The test for goodwill impairment gets easier

The Financial Accounting Standards Board (FASB) has released new guidance that simplifies the process for goodwill impairment testing for public companies and not-for-profit organizations (when applicable). Accounting Standards Update (ASU) No. 2017-04, Intangibles — Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, allows those companies to follow the one-step process that private companies have been permitted to use for several years.

Under ASU 2017-04, a goodwill impairment loss is measured as the excess of a reporting unit’s carrying amount (including goodwill) over its fair value. Impairment losses are limited to the total amount of goodwill allocated to the reporting unit. Essentially, the update removes the second step of the goodwill impairment test.

The impairment testing requirement

For accounting purposes, “goodwill” refers to the residual asset recognized in a business combination, such as a merger, after recognizing all other identifiable assets acquired and liabilities assumed. This intangible asset generally includes the reputation of the purchased business and its competitive advantages in the market. U.S. Generally Accepted Accounting Principles (GAAP) require that goodwill be carried on the books at its initial value less any “impairment.”

Goodwill is considered impaired when the implied fair value of goodwill in a company’s “reporting unit” (generally, an operating unit that has its own discrete financial information, separate from the overall company) is less than its carrying amount, or book value, including any deferred income taxes.

Current GAAP generally requires companies to test for impairment annually — and between annual tests in certain circumstances — using a two-step process:

1. The company calculates the fair value of the reporting unit and compares that amount with the reporting unit’s carrying amount, including goodwill. If the carrying amount is greater than the fair value, the company also must perform the second step.
2. The company measures the amount of goodwill impairment loss, if any, by comparing the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. The implied fair value is generally calculated by deducting the fair value of the reporting unit’s assets and liabilities from the fair value of the reporting unit itself. This is the same procedure required to determine the fair value of assets acquired and liabilities assumed in a business combination.