Costs often derail qualitative goodwill impairment assessment

Many companies are not making use of an optional, qualitative goodwill impairment test FASB recently introduced to enable less burdensome financial reporting, a new survey report shows.

Just 29% of public companies and 22% of private companies participating in financial advisory and investment banking firm Duff & Phelps’s 2013 U.S. Goodwill Impairment Study used the “Step 0” optional qualitative assessment for any reporting unit in their most recent testing. A total of 107 companies participated in the survey.

The Step 0 assessment was created to help companies determine whether often-costly quantitative goodwill impairment testing is necessary. Under the Step 0 option, a company is not required to calculate the fair value of a reporting unit unless an assessment of qualitative factors shows that it is more likely than not that the reporting unit’s fair value is less than its carrying amount.

The qualitative assessment option took effect for annual and interim goodwill impairment tests performed for fiscal years beginning after Dec. 15, 2011. In the Duff & Phelps survey, 13% of public companies and 22% of private companies said Step 0 was not cost-effective.

Duff & Phelps Managing Director Greg Franceschi, CPA, said two factors have led to companies’ reluctance to use the Step 0 approach. First, the Step 0 approach itself requires a great deal of effort and voluminous documentation.

Second, many companies take comfort in the rigorous analysis associated with the Step 1 approach, which gives them confidence and documentation to back their conclusion from the goodwill impairment test, Franceschi said.

If the company determines a quarter or two later that goodwill is impaired, finance executives who have completed Step 1 testing can feel confident that they made the proper decision in a prior quarter by not recording a goodwill impairment at that earlier time, Franceschi said.

“You really went through a thorough analysis and supported your position,” Franceschi said. “So it’s better safe than sorry, for lack of a better word. That’s what we’re finding in a practical environment today.”

Almost half (45%) of public company and private company respondents said they prefer the quantitative test and proceed directly to Step 1. And 13% of public companies and 11% of private companies said Step 0 was considered but not applied because of a lack of practical guidance.

To address the scarcity of guidance in this general area, the AICPA released a guide describing best practices for testing goodwill for impairment. Among other things, the guide outlines a framework for the application of the Step 0 assessment and provides an example illustrating the related thought process and documentation.

Seventy-one percent of public companies and 81% of private companies that applied Step 0 found no impairment and did not proceed to Step 1.

Step 0 methods differ

Methodologies varied for companies that applied Step 0. Twenty-five percent of public companies and 63% of private companies surveyed did not evaluate inputs and assumptions in the context of a specific valuation approach while applying Step 0. Rather, they appear to have considered qualitative factors in general terms.

But some companies – more public than private – did use a valuation approach:

• 25% of public companies and 32% of private companies used the income approach.
• 21% of public companies and 5% of private companies used the market approach.
• 29% of public companies and no private companies considered the income and market approaches equally.

Franceschi said the differing approaches may be the result of FASB guidance that provides a list of factors that need to be considered, which is not an all-inclusive list.

“When you have a broader set of guidance like that, that’s really more of a concept approach, you get a broader set of how people will interpret and apply it,” Franceschi said. “People will pick and choose the factors that they believe are most relevant to their particular industry and company at a particular point in time.”

The new AICPA goodwill impairment guide, which recommends to first identify the appropriate method(s) for determining the reporting unit’s fair value and then identify relevant inputs and assumptions in the context of those methods, is designed to help reduce diversity in practice in this area. Specifically, paragraphs 3.03–.04 (which appear in the “Identifying Inputs and Assumptions That Most Affect Fair Value” section of the qualitative assessment chapter) state the following:

3.03     An entity would identify the method(s) appropriate to measure the fair value of each of its reporting units and then identify the key inputs and assumptions that would most affect each method. Entities may want to consider the methods and inputs and assumptions used in their last quantitative test to determine whether they are still relevant and whether they have changed.

3.04     Understanding the inputs and assumptions that most affect the fair value of a reporting unit will enable entities to focus their efforts on evaluating the key inputs and assumptions that can most affect the outcome of the qualitative assessment so that those factors are given more weight.

Furthermore, paragraph 3.05 of the new guide goes on to say:

3.05     Depending on the nature of the reporting unit or availability of observable market prices, a calculation of fair value might utilize multiple valuation approaches or techniques. If that is the case, the task force believes the entity would need to consider the inputs and assumptions to, and relative weightings of, each valuation technique to identify those inputs and assumptions that most affect fair value

Many companies also are not using a similar optional qualitative impairment assessment for indefinite-lived intangible assets, finalized by FASB in 2012. Just 25% of public company respondents and 32% of private company respondents applied the optional qualitative impairment assessment to at least some of their indefinite-lived intangible assets.

More than half (52%) of public companies and 30% of private companies have continued with a quantitative test as done historically for impairment assessment of indefinite-lived intangible assets. Twenty-three percent of public companies and 37% of private companies said they do not have indefinite-lived intangible assets on the balance sheet.

The Duff & Phelps report also included a study that found that U.S. companies recorded $51 billion in goodwill impairment in 2012, a 76% increase from the $29 billion reported in 2011. The total was the highest reported since the financial crisis in 2008. A $27 billion goodwill impairment reported by GM in the fourth quarter of 2012 did not meet the criteria for the study.

Data from more than 5,100 companies, representing more than 93% of the market capitalization for U.S. publicly traded companies, were captured in the survey. Two-thirds (67%) of the goodwill impairment was reported in just three industries—information technology, industrials, and health care. And 47% of the impairment was attributable to the three largest impairment events.

—Ken Tysiac (ktysiac@aicpa.org) is a JofA senior editor.