Historically, many organizations have conducted goodwill and indefinite-lived intangible asset impairment testing by collaborating with valuation professionals and other advisers to measure fair value of their reporting units and indefinite-lived intangible assets. With recent changes to impairment testing and, specifically, the introduction of optional qualitative assessments to potentially avoid the quantitative tests, entities are seeking insights about how to navigate their way through the impairment-testing process and, where practical, reduce associated costs and complexity.
While the qualitative assessment will reduce the cost and complexity of impairment testing for many entities, there will be situations in which quantitative tests will continue to be the most effective way to perform impairment tests. The purpose of this article is to explore the qualitative assessment option and present factors that entities should consider before deciding to perform a qualitative assessment. An awareness of these topics will help entities evaluate whether a qualitative assessment is the most effective available solution for impairment testing.
EVALUATING THE APPLICATION OF ASU 2011-08 AND ASU 2012-02
FASB’s Accounting Standards Update (ASU) No. 2011-08, Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment, issued in September 2011, permits the use of a qualitative assessment in testing goodwill for impairment. ASU No. 2012-02, Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment, issued in July 2012, permits the use of a qualitative assessment in testing indefinite-lived intangible assets for impairment.
ASUs 2011-08 and 2012-02 did not change the quantitative tests for goodwill or indefinite-lived intangible asset impairment testing, respectively. For instance, ASU 2011-08 states that if, based on a qualitative assessment, an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the entity is required to perform Step 1 of the quantitative test. If, based on a qualitative assessment, an entity can support a conclusion that it is not more likely than not that the fair value is less than the carrying amount, then Step 1 is not required.
ASUs 2011-08 and 2012-02 provide entities the option to qualitatively assess events and circumstances relevant to the fair value of a reporting unit or indefinite-lived intangible asset to determine whether a quantitative test is required. The amount of analysis and documentation required will depend on specific facts and circumstances.
The intent of the ASUs was to reduce the burden on entities when it is more likely than not that an impairment would not be identified through the quantitative tests. In evaluating whether a qualitative assessment might be an efficient approach to impairment testing, entities could consider several factors, including:
- Costs of process implementation for qualitative assessments;
- Initial review of fair value at the time of a transaction;
- Possibility of an unclear outcome from a qualitative assessment;
- Moving in and out of the qualitative assessment from period to period;
- Ability to repurpose other valuations; and
- Uncertainty around in-process research and development (IPR&D) assets.
COSTS OF PROCESS IMPLEMENTATION FOR QUALITATIVE ASSESSMENTS
When conducting a qualitative assessment, an entity may consider the need to institute a process with appropriate internal controls. The extent of effort that may be required to implement the process and related controls varies depending on the entity’s circumstances with its reporting units and other indefinite-lived intangible assets. The ASUs provide examples of qualitative factors for consideration but do not provide explicit guidance regarding how these factors should be evaluated. The qualitative assessment process could, depending on the circumstances, introduce more variation in perspectives among management, valuation and auditing professionals, and regulators. Where opinions face a higher probability of varying, more discussion and documentation may be required. In some cases, it may be more effective to continue with existing quantitative tests when extensive efforts may be necessary to perform and document the qualitative assessment.
INITIAL REVIEW OF FAIR VALUE AT THE TIME OF A TRANSACTION
One of the most effective ways of monitoring the qualitative factors is to document the mindset in place at the business combination or asset acquisition date (collectively referred to as a transaction date) and identify the critical drivers of fair value for the reporting units or indefinite-lived intangible assets. This becomes especially important for an entity that intends to use the qualitative assessment at the impairment testing date immediately following the transaction date because, assuming the transaction price was at fair value, the cushion, which is the excess of the fair value over the carrying amount at the date of the last valuation, would be zero.
Analysis of fair value drivers and identification of events and circumstances at the time of the transaction and related subsequent changes in those drivers would serve as a highly relevant foundation for subsequent qualitative assessments.
POSSIBILITY OF AN UNCLEAR OUTCOME FROM A QUALITATIVE ASSESSMENT
Too close to call. If a reporting unit’s or indefinite-lived intangible asset’s fair value has recently been close to its carrying amount, then the lack of cushion may create alternative views about the results of the qualitative assessment. An unfavorable economic environment at the testing date may exacerbate this dynamic.
Also, as the amount of time between the last fair value measurement and the current testing date increases, the more difficult it may be to make a conclusion based solely on a qualitative assessment of relevant events and circumstances. In these situations the evidence presented in the qualitative assessment may not be sufficient to avoid the need to use a quantitative test. The uncertainty or lack of clarity about the qualitative assessment may make it more effective to begin with the quantitative test in these circumstances.
Single-asset volatility. In certain instances, the efforts involved in tracking individual factors may be excessive and may not be practical given the dynamic nature of businesses. A more holistic consideration of the business could be more effective because factors evolve quickly in a particular business environment.
For example, consider a hypothetical company that identified certain key fair value diagnostics—qualitative factors—at the transaction date linked to the customer base as critical to the impairment assessment of goodwill. Subsequent to the acquisition date, the company’s membership-based model evolved to a free-usage model funded instead by advertising revenues. Here, one might say that the business’s intangible asset mix has changed. The qualitative factors that an entity may have selected at the time of the acquisition, which are centered primarily on the membership-based intangible asset, may suggest negative business momentum or that recorded goodwill is in peril.
ASU 2011-08 allows for a change in factors and also allows for consideration of positive and mitigating factors. However, this example highlights the fact that goodwill tends to reflect the performance of a portfolio of assets deployed by the business for economic benefit rather than—in this case—narrowing in on one asset type. Quantitative goodwill impairment testing at the reporting unit level can accommodate shifts in the composition of the business’s tangible and intangible assets whereas a focus on a single asset cannot. This demonstrates a situation where the quantitative test can be less volatile than the qualitative assessment.
MOVING IN AND OUT OF THE QUALITATIVE ASSESSMENT FROM PERIOD TO PERIOD
Entities may wish to make a preliminary assessment each period to determine whether to begin with the qualitative assessment or to go directly to the quantitative test. Entities have an unconditional option each period to perform the qualitative assessment and may also alter their use of the qualitative assessment year over year. In the case of the latter, additional resources may be required if an entity decides to continue using the qualitative assessment but wishes to modify the factors considered relevant in the assessment. Although costs may be reduced in years when the qualitative assessment is sufficient to support a “no impairment” conclusion, comparatively higher costs may be incurred in years when an entity determines that it must revert to a quantitative test for a particular reporting unit or indefinite-lived intangible asset.
Several instances can be shown where quantitative tests have been performed in consecutive periods and the second test leveraged off insights gained from the first. On occasion, these efficiencies have allowed for the cost of the second test to be less than the first. If a qualitative assessment is performed between two quantitative tests, the interruption of year-over-year quantitative tests may result in a loss of cost efficiencies and relatively higher costs for the most recent quantitative test.
ABILITY TO REPURPOSE OTHER VALUATIONS
Occasionally, implementation of additional processes to perform a qualitative assessment may be unnecessary. For example, there may be times when inputs and other information from valuations performed for purposes other than impairment testing are readily available for use in a quantitative test. For example, some companies require an equity valuation for stock compensation purposes when applying ASC Topic 718, Compensation—Stock Compensation. Other examples include valuations conducted for purposes of supporting an entity’s compliance with loan covenants, or when private-equity investors require a periodic valuation of the entity’s equity for its mark-to-market purposes.
If the entity performs a valuation anyway, it may be more efficient to make adjustments to that valuation to comply with Step 1 of the goodwill impairment testing model rather than investing resources to implement processes and controls to perform the qualitative assessment. Potential differences between a valuation conducted for the aforementioned purposes and for purposes of ASC Topic 350, Intangibles—Goodwill and Other, may result from:
- Different valuation dates;
- Discount adjustments;
- Premium adjustments; and
- Dissimilar units of measurement (i.e., reporting unit vs. overall business level).
There may be practical challenges to leveraging such valuations, but in many cases the obstacles can be overcome. If so, the output of these valuations may make it easier to move directly to Step 1 and support a position about the absence of impairment.
UNCERTAINTY AROUND IPR&D ASSETS
The principles that apply to the intangible assets covered by ASU 2012-02 are largely consistent with those applicable to goodwill. However, certain indefinite-lived intangible assets, such as IPR&D assets, warrant special consideration. According to ASC Topic 805, Business Combinations, IPR&D assets acquired in a business combination are measured at fair value at the acquisition date and recorded as indefinite-lived intangible assets until the completion or abandonment of the associated research and development efforts. As a consequence, eventually the life of IPR&D assets will become known, unlike some other indefinite-lived intangible assets and goodwill that remain indefinite-lived for extended (i.e., indefinite) periods of time.
Indefinite-lived intangible assets that become finite-lived assets are tested for impairment using the indefinite-lived intangible asset fair value model one last time at that date. Subsequently, they are subjected to impairment testing under ASC Topic 360, Property, Plant, and Equipment (as a finite-lived, depreciable, or amortizable asset).
In its deliberations leading to the issuance of ASU 2012-02, FASB considered whether to retain the current quantitative impairment testing guidance for IPR&D assets and other indefinite-lived assets whose fair value involves significant uncertainties. FASB acknowledged the difficulty in conducting a qualitative assessment for IPR&D assets but opted not to exclude it from the scope of the new ASU because the assessment is optional and there may be situations where its use is appropriate.
From a practical standpoint, the nature of IPR&D assets may make use of the qualitative assessment less effective in many situations. The costs of implementing a process and related controls, as well as the uncertainty of the result, may outweigh the benefits derived from avoiding a quantitative test. The situation becomes more pronounced if processes or qualitative factors differ across discrete projects. Isolating key drivers and events and circumstances underlying an IPR&D project may be more difficult than assessing it holistically. However, entities may use the qualitative assessment with greater frequency for situations in which an IPR&D project is nearing successful completion or is completed successfully and tested one last time as an indefinite-lived intangible asset.
The qualitative assessment framework for impairment testing recently introduced by the ASUs may reduce complexity and costs for many entities. In other cases the qualitative assessment may not prove cost-beneficial. Professionals may want to develop a screen to help more quickly determine whether the qualitative assessment for impairment testing is likely to be the most efficient strategy.
Careful consideration should be given to the facts and circumstances for specific reporting units and indefinite-lived intangible assets to determine the most effective and efficient path forward. Some entities may be better served continuing with the quantitative test to assess impairment of goodwill for some of their reporting units or certain indefinite-lived intangible assets.
New Chapter in the Works
The AICPA’s Financial Reporting Executive Committee (FinREC) has issued a working draft of a new chapter of the AICPA Accounting and Valuation Guide Testing Goodwill for Impairment (the Guide). The new chapter - chapter 2, Qualitative Assessment - discusses and illustrates how to perform the optional qualitative assessment to determine whether it is necessary to perform the two-step goodwill impairment test described in FASB ASC 350-20. This new chapter was developed in response to feedback received on the working draft the Guide which was released in November of 2011.
The working draft of the new chapter is available at aicpa.org. Interested parties are encouraged to submit their informal feedback on the new chapter by December 31, 2012.
The addition of a qualitative assessment for impairment testing under recent Accounting Standards Updates may reduce complexity and costs for many companies.
The determination as to whether a qualitative assessment will reduce costs and complexity may not be straightforward, and certain factors should be considered when determining whether it is more cost-effective to perform the qualitative assessment or to proceed directly to the quantitative impairment tests for goodwill or indefinite-lived intangible assets.
Factors to consider include the costs to implement the qualitative assessment process, unclear outcomes of the qualitative assessment, moving in and out of the qualitative assessment from period to period, the ability to repurpose other valuations, and uncertainty around IPR&D assets.
Valuation professionals can help entities move quickly to determine if the qualitative assessment is cost-efficient in their situation. Some entities will end up continuing to use a quantitative test to assess goodwill impairment.
BJ Orzechowski (firstname.lastname@example.org) is a valuation services partner at KPMG LLP in Philadelphia. Peter Lyster (email@example.com) is a managing director in KPMG’s Department of Professional Practice in New York City.
To comment on this article or to suggest an idea for another article, contact Neil Amato, senior editor, at firstname.lastname@example.org or 919-402-2187.
“The New Qualitative Assessments in Goodwill Impairment Testing May Not Be Simple,” Corporate Finance Insider, Feb. 2, 2012
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