Fair Value Accounting And Intangible Assets: Goodwill Impairment And Managerial Choice
In January 2017, FASB issued Accounting Standards Update (ASU) 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which eliminated the calculation of implied goodwill fair value. Instead, companies will record an impairment charge based on the excess of a reporting unit’s carrying amount of goodwill over its fair value. This guidance simplifies the accounting as compared to prior GAAP.
Fair Value Accounting And Intangible Assets Goodwill Impairment And Managerial Choice
Managerial Accounting Index; ARTICLES; STUDY AIDS. Topic Progress: ← Back to Lesson. This video explains what intangible assets are and gives examples of several types of intangible assets. Share this: Twitter; Facebook. Intangible Assets in Financial Accounting; Goodwill, Defined and Explained; Goodwill Impairment Single Step Test ASU. GOODWILL AND INTANGIBLE ASSETS (ASPE 3064 AND IAS 38) July 4, 2013 PMR ASPE 3064. An entity shall make an accounting policy choice to either: (a) expense such expenditures as incurred;. However the revaluation model is only available if an active market exists for that intangible. This is fair rare but some examples are taxi. Accounting Discretion in Fair Value Estimates: An Examination of SFAS 142 Goodwill Impairments. Carla Carvalho, Ana Maria Rodrigues and Carlos Ferreira, The Recognition of Goodwill and Other Intangible Assets in Business Combinations. Managerial ability and goodwill impairment, Advances in Accounting, 32, (42).
This article provides an overview of the goodwill impairment assessment under the new guidance and some specific income tax considerations regarding the financial implications of goodwill impairment. Current GuidanceUnder the current guidance, companies can first choose to assess any impairment based on qualitative factors (Step 0). This option allows entities to first assess these factors in order to determine whether a reporting unit’s fair value is more likely Lived Intangibles,” The CPA Journal, June 2014.) If a company fails this test or decides to bypass this step, it must proceed with the following two-step quantitative assessment of goodwill impairment.First, the company compares the fair value of the reporting unit to its carrying amount (Step 1). If the fair value is lower, the company must then calculate any goodwill impairment charge by comparing the implied fair value of goodwill to its carrying amount (Step 2). Goodwill impairment may result if and only if the calculated implied fair value of goodwill is lower than its carrying amount. An impairment loss reduces the recorded goodwill and is irreversible. The current guidance requires companies to calculate the implied fair value of goodwill in Step 2 by calculating the fair value of all assets (including any unrecognized intangible assets) and liabilities of the reporting unit and subtracting it from the fair value of the reporting unit previously calculated in Step 1.
This process makes any goodwill impairment analysis costly and complex. Private companies can, however, elect to amortize the goodwill that they have acquired in business combinations on a straight-line basis over 10 years, or less if the entity demonstrates that another useful life is more appropriate, and can elect to use a one-step goodwill impairment test (ASC 350-20-35-63). Thus, the new guidance may not be applicable to privately held companies.
(For additional information, see Lange, Fornaro, and Buttermilch, “A New Era for Private Company Accounting Standards, Changes in Long-standing Practices for Goodwill”, The CPA Journal, January 2015.). Impairment AssessmentUnder ASU 2017-04, companies must record goodwill impairment charges if a reporting unit’s carrying value exceeds its fair value. The impairment charge is based on that difference and is limited to the amount of goodwill allocated to that unit; thus, the new guidance eliminates Step 2 analysis of the current goodwill impairment testing. Companies continue to have the option of performing a qualitative assessment of goodwill impairment; however, if a company performs a qualitative assessment of its goodwill and fails, it must proceed with quantitative impairment testing (ASC 350-20-35-3A).Goodwill impairment charges under the new guidance may differ from the current guidance because the unit difference (carrying value of unit less fair value of unit) always overrides the goodwill difference (goodwill carrying value less goodwill fair value). Therefore, if the unit difference under the new guidance is higher or lower than the goodwill difference, it will replace the goodwill difference, which may create a higher or lower goodwill impairment charge. Furthermore, while some companies may not recognize any impairment under the current guidance when they fail Step 1, under the new guidance, if the carrying value of the reporting unit exceeds its fair value, there will always be some amount of goodwill impairment.
Reflects goodwill impairment alternatives under different scenarios. Order of Impairment TestingIf companies test goodwill and long-lived assets (held and used) at the same time because of a triggering event, they must follow a certain order in their impairment testing. Prior to testing goodwill for impairment, companies should first test other assets (e.g., accounts receivable, inventory) and indefinite-lived intangible assets, then long-lived assets (including definite-lived intangible assets), and finally, goodwill. They should record any impairment from each test before proceeding to the next test (ASC 350-20-35-31).
Dissent from GuidanceSeveral FASB board members dissented from the issuance of the new standard, arguing that it might result in an accounting outcome that does not reflect the relevant economic conditions and that there are instances that the one-step model may result in overstatement or understatement of goodwill impairment. For example, in a rising interest rate environment, there is a possibility that the fair value of reporting units with significant financial assets will fall below their book values. The new standard mandates the impairment of goodwill even in instances where the decrease in the reporting unit’s fair value might have been caused by a reduction in the fair value of financial assets carried at amortized cost rather than a decline in the fair value of goodwill.
To address the possible overstatement of goodwill impairment, the dissenting board members recommended that entities should have a choice of electing the two-step method.The one-step method may also result in understatement of goodwill impairment if the fair value of liabilities is less than their carrying amounts, for example, due to deterioration of its creditworthiness. In this scenario, the entity may not be required to, and does not have any incentive to, record any impairment charges for its goodwill.Finally, the new standard has incentivized companies with zero or negative carrying amounts of net assets to proceed immediately to Step 1 of goodwill impairment test to avoid reporting any goodwill impairment. Tax Considerations at AcquisitionThe income tax consequences of a business combination follow one of three patterns (see ). In a taxable transaction, the acquirer takes a fair value tax basis in the net assets acquired; in a nontaxable transaction, the acquirer takes a carryover basis in the net assets but a fair value basis in any acquired stock; in a nontaxable exchange, the acquirer takes a carryover basis in both the net assets and any acquired stock. The tax treatment of an acquisition may directly or indirectly affect the price of the transaction and the amount of goodwill and its future possible impairment, since an acquirer might be willing to pay more for an acquisition in a taxable transaction if such transaction can provide a step-up in the tax basis of the acquired net assets. Furthermore, the structure of an acquisition can also dictate whether an acquirer can benefit from the existing tax attributes (e.g., tax credit carryforwards and net operating loss) of an acquiree. Tax Treatment of Business CombinationsUnder the current guidance, Step 2 is generally comparable whether the transaction is taxable or nontaxable because, by definition, the amount of goodwill should remain the same whether the transaction is taxable or nontaxable.
Under the new guidance, however, goodwill impairment in Step 1 is generally lower when the acquisition is a taxable transaction because the new guidance determines the impairment by comparing the total carrying value of the unit to its total fair value. Because an acquirer is usually willing to pay a higher sale price for a taxable transaction as opposed to a nontaxable transaction, the total fair value is usually higher in a taxable transaction, resulting in a lower impairment charge.
Furthermore, companies may need to include deferred tax balances related to assets (in this case goodwill) and liabilities in determining the reporting unit’s carrying value. Tax Implications of Goodwill ImpairmentUnder ASU 2017-04, companies recognize an impairment charge to the extent that the carrying value of a reporting unit exceeds its fair value (not to exceed the carrying value of goodwill).
To determine the fair value of the unit, companies determine whether the hypothetical sale has occurred in a taxable or nontaxable transaction, as discussed above. This determination could affect the fair value of the unit and thus any goodwill impairment charges.In certain jurisdictions, goodwill amortization is tax deductible.
If a company or reporting unit operates in these jurisdictions, goodwill impairment charges may decrease its deferred tax liability (DTL) or increase its deferred tax asset (DTA). A decrease in DTL or an increase in DTA causes an immediate increase in the carrying value of the reporting unit, which would require additional impairment charges (ASC 350-20-35-20 & 21 and ASC 850-740-25).ASU 2017-04 has addressed this issue and requires an entity to calculate the impairment charge and the deferred tax effect simultaneously (similar to how an entity calculates goodwill and the related DTAs in a business combination). For example, if Entity A has goodwill impairment charges of $1,000 (the excess of the carrying amount of reporting unit over its fair value) and its effective tax rate is 40%, the impact of impairment on the carrying value of goodwill is $600 $1000 − ($1000 × 40%). If Entity A uses simultaneous equations (based on the new guidance), however, the goodwill impairment charge is $666 40% divided by (1 – 40%) × $1,000, ASC 350-20-55-23C & D).reflects that straight application of a $1,000 goodwill impairment loss results in a carrying value amount of $12,600, which would still exceed the fair value of $12,000.
Reflects what happens when Entity A calculates its goodwill impairment charge and deferred tax impact simultaneously. In this scenario, the carrying amount of $12,000 equals the fair value of the unit for $12,000. The journal entry for goodwill impairment is as follows. Going ForwardMany companies may decide to adopt the new goodwill impairment guidance in ASU 2017-04 prior to its effective date because it simplifies the goodwill impairment testing process. But it is worth noting that the guidance complicates the tax implications of goodwill accounting in certain jurisdictions where goodwill amortization is deductible for tax purposes. Companies should examine the specific details of their goodwill structure to determine the impact of the new guidance for financial reporting purposes.
IFRS 38Choice between historical cost model and revaluation model (must be applied consistently for all assets in a particular class; i.e. All patents can be at cost and all licenses can be at revaluation model)However the revaluation model is only available if an active market exists for that intangible. This is fair rare but some examples are taxi or fishing licenses that are frequently bought and sold. Just know that there are two options for IFRS. Same goes for amortization under IFRS; if indefinite life no amortization.
Website CostsUnder ASPE there is no specific criteria for websites but they would fall under the general criteria for capitalization (identifiable, control, future benefit).Under IFRS there is a specific SIC for website costs; SIC 32. This interpretation standard falls back to the general criteria for intangible assets but offers addition guidance as well. The main issue is whether a future economic benefit exists (criteria #3). It specifically states that if a website is used solely to promote or advertise products then it cannot be capitalized as it does not have a probable future economic benefit. However if the website can also take orders online then it can be established that a future economic benefit will result.The treatment under ASPE and IFRS would then be the same for website costs, but just be aware that there is a SIC 38 under IFRS that deals specifically with website costs. Final ThoughtsCould be tested on the capitalization criteria in terms of multiple choice or on a case. Another possible test question could be to calculate the costs that can be capitalized and/or expensed.R&D criteria might be hard to memorize but I recommend copy and pasting from the handbook on a case.
This makes it easy to apply each criteria to a case fact as you work your way through the criteria. For the CKE, perhaps try to remember examples of R&D activities in order to help you determine which activities should be capitalized or expensed.Also on a case, you might need to assess the useful life of an intangible asset. Management may want to show it as an indefinite life intangible, but you likely should challenge this assertion if case facts lead to it. You might see things like “the average product life cycle of similar products is 3 years” or “the intangible asset will expire after 10 years”.There is an increased chance of being tested on websites to keep up to date on IT advances. Apply the general rules, but remember that the website has to be able to take and place orders online (not just advertising products).