FAS No. 142: Accounting for Goodwill and Intangibles

A significant change in accounting for intangible assets occurred with Financial Accounting Standard (FAS) No. 142. This standard replaced the practice of systematic amortization, where the value of these assets was gradually reduced over a set period, with an impairment-only model. The principles originally set forth in FAS 142 have since been integrated into the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) under Topic 350, “Intangibles—Goodwill and Other,” which is the authoritative source for U.S. Generally Accepted Accounting Principles (GAAP).

The shift to an impairment-only approach was driven by the view that certain intangible assets do not lose value in a predictable, time-based manner. Instead, their value is only reduced when economic circumstances indicate a loss has occurred. This guidance requires companies to assess the value of these assets periodically and recognize a loss only when their carrying value exceeds their fair value. This approach aims to provide financial statement users with more relevant information by reflecting the current economic value of these assets.

Scope and Key Assets Covered

The guidance within ASC 350 applies to intangible assets that a company acquires, whether purchased individually or as part of a business combination. These assets are categorized into two main types that fall under the impairment-only model. The first is goodwill, which arises during a business acquisition and represents the premium the acquiring company pays over the fair value of the identifiable net assets of the business it purchases. This amount captures assets like brand reputation, customer loyalty, and synergies.

The second category is indefinite-lived intangible assets. An asset is classified in this group if there is no foreseeable limit on the period over which it is expected to contribute to a company’s cash flows. Common examples include trademarks that can be renewed perpetually, broadcast licenses, and certain perpetual franchise rights. These assets are not amortized because their economic life is not considered to be finite.

In contrast, finite-lived intangible assets are outside the scope of the impairment-only rules. Assets like patents, copyrights, and customer lists have a limited legal or economic life. They are still subject to amortization, meaning their cost is expensed over their estimated useful lives.

The Goodwill Impairment Test

Public companies must test goodwill for impairment at least annually, and this test must be performed at the same time each year. A test is also required between annual assessments if a “triggering event” occurs. A triggering event is an event or change in circumstances that suggests the fair value of a reporting unit may have fallen below its carrying amount, such as a significant adverse change in the business climate or the loss of key personnel.

An accounting alternative is available for private companies, which can elect to amortize goodwill on a straight-line basis over a period not to exceed 10 years. If a private company chooses this option, it is no longer required to perform an impairment test annually. Instead, it only needs to test goodwill for impairment when a triggering event occurs.

To reduce the cost and complexity of impairment testing, companies can first perform an optional qualitative assessment. In this step, a company evaluates economic conditions and entity-specific factors to determine if it is “more likely than not” that the fair value of a reporting unit is less than its carrying amount. A “more likely than not” threshold is a likelihood of more than 50 percent, and if the assessment indicates a decline in value is not likely, no further testing is necessary.

If the qualitative assessment is skipped or indicates a potential impairment, the company must proceed to a quantitative test. The test involves comparing the fair value of a reporting unit to its carrying amount, including the allocated goodwill. A reporting unit is an operating segment of a company or a business unit one level below an operating segment. Should the carrying amount of the reporting unit exceed its fair value, an impairment loss is recognized for the excess, though the loss cannot be greater than the total goodwill allocated to that unit.

Accounting for Other Indefinite-Lived Intangible Assets

The impairment test for indefinite-lived intangible assets other than goodwill, such as a trademark or a broadcast license, follows a more direct process. These assets are tested for impairment at the individual asset level rather than at the reporting unit level. The test is performed at least annually, or more frequently if a triggering event indicates the asset might be impaired, and it should be done at the same time each year.

Similar to the goodwill test, companies have the option to first perform a qualitative assessment to determine if the full quantitative test is necessary. An entity can evaluate relevant events and circumstances to see if it is more likely than not that the intangible asset is impaired. Factors to consider could include a decline in the asset’s market demand or adverse legal factors. If this assessment suggests an impairment is not likely, no further steps are needed.

If the quantitative test is required, the process is a straightforward, one-step comparison. The company compares the fair value of the specific intangible asset with its carrying amount on the balance sheet. If the carrying amount of the asset is greater than its fair value, an impairment loss is recorded for the difference. For example, if a trademark has a carrying value of $1 million but a market downturn reduces its fair value to $700,000, a $300,000 impairment loss would be recognized.

Financial Statement Presentation and Disclosure

When a company recognizes an impairment loss for goodwill or another indefinite-lived intangible asset, the amount must be presented as a separate line item within income from continuing operations on the income statement. Detailed disclosures are also required in the footnotes to the financial statements. For each goodwill impairment loss recognized, the company must describe the facts and circumstances that led to the impairment, the amount of the loss, and the method used to determine the fair value of the associated reporting unit.

Companies must also provide a detailed reconciliation of the carrying amount of goodwill for the period. This disclosure, found in the footnotes, shows the beginning balance of goodwill, the amount of any new goodwill acquired through business combinations, and any impairment losses recognized. The ending balance gives investors a clear picture of the changes in the company’s goodwill account from one period to the next.