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New Goodwill Impairment Standard Leaves Questions

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September 16, 2011

The new goodwill impairment testing standard may give companies more options and flexibility, but it also leaves some questions unanswered, according to one expert.

Greg Forsythe, director of business valuation at Deloitte Financial Advisory Services, noted that the new standard released by the Financial Accounting Standards Board on Thursday provides some companies with a way to avoid the need to do the traditional two-step test, which potentially could make things easier for them (see FASB Issues Goodwill Impairment Testing Standard).

“From FAS 142, way back in 2001, we’ve had a goodwill impairment test that we essentially refer to as a two-step test,” he said Friday. “We’ve had what is referred to as the reporting unit level within companies. Companies can have anywhere from one to many reporting units, and many with goodwill need to be tested. Essentially the process is you value that reporting unit, and if the reporting unit’s value is greater than their carrying value, then you’re fine, and you don’t need to do anything further. And if it happens to be less, then you need to go through step two, which is essentially a residual analysis to come up with an implied goodwill value. Then that number is compared with the actual goodwill on the balance sheet, and if your goodwill implied is less than what’s on the balance sheet, then you write off the difference. That’s historically what companies have done. As you can imagine, for companies with many reporting units, that can start to become a costly exercise, and there are a lot of things they need to do to effectuate it.”

FASB’s new Accounting Standards Update gives companies the option of doing a qualitative assessment first, he noted.  An entity no longer would be required to calculate the fair value of a reporting unit unless the entity determines, based on that qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. Depending upon whether or not they can prove, more likely than not, that the fair value is less than the carrying value, then the two-step test is required, but if they can prove that their fair value is higher, then they don’t need to go through the analytical two-step process. If they cannot prove that, then they need to go through the original evaluation process.

“In terms of the literature that comes out from the FASB, we’ve had a lot of thick documents on fair value in recent years, but this one it’s pretty skimpy in comparison, because it is fairly simple in concept,” Forsythe noted. “However, what’s simple in concept may have some complexity and challenges around it. I think that’s where everyone is right now, sort of trying to think through what this might mean, and what auditors might need to do to audit this kind of qualitative data, which is for the first time new in a fair value concept. There’s never been this kind of qualitative assessment under a fair value topic, and companies are wondering about whether it warrants taking this option or to continue to do what they’ve done in the past. So there are lots of questions being asked, but no real answers yet.”

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