Goodwill Impairment: Open to Interpretation, Again
Companies and
auditors are clamoring for clarification about measuring goodwill impairment.
A
relatively new goodwill accounting rule got its first real test drive last
year when the ripple effect from the 2008 recession hit company balance
sheets. More than two-thirds (68%) of public companies in the United States
recognized a goodwill impairment under the rule known as Topic 350 (formerly
FAS 142), writing down an aggregate $260 billion, according to a report
issued by financial advisory firm Duff & Phelps and the Financial
Executives Research Foundation. The report examined nearly 6,000 publicly
held companies.
Now, as 2009 results are
filed, there is anecdotal evidence that goodwill write-downs have declined,
says Greg Franceschi, who heads up the global financial reporting practice
for Duff & Phelps. He notes that during the past 18 months there has been
an increase in company values, so by default there are fewer goodwill
write-offs.
Nevertheless,
a new accounting wrinkle has surfaced related to goodwill impairments. At
issue is whether companies should determine the fair value of a reporting
unit — and thereby the value of the related goodwill — based on either the
unit's equity value or its enterprise value. (In general, enterprise value is
the sum of the fair value of debt and equity.)
The
question was sparked by a December speech given by Evan Sussholz, an
accounting fellow in the Office of the Chief Accountant at the Securities and
Exchange Commission. In his speech, Sussholz suggested that in certain
situations, using an enterprise-value measurement may provide a more
economically accurate picture of the reporting unit. His suggestion left
preparers and auditors clamoring for a clarification, as companies have
historically applied the equity-value approach to impairment testing, says
PricewaterhouseCoopers partner Larry Dodyk.
In
response, the Financial Accounting Standards Board and the American Institute
of Certified Public Accountants have launched efforts to figure out whether
additional guidance on the subject is needed. FASB's emerging issues task
force is slated to start discussing potential guidance during the second half
of the year, while the AICPA is currently working on completing a practice
aid, which is a sort of unofficial manual that discusses best practices and
concepts that auditors and preparers may want to apply.
Topic
350 requires companies to perform a goodwill impairment test at least once a
year to determine if the current value of an acquired reporting unit is worth
more or less than its original price. The test is a two-step process in which
the company must first compare the fair value of a reporting unit with its
original price — the amount the company carries on its books. If the book
value exceeds the fair value, then the asset is impaired and a second step is
required to measure the amount of the impairment. If the book value is lower
than the unit's fair value, then the asset passes the test and nothing more
is required.
The
confusion over whether to use equity value or enterprise value stems from the
seemingly straightforward first step of the test, because the accounting rule
is unclear. Sussholz said that originally, the SEC didn't believe the
selection of one approach over the other would affect the test outcome.
However, since taking a closer look at the practical implications, SEC
staffers have acknowledged one unanticipated situation that is a potential
problem: when the book value of a reporting unit measured at the equity level
is negative.
Intuitively,
it might seem that a negative book value would mean a reporting unit is on
the verge of bankruptcy, but that may not be the case. Dodyk explains that a single
reporting-unit company, for example, may have negative shareholders' equity
as a result of unrecognized assets (such as intangibles) that have
significant value but don't figure into the equity equation. Heavy borrowing
for a leveraged buyout could also send shareholders' equity into negative
territory.
Consider
what happens in an equity-value impairment test when a reporting unit's book
value is negative. By definition, the fair value of common equity cannot be
less than zero, because the equity is essentially a call on the company's
operations. That means the fair value of a reporting unit measured at the
equity level would always be greater than a negative book value, and
therefore always pass step one of the impairment test. That would be the case
even if significant goodwill exists and the underlying operations of the
reporting unit "may be deteriorating," asserted Sussholz.
On
the other hand, says Franceschi, testing for impairment at the enterprise
level would include the reporting unit's debt burden, providing what Sussholz
claimed was a more accurate picture of the company's financial health. To be
sure, his speech opened up the possibility that another testing approach may
be permitted or required.
Franceschi doesn't believe
the additional guidance will cause a significant increase or decrease in
goodwill write-offs. But it may require companies to rethink valuation models
and approaches, especially if the guidance recommends that companies use more
judgment when determining a reporting unit's fair value. "For valuation
issues, you can never have something that says, 'This is the way to do it,
and the only way to do it,'" he says. "There may be multiple
approaches one needs to consider."
Another concern with
tinkering with Topic 350 is that it may spark other changes. "Once you
open the rules to the goodwill impairment test, you never know where it is
going to go," says Dodyk.
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