Over the years, the subsequent accounting for goodwill has been an area that has seen a lot of changes and our blog has tried to keep you up to date with all of these. Where do we stand now?
First off, goodwill mainly arises from a business combination where the purchase price exceeds the fair values of assets (including intangibles assets) and liabilities of the acquired company. Normally, goodwill is not amortized and is subject to impairment testing. However, an accounting alternative for private companies can be elected which allows goodwill to be amortized straight-line over its useful life and not to exceed 10 years. However, some of the requirements are:
- There must be an accounting policy in place to test goodwill for impairment at the entity level or reporting unit level.
- Goodwill must be tested for impairment whenever there is an event or a change in circumstances (a triggering event) where the fair value of the entity or reporting unit might be less than the carrying amount. If there is no triggering event, impairment testing is not required.
Testing for impairment of goodwill is performed in two steps.
- Step 1 requires the entity to compare the fair value of a reporting unit to its carrying value including goodwill. If the reporting unit’s fair value is less than its carrying value including goodwill, then proceed to Step 2.
- Step 2 requires the entity to calculate an estimated impairment loss as the excess of the carrying amount of goodwill over its implied fair value.
An entity can also elect to assess impairment of goodwill using qualitative factors before implementing the two-step impairment test. If there is a probability of more than 50% (more likely than not) that the fair value of a reporting unit is less than its carrying amount, then the entity proceeds to the two-step impairment test. If the probability is 50% or less, the entity can bypass the two-step impairment test and continue to assess qualitative factors in later periods. Some of the qualitative factors to consider are:
- Economic conditions
- Industry and market conditions
- Increased costs having negative impact on cash flows
- Changes that are specific to the entity (loss of major customers, change of key personnel/management, etc.)
In 2017, an accounting standards update was issued to simplify the subsequent measurement of goodwill by eliminating Step 2 (from the two-step goodwill impairment test). With this election, an entity can simply recognize an impairment loss for the reporting unit’s carrying value that is above its fair value (Step 1 of the impairment test) as long as the impairment loss is not greater than the carrying amount of the goodwill.
For private companies, this is effective for years beginning after December 15, 2021. However, early adoption is currently permitted.
Patrick Herrera, CPA