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.

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