How to Implement “Step 0” of the New Goodwill Impairment Testing Standards

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The Financial Accounting Standards Board (FASB) issued new guidance that is aimed to make goodwill impairment testing easier for companies, and this guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011.

How will the new standard impact my company? 

The new standard modifies the previous two-step model, by creating a “step 0” option that allows companies to qualitatively assess whether it is more likely than not that the reporting unit’s fair value is greater than its carrying amount. If this assessment concludes that the fair value is greater than the carrying amount, the step 1 analysis of measuring the fair value of the reporting entity and comparing it to the carrying amount is not necessary.  If the new standard is implemented effectively, it can GREATLY reduce the time and costs associated with annual goodwill impairment testing.

What “Qualitative” factors should be considered? 

The FASB’s guidance under AccountingStandards Codification Topic 350-20-35 lists the following examples of events and circumstances that may be considered when making the qualitative assessment of whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount:

a. Macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets

b. Industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (consider in both absolute terms and relative to peers), a change in the market for an entity’s products or services, or a regulatory or political development

c. Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows

d. Overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods

e. Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation

f. Events affecting a reporting unit (change in net assets, potential selling or disposing of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit

g. If applicable, a sustained decrease in share price (consider in both absolute terms and relative to peers).

How can my company successfully implement this guidance?

1. Prepare a detailed memo that outlines management’s consideration of the above qualitative factors. This memo should be updated for each required testing period, and should clearly support management’s conclusions on the fair value of the reporting unit vs. the carrying value. Note that the above list is not intended to be an all-inclusive list of relevant qualitative factors.

2. Consult with your company’s auditors early in the process to determine if there are other risks or factors that could impact the conclusions reached by management that may not have been initially considered.

3. Continually monitor financial performance and changes in relevant qualitative criteria to ensure the “step 0” analysis stays current.  If financial performance deteriorates or events and circumstances change during a reporting period, it may become necessary to perform additional procedures.

Evan Powell, CPA