Clearing up confusion over goodwill impairment rules

Private companies are struggling with how to apply the goodwill impairment model in today’s uncertain, volatile conditions. Here is a closer look at the rules and how to interpret them.

Evolving guidance

During a September 22, 2020, meeting of the Private Company Council (PCC), the primary advisory body to the Financial Accounting Standards Board (FASB) on private company matters, members discussed concerns from private companies about how to apply the impairment model for goodwill during the COVID-19 crisis. Under U.S. Generally Accepted Accounting Principles (GAAP), goodwill is an intangible asset that may have to be reported as the result of a business merger or acquisition. The book (or carrying) value of goodwill is determined by deducting the fair market value of tangible assets, identifiable intangible assets, and liabilities obtained in the purchase from the purchase cost.

Goodwill becomes impaired if its fair value declines below the amount reported on the company’s balance sheet. Impairment write-downs reduce the carrying value of goodwill on the balance sheet. They also lower profits reported on the income statement.

Over the past decade, the FASB has changed or simplified the accounting model for goodwill several times. In 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-02, Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill. The updated standard created an alternative that allows private companies to elect to amortize goodwill on a straight-line basis over a period not to exceed 10 years. Private companies that elect this alternative aren’t required to test goodwill for impairment each year, but they’re still required to test goodwill for impairment when a triggering event happens.

Examples of triggering events include the loss of a key customer, unanticipated competition or negative cash flows from operations. Impairment may also occur if, after an acquisition has been completed, there’s a stock market or economic downturn that causes the parent company or the acquired business to lose value.

In 2017, the FASB issued Accounting Standards Update (ASU) No. 2017-04, Intangibles — Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The updated standard eliminated the second step of the quantitative two-step impairment test and allowed for early adoption for tests performed after January 1, 2017. In 2019, the FASB issued ASU No. 2019-06, which extended the private company accounting alternatives to nonprofit entities.

Common misconception

When testing for impairment during the pandemic, some companies have been combining goodwill with other long-lived assets. For example, though these companies might recognize that there was a triggering event associated with COVID-19 in April, they’re not recognizing impairment because they believe that, overall, asset values recovered by August or September.

What these companies fail to recognize is that there are two distinct models that they need to apply — one for goodwill and a different model for long-lived assets. So, it’s generally inappropriate to lump these analyses together.

Educational outreach vs. rule changes

The PCC believes that educational outreach will help companies understand the full messaging behind the guidance for goodwill impairment testing. When addressing this issue, companies must make a distinction between judgment and hindsight. For example, a goodwill impairment test may have been triggered in March or April — when fears about COVID-19 peaked — if management seriously contemplated winding down operations. Though the conditions may not seem as dire in hindsight, management needs to look at impairment through the lens of what was known at the moment, not what’s known today.

Some small businesses have suggested that the FASB provide a one-time-only COVID-19-related exception for private companies. These companies say that the accounting rules don’t mesh well with the unprecedented COVID-19 pandemic. Essentially, they view a decline in value as a temporary situation that will build itself back over time.

However, PCC members generally favor education, as opposed to making more changes to the rules. In the coming months, the PCC is planning to provide education to help private companies and practitioners navigate the issue of goodwill impairment during the COVID-19 pandemic.

We can help

Does your company report goodwill on its balance sheet? If so, your KraftCPAs advisor can explain how the accounting rules apply to your situation, including whether the pandemic qualifies as a triggering event that requires you to perform a goodwill impairment test.

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