Goodwill sits on the balance sheet until someone proves it is worth less. For an entity that does not use the private company amortization alternative, the proof is a test at the reporting unit level. ASU 2017-04 shortened that test to one quantitative comparison. This guide covers the reporting unit, the optional qualitative assessment often called step 0, the quantitative test, the cap on the loss, a worked entry and the audit procedures. Entities that elected to amortize goodwill follow a different path, covered in the private company goodwill amortization alternative. For the broader treatment, see impairment of long-lived assets and goodwill for private companies.
What is a reporting unit?
Baker Tilly describes a reporting unit as generally an operating unit with its own discrete financial information, separate from the rest of the company. The test runs unit by unit, so the way the entity defines its units and assigns goodwill and shared assets to them determines where a loss can appear. Entities with several divisions need documented support for both.
How often is goodwill tested?
At least annually, and between annual tests when a triggering event occurs. PwC distinguishes goodwill and indefinite-lived intangibles, which require annual testing, from held-and-used long-lived assets, which are tested whenever events or circumstances indicate the carrying amount may not be recoverable. The annual test is a minimum. A loss of a major customer, a sharp drop in a unit's results or a decision to restructure can call for a test before the annual date.
What is the qualitative assessment?
An optional first look. Baker Tilly explains that, under ASU 2011-08, a company may first assess whether it is more likely than not that a reporting unit's fair value is below its carrying amount. If the answer is no, no quantitative test is needed. If the answer is yes, or the company skips the assessment, the quantitative test follows. Cohen & Company makes the same point: a company that fails the qualitative step or bypasses it proceeds to the quantitative assessment. ASU 2011-08 defines more likely than not as a likelihood of more than 50 percent.
A documented qualitative conclusion needs real evidence, such as results against budget, market data and the cushion between fair value and carrying amount in the last quantitative test.
What does ASU 2017-04 change in the quantitative test?
ASU 2017-04 removes step two. Under the old approach, a failing step one led to a hypothetical purchase price allocation to compute the implied fair value of goodwill. Now the test is one comparison. Baker Tilly states that impairment equals the excess of a reporting unit's carrying amount over its fair value, and that the implied fair value of goodwill is no longer calculated. EisnerAmper and Cohen & Company both say the entity recognizes a charge for the excess of carrying amount over fair value, and Baker Tilly adds that carrying amount includes goodwill.
One feature limits the result. Baker Tilly states that impairment losses are limited to the total amount of goodwill allocated to the reporting unit.
EisnerAmper notes that ASU 2017-04 also eliminated the requirement for a reporting unit with a zero or negative carrying amount to perform a qualitative assessment.
Worked example
Illustration only, with round numbers. A reporting unit has net assets of $12,000,000 including $3,000,000 of goodwill. A valuation puts the unit's fair value at $10,000,000. Fair value is below carrying amount by $2,000,000, and that is below the $3,000,000 of goodwill, so the loss is $2,000,000. Tax effects are ignored here.
| Account | Debit | Credit |
|---|---|---|
| Goodwill impairment loss | $2,000,000 | |
| Goodwill | $2,000,000 |
Goodwill for the unit falls to $1,000,000.
Now change one fact. If fair value had been $8,000,000, the shortfall would be $4,000,000, but the loss is capped at the $3,000,000 of goodwill. The remaining $1,000,000 of shortfall is not a goodwill loss. It is not recorded against goodwill.
Audit angle
The test is an estimate of fair value, so the audit work is on inputs and bias. See auditing accounting estimates.
- Reporting units and allocation. Agree the units to how management runs the business, and the goodwill allocation to the acquisition records.
- Qualitative conclusion. Test whether the evidence supports "no more likely than not." Challenge a qualitative pass in a year with declining results.
- Fair value inputs. Compare forecasts to budgets, backlog and history. Test the discount rate, the terminal growth and market multiples. Reconcile the sum of the unit values to the entity's market or deal value where one exists.
- Specialists. If management used a valuation firm, evaluate competence and the work. See using the work of a specialist and fair value measurement.
- Carrying amount. Recompute the unit's carrying amount, including whether assets and liabilities are assigned consistently with the valuation.
- Timing. Look for triggering events between the annual test and year end, and for events after year end that bear on conditions at the balance sheet date.
- Recording. Recompute the loss and the cap, and check disclosure.
Evidence to keep in the file: the valuation report or internal model with its version history, the approved forecast, a reconciliation of the unit's carrying amount to the trial balance, the memo supporting any qualitative conclusion and the calculation of the loss. A reviewer who opens the file should be able to rebuild the number without asking management for a second explanation. Where the balance is large relative to equity, document the sensitivity of fair value to the discount rate and growth assumptions, because a small change can move a unit across the line.
Common misstatements: a qualitative pass with no evidence, forecasts that exceed the business's history, a carrying amount that excludes liabilities the valuation assumes, and a missed trigger.
CORAA prepares ready-to-review audit files for US CPA firms from QuickBooks books; you review and sign. See /us.
Sources
- Baker Tilly, The test for goodwill impairment gets easier: https://www.bakertilly.com/insights/the-test-for-goodwill-impairment-gets-easier
- EisnerAmper, Goodwill impairment test simplification (ASU 2017-04): https://www.eisneramper.com/goodwill-ta-blog-0717
- Cohen & Company, Early adoption of simplified goodwill impairment: https://www.cohenco.com/insights/articles/early-adoption-of-simplified-goodwill-impairment
- FASB, ASU 2011-08, Testing Goodwill for Impairment (qualitative assessment, more-likely-than-not threshold): https://storage.fasb.org/ASU%202011-08.pdf
- PwC, Bankruptcies and liquidations guide, 2.2 Asset impairments (annual testing contrast): https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/bankruptcies_and_liq/bankruptcies_and_liq_US/chapter_2_accounting_US/22_asset_impairments_US.html
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