated by ASC 350-20 to give investors a clear understanding of this asset. A primary disclosure is a reconciliation of the beginning and ending carrying amounts of goodwill, which separately identifies the gross amount of goodwill acquired and any impairment losses recognized.
When a goodwill impairment loss is recorded, the company must describe the facts and circumstances that led to the impairment and state the amount of the loss. It must also disclose the method used to determine the fair value of the associated reporting unit. For private companies that elect the accounting alternative, additional disclosures are required, including the amortization period for goodwill and the total amortization expense recognized.