On October 6, 2010, the Financial Accounting Standards Board (FASB) proposed two critical changes to the way companies test for impairment of goodwill as part of an accounting standards update on Topic 350. Specifically, FASB adopted the so-called equity premise to standardize the determination of the carrying amount of a reporting unit. In addition, FASB proposed that when a reporting unit’s carrying amount is zero or a negative amount, the second step of the impairment test must be performed when it is more likely than not that a goodwill impairment exists.
For financial accounting purposes, the intangible asset known as goodwill is not amortized under U.S. generally accepted accounting principles (GAAP). Instead, goodwill is tested for “impairment” at a reporting unit level in a two-step process. First, an entity must assess whether the carrying amount of a reporting unit exceeds its fair value (Step 1). Then, if it does, an entity must perform an additional test to determine whether goodwill has been impaired and to calculate the amount of that impairment (Step 2).
The first proposed change addresses how an entity will calculate the carrying amount of a reporting unit for purposes of applying Step 1 of the goodwill impairment test. Companies currently have two options for calculating the carrying amount of each reporting unit:
- the equity premise (calculated as the difference between total assets and total liabilities of the reporting unit), or
- the enterprise premise (calculated as the difference between the total assets and liabilities of the reporting unit, excluding liabilities that are part of the capital structure of the reporting unit)
The amendments in the proposed update would clarify that the equity premise is the only method an entity can use for purposes of calculating the carrying amount of a reporting unit.
Additionally, the proposed changes would modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity would be required to perform Step 2 of the goodwill impairment test if there are adverse qualitative factors that indicate that it is more likely than not that a goodwill impairment exists. The qualitative factors shall be those set forth in ASC 350-20-35-30, which include the following:
- a significant adverse change in legal factors or in the business climate
- an adverse action or assessment by a regulator
- unanticipated competition
- a loss of key personnel
- a more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of
- recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit
Comments on the proposed changes are due on November5, 2010. If adopted, the proposed changes would be effective for public companies in fiscal years and interim periods within those years, beginning after December 15, 2010, and for private companies one year later. Early adoption for public companies would not be permitted.