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.
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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.
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 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.
Read: 8 Real-World Examples of Goodwill Impairment (With HUGE Impact).
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:
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.
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:
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.
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.
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.
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.
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.
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.
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.
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. Reach out to explore our services further.
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:
ASC 350 mandates annual testing of goodwill for impairment, typically at the reporting unit level. Companies must also test goodwill whenever a triggering event or change in circumstances indicates that the fair value of a reporting unit may have decreased.
A reporting unit in ASC 350 is an operating segment or a component of an operating segment for which discrete financial information is available and regularly reviewed by management. Goodwill is tested for impairment at the reporting unit level, meaning each unit’s fair value is compared to its carrying amount, including goodwill. Properly defining reporting units is necessary for ensuring that goodwill impairment testing accurately reflects the economic conditions and risks specific to each part of the business.
The qualitative assessment, often referred to as “Step 0,” allows companies to evaluate whether it’s more likely than not (a likelihood of over 50%) that the fair value of a reporting unit is less than its carrying amount before proceeding with the quantitative test. If qualitative factors suggest no impairment, companies can skip the quantitative test, potentially saving time and resources. Qualitative factors include macroeconomic conditions, industry trends, financial performance, and changes in management or customer base.
No, once an impairment loss is recorded, it is permanent. ASC 350 does not allow for the reversal of impairment losses in future financial periods, as they reflect a long-term decline in asset value.
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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.
