FAS 142: Accounting for Goodwill and Intangibles

Statement of Financial Accounting Standards 142 (FAS 142) changed the accounting for goodwill and other intangible assets. Issued in 2001 by the Financial Accounting Standards Board (FASB), it moved away from the practice of systematic amortization for goodwill. Instead, it introduced an impairment testing approach, which dictates that the value of goodwill should only be reduced on the balance sheet when its value is determined to have decreased.

The principles from FAS 142 are now part of the FASB’s Accounting Standards Codification (ASC), the authoritative source for U.S. Generally Accepted Accounting Principles (GAAP). This guidance is found under ASC 350, “Intangibles—Goodwill and Other.” The core concepts of non-amortization for certain intangibles and the requirement for regular impairment testing remain the foundation of modern accounting for these assets.

The Shift from Amortization to Impairment

Previously, Accounting Principles Board (APB) Opinion No. 17 governed goodwill accounting. This standard required companies to amortize goodwill, which is the premium paid in an acquisition over the fair value of the identifiable net assets. Goodwill was amortized on a straight-line basis over its estimated useful life, not to exceed forty years. This practice was based on the idea that goodwill’s value diminishes over time, and this decline should be recognized as a systematic expense on the income statement.

The FASB moved away from this model because goodwill’s value does not necessarily decline in a predictable manner. Unlike machinery that wears out, the value of goodwill, which represents synergies, brand reputation, and customer relationships, could remain stable or even increase. Amortizing goodwill often did not reflect the economic reality of the asset, and the resulting expense was not useful for analyzing a company’s performance.

This led to the introduction of the impairment-only model. For public companies, goodwill is not amortized but is instead tested for impairment at least once a year. An impairment loss is recognized as an expense only when the fair value of the acquired business is less than its recorded amount. The FASB provides an alternative for private companies, which can elect to amortize goodwill on a straight-line basis over ten years or less, requiring impairment testing only when a triggering event occurs.

The Goodwill Impairment Test

The goodwill impairment test is performed at the level of a “reporting unit,” which is a distinct operating segment of a company. The analysis begins with an optional qualitative assessment, or “Step 0.” In this step, a company evaluates economic conditions, industry trends, and other factors to determine if it is more likely than not that the reporting unit’s fair value is less than its carrying amount. If a decline in value is not likely, no further testing is required for that period.

If the qualitative assessment indicates potential impairment, or if a company bypasses it, a quantitative test must be performed. The quantitative test compares the fair value of the reporting unit with its carrying amount (its assets minus liabilities, including goodwill). Determining the fair value is a complex process that may involve valuation techniques like discounted cash flow analysis or analysis of comparable businesses.

If the reporting unit’s carrying amount exceeds its fair value, an impairment loss must be recognized. Originally, the guidance required a second, more complex step to measure the loss, but the FASB eliminated this in 2017 to reduce complexity. The impairment loss is calculated as the amount by which the carrying amount exceeds the fair value, but the loss cannot exceed the total goodwill allocated to that unit. This loss is recorded as a non-cash charge on the income statement, reducing both the carrying value of goodwill and the company’s net income.

Accounting for Other Intangible Assets

ASC 350 also specifies the treatment for intangible assets other than goodwill, dividing them into two categories based on their useful lives. This differentiation dictates whether an asset’s cost is expensed over time or is subject to impairment testing similar to goodwill.

The first category is intangible assets with a finite useful life, such as patents, copyrights, and customer lists that are expected to generate cash flows for a foreseeable period. These assets are amortized over their estimated useful life. The amortization method should reflect the pattern in which the asset’s economic benefits are consumed.

The second category is intangible assets with an indefinite useful life, such as certain trademarks and brand names, for which there is no foreseeable limit on their ability to generate cash flows. These assets are not amortized but are tested for impairment at least annually by comparing the asset’s fair value with its carrying amount. Accounting rules evolve, and recent guidance requires certain crypto assets, previously treated as indefinite-lived intangibles, to be measured at fair value with changes recognized in net income.

Required Financial Statement Disclosures

To ensure transparency, companies must provide detailed disclosures in their financial statement footnotes regarding goodwill and other intangible assets. This information helps investors and analysts understand the composition of these assets and any changes during the reporting period.

For goodwill, a company must disclose the total carrying amount at the beginning and end of the period, with a reconciliation of the changes. This reconciliation details any goodwill acquired, impairment losses recognized, and adjustments from business disposals. If an impairment loss is recorded, the company must also describe the circumstances leading to the impairment and the method used to determine the reporting unit’s fair value.

Disclosures for other intangible assets must be separated by major asset class, such as brand names or patents, and distinguish between assets with finite and indefinite lives. For amortized intangibles, the disclosure must include the gross carrying amount, accumulated amortization, and total amortization expense for the period. For unamortized intangibles, the carrying amount for each major class must be presented.