A Practical Guide to Accounting Standards Codification 350 and Goodwill Impairment Testing

You sit down at your desk, coffee in hand, and open the file containing the company’s latest financial statements. As chief accountant, it’s your job to ensure these comply with GAAP. Your eyes scan over the various accounts until they land on goodwill – an intangible asset representing things like brand recognition and customer loyalty. You know this requires impairment testing under ASC 350 to ensure it’s not overstated on the balance sheet. While complex, you see this task as vitally important; accounting standards exist to provide useful information to financial statement users. You take a sip of coffee, cracks your knuckles, and begin your analysis. You have a duty to shareholders and must apply these rules objectively. Time to put ASC 350 to work.

Overview of ASC 350 and Goodwill Impairment

ASC 350, also known as the “Intangibles – Goodwill and Other” accounting standard, requires companies to annually evaluate goodwill for impairment. Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination.

Companies must test goodwill for impairment at least annually at the reporting unit level. A reporting unit is an operating segment or one level below an operating segment. The test involves comparing the fair value of each reporting unit to its carrying amount, including goodwill. If the fair value is less than the carrying amount, an impairment loss must be recognized.

  • Fair value can be determined using a market approach (comparing to similar businesses), an income approach (discounted cash flow analysis), or a combination of both.
  • The loss recognized is the difference between the fair value and carrying amount of the reporting unit, not to exceed the total amount of goodwill.
  • Once recognized, an impairment loss cannot be reversed in future periods.

ASC 350 aims to ensure that goodwill is not overstated on the balance sheet and that any deterioration in value is properly recorded in the income statement. Performing goodwill impairment testing requires significant judgment and estimates which can be complex and subject to uncertainties. Following ASC 350 guidance helps promote consistency and transparency in financial reporting.

Goodwill

Goodwill impairment testing requires judgment and estimates that can have a material impact on the financial statements. As an accountant, you must evaluate goodwill for impairment at least annually or more frequently if events or changes in circumstances indicate that goodwill may be impaired.

To test for impairment, you first need to identify the reporting units that goodwill is assigned to. This is typically at the operating segment level or one level below. Then determine the fair value of each reporting unit. This can be estimated using discounted cash flow models, guideline company methods, or other valuation techniques.

If the fair value of a reporting unit is less than its carrying amount, including goodwill, you must determine the implied fair value of goodwill. This involves valuing all assets and liabilities of the reporting unit as if it had been acquired in a business combination. Any excess of the fair value of the reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill.

An impairment loss is recognized if the carrying amount of goodwill exceeds its implied fair value. The loss cannot exceed the carrying amount of goodwill and must be allocated to each asset in the unit proportionally based on the relative fair values.

Impairment testing goodwill is more art than science. Judgment is required in determining reporting units, estimating fair values, and allocating impairment losses. Following the principles of transparency and conservatism, as accountants we must apply our professional judgment objectively and document the process thoroughly. Our role is to provide unbiased financial information to help stakeholders make better decisions, not manipulate results to achieve desired outcomes. Integrity is the bedrock of our profession.

General Intangibles Other Than Goodwill

When reviewing intangible assets for impairment under ASC 350, the first step is to identify intangibles other than goodwill that could be impaired. These include:

  • Trademarks, trade names, or brand names: The value of a brand is based on customer awareness, loyalty, and perception. If the brand image has declined or legal rights to a trade name have expired, impairment may exist.
  • Customer relationships: Relationships with major customers represent an intangible asset that could become impaired if a key customer contract is lost or not renewed.
  • Technology-based intangibles: Patents, proprietary processes, and software can lose value over time as technology changes. Regular reviews are needed to determine if remaining useful lives are appropriate or if impairment exists.
  • Contract-based intangibles: Franchise agreements, licenses, permits, and contracts that generate cash flows could be impaired if the contractual rights expire or cash flows decline significantly.

Once potentially impaired intangibles have been identified, determine if events and circumstances indicate their carrying amounts may not be recoverable. Compare undiscounted cash flows to the carrying amount of the intangible. If undiscounted cash flows are less than the carrying amount, the intangible may be impaired.

In that case, determine the fair value of the intangible and recognize an impairment loss for the excess of carrying amount over fair value. Fair value can be estimated using discounted cash flow models, market comparisons, or other valuation techniques.

Impairment of intangibles other than goodwill is often overlooked, so careful analysis under ASC 350 is important. Reviewing intangibles regularly and when events occur that could indicate impairment will help ensure carrying amounts remain fair and recoverable on an ongoing basis.

When to Test Goodwill for Impairment Under ASC 350

When should companies test goodwill for impairment under ASC 350? According to the accounting standards codification, goodwill must be tested for impairment at least annually or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

Some indicators that may signal goodwill impairment and require interim testing include:

  • Significant adverse changes in the business climate or legal factors
  • Loss of key personnel
  • Decline in stock price and market capitalization
  • Slower growth rates

If any of these unfavorable events transpire, management should reassess goodwill for impairment to determine if the carrying value still exceeds the fair value. It is better to test goodwill for impairment too frequently rather than not enough. Some companies choose to test goodwill for impairment at the same time each year, such as at the end of the fiscal year. This provides consistency and allows for year-over-year comparisons.

When goodwill impairment testing is required either annually or due to a triggering event, companies should follow a two-step goodwill impairment test. Step 1 compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value is less than the carrying amount, step 2 is required to measure the amount of impairment loss. The loss is calculated as the excess of the reporting unit’s carrying amount over its fair value, not to exceed the total amount of goodwill allocated to that reporting unit. Any goodwill impairment loss must be recognized as a loss in the income statement.

In summary, goodwill impairment testing is required at least once a year as well as upon the occurrence of events or changes in circumstances that would indicate the carrying amount of goodwill may not be recoverable. Following the proper goodwill impairment testing procedures is critical to ensure goodwill is not overstated on the balance sheet.

How to Calculate Goodwill Impairment Under ASC 350

Step 1: Identify Reporting Units

First, you must identify your company’s reporting units. These are components of your business for which discrete financial information is available and reviewed regularly by management. Often, reporting units are the same as operating segments or one level below.

Step 2: Determine Carrying Value

Calculate the carrying value of each reporting unit by assigning assets and liabilities, including goodwill. The carrying value represents what is on your balance sheet.

Step 3: Estimate Fair Value

Estimate the fair value of each reporting unit. Fair value is the price that would be received to sell the unit as a whole in an orderly transaction between market participants. Use a discounted cash flow model or a market multiple approach.

Step 4: Compare Carrying Value to Fair Value

Compare the carrying value of each reporting unit to its estimated fair value. If a reporting unit’s carrying value exceeds its fair value, goodwill impairment may exist.

Step 5: Measure and Record Impairment Loss

To measure the impairment loss, calculate the implied fair value of goodwill. This is done by allocating the fair value of the reporting unit to all of its assets and liabilities, with the residual amount being the implied fair value of goodwill. An impairment loss should be recognized for the amount by which the carrying amount of goodwill exceeds its implied fair value. The loss should be recorded as an operating expense on the income statement and reduces the carrying value of goodwill on the balance sheet.

Following these steps carefully and accurately can help ensure you properly test goodwill for impairment under ASC 350. Early identification of potential goodwill impairment allows you to determine appropriate next steps to avoid or minimize the impact.

Best Practices for Goodwill Impairment Testing

To effectively test goodwill for impairment, there are several best practices to keep in mind:

  • Perform impairment testing annually. According to ASC 350, goodwill must be tested for impairment at least once every year. It is best to test goodwill at the same time each year, such as at the end of the company’s fiscal year.
  • Use a two-step process. Follow the guidance in ASC 350 to first assess if the fair value of a reporting unit is less than its carrying amount. If so, proceed to calculate the implied fair value of goodwill to determine if an impairment loss should be recognized.
  • Compare to relevant benchmarks. Compare the fair value of reporting units to relevant benchmarks like the value of comparable companies and recent transactions of similar businesses. These benchmarks can provide objective evidence to support your fair value estimates.
  • Document assumptions and estimates. Thoroughly document all assumptions and estimates used to determine the fair value of reporting units. Be prepared to explain them to auditors. Changes in assumptions and estimates from prior years should also be documented and explained.
  • Consider all forms of value. When estimating the fair value of a reporting unit, consider market, income and cost approaches. The approach or approaches selected should be those that are most representative of the reporting unit’s fair value.
  • Review for triggering events. Continuously review for events or changes in circumstances that could trigger an impairment review outside of the required annual test, such as a significant adverse change in the business climate or a decline in market capitalization below book value.
  • Impairment charges are permanent. Remember, impairment charges reduce the carrying amount of goodwill permanently. They cannot be reversed in future periods. Exercise caution to avoid unnecessary write-downs of goodwill.

Conclusion

While accounting standards can seem dry and technical, ASC 350 and goodwill impairment testing illustrate how principles affect real-world business decisions. By looking beyond the numbers to see standards as guidelines for presenting useful financial information, accountants serve a vital role. Though you may forget the details over time, remember that standards aim to reflect economic reality. Approach them not as arbitrary rules to follow, but as tools to apply with professional judgment. Through this lens, you can transform abstract accounting into a narrative of business performance. The standards are a means to an end of accurate, decision-useful reporting. Keep this firmly in mind as you perform impairment testing and make key accounting choices. Let ASC 350 guide you in telling the company’s financial story.

How Can Eton Help?

At Eton Venture Services, we are dedicated to helping you accurately report the value of your intangible assets through rigorous and defensible goodwill impairment testing. Don’t risk your company’s critical financial reporting compliance efforts with software-driven “form” models or inexperienced teams. Trust Eton’s team of experts to provide you with precise, compliant, and independent valuations that safeguard your interests and ensure compliance while maximizing tax advantages. Join the industry leaders who have already benefited from our exceptional client service and valuation expertise. Let Eton Venture Services guide you through the complexities of goodwill impairment testing and financial reporting compliance during uncertainies around triggering events. Contact Eton Venture Services today.

FAQs on Accounting Standards Codification 350 and Goodwill Impairment

If you are responsible for preparing and auditing financial statements, you likely have questions about Accounting Standards Codification 350 regarding goodwill impairment. Here are some common FAQs to help strengthen your understanding:

What is goodwill impairment?

Goodwill impairment refers to a reduction in the value of goodwill, an intangible asset on the balance sheet representing the excess of the purchase price over the fair value of net assets acquired in a business combination.

Goodwill impairment testing involves comparing the fair value of a reporting unit to its carrying amount, including goodwill. If the carrying amount exceeds fair value, goodwill may be impaired. Fair value is estimated using discounted cash flow models and market multiples.

Public companies test goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate the fair value of a reporting unit may have declined below its carrying amount. Private companies can elect to test less frequently.

Step 1) Identify reporting units.

Step 2) Determine reporting unit fair values.

Step 3) Compare fair values to carrying amounts.

Step 4) Recognize any impairment loss.

The loss is the excess of carrying amount over fair value, not to exceed the amount of goodwill allocated to that reporting unit.

An impairment loss reduces the carrying amount of goodwill and is recorded as an operating expense, decreasing net income and equity. Future amortization expense may also decrease. The fair value becomes the new basis for future impairment tests.

Indicators include reduced cash flows, loss of key personnel, increased competition, change in regulatory environment, disposition of a significant portion of a reporting unit, and change in business environment. If present, test goodwill for impairment between annual tests.

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President & CEO

Chris co-founded Eton Venture Services in 2010 to provide mission-critical valuations to venture-based companies. He works closely with each client’s leadership team, board of directors, internal / external counsel, and independent auditor to develop detailed financial models and create accurate, audit-proof valuations.

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