What ASU 2017-04 Means for Goodwill Impairment Testing

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2017-04 to reduce the cost and complexity of financial reporting for goodwill. Goodwill is an intangible asset recorded during a business acquisition, representing the premium paid over the fair value of identifiable assets. Historically, testing this asset for a decline in value, known as impairment, was a complicated process that many found burdensome.

ASU 2017-04 streamlines the measurement of goodwill impairment by removing a complex step from the test. This change provides more timely information to investors and simplifies the accounting without altering the underlying principle of when goodwill should be evaluated. The updated standard makes the process more efficient for all entities with goodwill on their balance sheets.

The Two-Step Goodwill Impairment Test Before the Update

Before ASU 2017-04, entities followed a two-step quantitative impairment test outlined in Accounting Standards Codification (ASC) Topic 350. This process was performed annually, or more frequently if certain events indicated a potential decline in value. The first step involved comparing the fair value of a reporting unit to its carrying amount, which is the value recorded on the company’s balance sheet.

If a reporting unit’s carrying amount exceeded its fair value, the company had to proceed to the second step. If the fair value was greater than the carrying amount, no further action was needed. This initial step acted as a screen to determine if a more detailed calculation was necessary.

The second step was the source of the complexity that the new standard eliminated. In this step, a company had to determine the implied fair value of the reporting unit’s goodwill. This required performing a hypothetical purchase price allocation for the reporting unit as of the testing date. The process involved assigning the fair value of the reporting unit to all of its assets and liabilities as if it had just been acquired.

The excess of the reporting unit’s fair value over the amounts assigned to its assets and liabilities was considered the implied fair value of goodwill. This implied value was then compared to the carrying amount of the goodwill. An impairment loss was recognized for any amount by which the carrying amount of goodwill exceeded its implied fair value.

The Simplified Test Under ASU 2017-04

ASU 2017-04 simplifies the goodwill impairment test by eliminating the second step. Under the new guidance, an entity performs a single quantitative assessment by comparing the fair value of a reporting unit with its carrying amount. If the carrying amount is higher than the fair value, an impairment loss is recognized for the difference, removing the need for the hypothetical purchase price allocation.

A constraint under the simplified test is that the recognized impairment loss cannot exceed the total amount of goodwill allocated to that reporting unit. For example, a reporting unit has a carrying amount of $10 million, which includes $2 million of goodwill. If its fair value is $9 million, the carrying amount exceeds the fair value by $1 million, and the company records a $1 million impairment charge. If the fair value was instead $7.5 million, the impairment charge would be capped at the $2 million carrying amount of goodwill.

The update preserves the option for entities to first perform a qualitative assessment, sometimes called “Step 0.” This allows companies to determine if it is more likely than not that a reporting unit’s fair value is less than its carrying amount. If an impairment is deemed unlikely based on economic and industry factors, the quantitative test can be avoided. Otherwise, the one-step quantitative test must be performed.

The new guidance applies the same impairment testing methodology to all reporting units, including those with a zero or negative carrying amount. Previously, these reporting units were subject to different considerations. This standardization improves the consistency of financial reporting for goodwill.

Applicability and Effective Dates

The simplified goodwill impairment test under ASU 2017-04 applies to all public business entities and not-for-profit entities with goodwill on their balance sheets. The FASB established a staggered implementation schedule. For public business entities that are U.S. Securities and Exchange Commission (SEC) filers, the guidance became effective for fiscal years beginning after December 15, 2019.

Public business entities that are not SEC filers were required to apply the new standard for fiscal years beginning after December 15, 2020. All other entities, including not-for-profits, had an effective date for fiscal years beginning after December 15, 2021. Early adoption was also permitted.

It is important to distinguish this update from an alternative available to certain entities. The FASB previously provided a separate option for private companies, allowing them to amortize goodwill over a period of up to ten years and use a simplified impairment test. This private company alternative was later extended to not-for-profit entities. As a result, not-for-profits can elect to either adopt the one-step impairment test under ASU 2017-04 or choose the option of amortizing goodwill.