Accounting Concepts and Practices

What Is ASC 350-20-35 for Goodwill Impairment?

ASC 350-20-35 provides the accounting framework for goodwill's subsequent measurement, detailing the process to assess if its carrying amount exceeds its fair value.

The Financial Accounting Standards Board (FASB) details how companies account for goodwill in Accounting Standards Codification (ASC) 350-20-35. When a company acquires another business for a price higher than the fair value of its identifiable assets, the excess amount is recorded as goodwill. This represents intangible assets like brand reputation, customer relationships, or proprietary technology. The purpose of this standard is to ensure the value of goodwill on financial statements reflects its economic reality.

For public companies, goodwill is not amortized, or gradually expensed over time. Instead, it must be periodically evaluated for impairment to ensure its recorded value is not overstated compared to its fair value. This process provides a systematic method for companies to assess whether the value of their goodwill has declined.

The Goodwill Impairment Test Trigger

A company must test a reporting unit’s goodwill for impairment under two circumstances. The first is on an annual basis. This yearly test can be performed at any point during the fiscal year, but the timing must be consistent each year to ensure the comparability of financial data.

The second circumstance is the occurrence of a triggering event, which is a change in circumstances suggesting it is more likely than not that the fair value of a reporting unit has fallen below its carrying amount. Examples of triggering events include:

  • Significant adverse changes in the business climate or legal factors
  • The loss of key personnel
  • An expectation that a reporting unit or a significant portion of it will be sold
  • A sustained decrease in the company’s stock price

This list is not exhaustive, and management must use judgment to identify other relevant events. Before testing goodwill for impairment, a company must first assess other assets for impairment. For instance, if a group of long-lived assets like property, plant, and equipment needs to be tested, that test must be completed first. This sequence is required because the carrying amount of the reporting unit must reflect any impairment losses on other assets before the goodwill test begins.

Performing the Qualitative Assessment

As an optional first step in the annual impairment test, a company can perform a qualitative assessment, known as “Step 0.” The goal is to determine if it is more likely than not (a greater than 50% chance) that a reporting unit’s fair value is less than its carrying amount. If the assessment indicates this is not the case, no further action is needed for that period.

If the assessment indicates an impairment is likely, or if the company skips the qualitative assessment, it must perform the quantitative test. When performing the qualitative assessment, management considers a variety of factors, including:

  • Macroeconomic conditions, such as a deterioration in the general economy
  • Industry and market considerations, like a decline in market-dependent metrics
  • Cost factors, such as increases in raw materials or labor
  • Entity-specific items, like a negative trend in operating results or a change in management

A company must weigh all events and circumstances to form a conclusion, as no single factor is determinative. A company with a significant cushion between its fair value and carrying amount from its last quantitative test may be able to withstand more negative factors before a new quantitative test is necessary.

The Quantitative Impairment Test

A company must perform a quantitative impairment test if it skips the qualitative assessment or if that assessment indicates a potential issue. This single-step process compares the fair value of a reporting unit with its carrying amount. A reporting unit is an operating segment, or one level below it, where goodwill is tested.

The carrying amount is the unit’s value as recorded on the company’s books. This includes all of its assets and liabilities, such as accounts receivable, inventory, and property, plant, and equipment, plus the goodwill allocated to that unit. The fair value is the price the reporting unit would sell for in an orderly transaction between market participants. Companies estimate this value using techniques like the discounted cash flow method or by analyzing comparable business transactions.

If the reporting unit’s fair value is greater than or equal to its carrying amount, no impairment exists, and the test is complete. If the carrying amount exceeds the fair value, an impairment has occurred, and the company must measure the loss. This simplified single-step test replaced a more complex two-step process in 2017.

Recognizing and Measuring the Impairment Loss

When a quantitative test shows that a reporting unit’s carrying amount is greater than its fair value, the company must recognize an impairment loss. The loss is the amount by which the carrying amount exceeds the fair value. However, the impairment loss cannot exceed the total amount of goodwill allocated to that reporting unit.

For example, if a reporting unit has a carrying amount of $10 million and a fair value of $9 million, the impairment is $1 million. If the unit’s allocated goodwill is $1.5 million, the full $1 million loss is recognized. If the allocated goodwill was only $700,000, the loss would be capped at $700,000.

The loss is recorded by debiting a “Goodwill Impairment Loss” expense account and crediting the “Goodwill” asset account, reducing its value on the balance sheet. The impairment loss must be presented as a separate line item within income from continuing operations on the income statement, unless it is associated with a discontinued operation. Once an impairment loss is recognized, it cannot be reversed in a future period, even if the reporting unit’s fair value recovers.

Accounting Alternative for Private Companies

Private companies and not-for-profit entities can use an accounting alternative that simplifies how they account for goodwill. This option, from the FASB’s Private Company Council (PCC), allows them to amortize goodwill and use a simpler impairment testing model.

A private company can elect to amortize goodwill on a straight-line basis over 10 years. A shorter period may be used if the company can demonstrate that another useful life is more appropriate. This amortization is recorded as a periodic expense, gradually reducing the goodwill balance over time.

This election also changes impairment testing. Instead of an annual test, a private company using this alternative only tests for impairment when a triggering event occurs, reducing complexity and cost. The triggering events are similar to those for public companies. The test itself is also simpler, as the company can perform it at the entity level as a whole instead of for each reporting unit. The impairment loss is the amount by which the entity’s carrying amount exceeds its fair value, capped at the total amount of goodwill.

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