GAAP UPDATE SERVICE Volume 17, Issue 7 April 15, 2017 PRONOUNCEMENT: Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU No. 2017-04 issued January 26, 2017). EFFECTIVE DATES: Public companies that file with the SEC are required to adopt no later than fiscal years beginning after December 15, 2019. Public business entities that do not file with the SEC are required to adopt no later than fiscal years beginning after December 15, 2020. Private companies are required to adopt no later than fiscal years beginning after December 15, 2021. All companies are permitted to early adopt for an interim or annual goodwill impairment test performed after January 1, 2017. More information is presented below. Summary & Highlights This new standard, ASU No. 2017-04, significantly changes the way in which a company measures a goodwill impairment charge. The good news is that the new standard simplifies the measurement of a goodwill impairment charge. It reduces the cost of that computation by eliminating the need to obtain detail fair value information for the individual assets and liabilities of the reporting unit that houses the goodwill. The perhaps not-as-good news is that the simpler approach can result in a different impairment charge than under prior accounting solely due to the mechanics of the new measurement model. A company that would not have recorded an impairment charge under the prior accounting may find it necessary to record an impairment loss under the new standard. Additionally, the new approach eliminates the possibility of a goodwill impairment charge when a reporting unit’s net book value is zero or negative. Under the new standard, the amount of a goodwill impairment charge is measured as the arithmetic difference between (i) the fair value of the reporting unit as a whole and (ii) the book value of the reporting unit as a whole. Companies are not required (or permitted) to determine the implied fair value of goodwill by performing a hypothetical purchase price allocation to the assets and liabilities within the reporting unit. In short, rather than measuring impairment as the difference between the implied fair value and book value of goodwill, the new standard presumes that the entire difference between the reporting unit’s fair value and the book value represents an impairment of goodwill. The new standard does not affect the private company alternative accounting model for goodwill that permits eligible private companies to amortize goodwill and assess impairment only upon the occurrence of a triggering event.1 Analysis and Implementation Objective and Background Accounting for goodwill has been studied and debated by the accounting profession several times in the past 50 years. Prior to 1970, goodwill was not amortized. Then, with the issuance of APB Opinion No. 17, Intangible Assets, goodwill was required to be amortized over a period not to exceed 40 years. Twenty-five or so years later, when the FASB decided to broadly readdress the accounting for business combinations, it added a project on intangible assets and goodwill. In 2001, after extensive debate regarding the nature of goodwill and how to best represent it in the financial statements, the FASB published Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”) which eliminated goodwill amortization and required an annual goodwill impairment test based on fair values.2 During the deliberations leading up to SFAS No. 142, constituents suggested that the least costly approach to evaluating goodwill for impairment would be a one-step model that would compare the fair value of a reporting unit with its carrying value. The FASB rejected that approach on the basis that the result “could not be said to be an estimate of the implied fair value of goodwill.”3 Instead, the FASB attempted to address the cost/benefit concerns expressed by constituents by creating a two-step model that would require determining the implied fair value of goodwill (Step 2) only if the comparison of the reporting unit’s book value and fair value (Step 1) indicated a potential impairment. In this way, companies would incur the cost to estimate the fair value of the reporting unit each year, but would incur the incremental costs to determine the implied fair value of goodwill only if the first step indicated a potential problem. That two-step approach, however, remained a source of complexity and cost. In response to these concerns, the FASB added an optional, qualitative assessment (so-called “Step 0”) to the accounting model in 2011 that both public and private companies hoped would reduce the cost of impairment analyses in many situations. However, in 2014, the FASB took a very significant step by introducing an alternative, simplified goodwill accounting model solely for private companies4. Eligible private companies electing this accounting alternative amortize goodwill over a period not to exceed 10 years and test for impairment only upon the occurrence of a triggering event. This alternative method also permits eligible private companies to test for impairment on a consolidated basis (rather than at the reporting unit level) and to measure impairment by comparing the book value of the company (or reporting unit, if applicable) to its fair value. As a result of permitting this simplified alternative for private companies, and in a nod to the one-step approach used in financial statements prepared under IFRS5, in 2015 the FASB took on a project to determine whether the existing goodwill impairment model could be further simplified for all companies. This new standard, ASU No. 2017-04, is the result of that project. This new goodwill impairment standard did not obtain unanimous support from all Board members or from constituents. In fact, three of the seven Board mem2 © 2017 CCH Incorporated and its affiliates. All rights reserved. bers dissented. Those Board members along with several constituents observed that the one-step approach would misidentify and misstate goodwill impairment in some circumstances, an outcome that the Board acknowledges in its Basis for Conclusions. They were also troubled that the simplified approach would never give rise to goodwill impairment when the carrying value of the reporting unit was zero or negative. They argued that a two-step approach was a better, more conceptually sound method of determining impairment. For these reasons, several constituents encouraged the FASB to permit companies to select an accounting policy from two acceptable alternative methods: the simplified one-step method or the pre-existing two-step method. Ultimately, the majority of the Board concluded that all companies should follow the same one-step approach. They rejected permitting companies to use a two-step approach on the basis that it “could create confusion and may decrease comparability” as well as potentially making it “more difficult for users to interpret what that impairment represents if entities are calculating goodwill impairment in different ways.”6 Principal Changes Accounting—The new standard changes the way in which an impairment of goodwill is measured. Previously, the goodwill impairment charge was computed based on the difference between the carrying amount of goodwill and its implied fair value at the impairment testing date. Step 1 was to determine the fair value of the reporting unit. If the fair value of the reporting unit was less than its carrying value, then the company moved on to Step 2. In Step 2, the company allocated the estimated fair value of the reporting unit as a whole, as determined in Step 1, to all of the assets and liabilities of the reporting unit as if a third party had purchased the reporting unit. This was often referred to as a “hypothetical purchase price allocation” because it represented the amounts that a hypothetical buyer of the reporting unit would record were it to purchase the reporting unit at its estimated fair value. Under prior accounting, even when the fair value of the reporting unit was less than its carrying value, the implied fair value of goodwill could have exceeded its carrying value. Said differently, a reporting unit could have “flunked” Step 1 and not recorded a goodwill impairment charge under Step 2. Or the amount of the goodwill impairment charge computed in Step 2 could have been larger or smaller than the Step 1 differential. There are several possible reasons for this outcome: The assets in the reporting unit might have included unrecorded identifiable intangibles (e.g. a legacy trademark or technology that was generated internally) that are not included in the reporting unit’s carrying value. The fair values of some assets, such as loans or receivables, might have been less than carrying value because the impairment model for these financial assets is not based on fair value. The fair value of some liabilities might have been significantly more or less than carrying value because of changes in interest rates and/or creditworthiness. The inherent goodwill of the reporting unit might have included unrecorded goodwill related to any legacy business that was part of the reporting unit. © 2017 CCH Incorporated and its affiliates. All rights reserved. 3 Any of these situations would affect the residual amount from the hypothetical purchase price allocation, i.e., the implied fair value of goodwill. Under the new standard, the amount of a goodwill impairment charge is the amount by which the carrying value of the reporting unit exceeds its fair value. TABLE 1 For example, assume the carrying value of a reporting unit is $100, its estimated fair value at the impairment testing date is $90 and goodwill is $15. Under these assumptions, the goodwill impairment charge is $10 (i.e., the amount by which the reporting unit’s $100 carrying value exceeds its $90 fair value.) Any loss should not exceed the carrying amount of goodwill. Thus, using this same example, if the carrying value of goodwill were $8 (rather than $15), the goodwill impairment charge would be $8. Because the new standard does not attempt to measure the implied fair value of goodwill, the amount of a goodwill impairment charge under the new accounting standard in this example could differ significantly from the amount that would have been recorded under the prior standard. In some jurisdictions, goodwill is deductible for tax purpose. This creates a deferred tax asset or liability for the book vs. tax basis difference in goodwill recorded at the date of the acquisition. Under the new accounting standard, this situation requires the use of a simultaneous equation to solve for the amount of the impaired goodwill. That’s because any change in the book value of the goodwill simultaneously changes the related deferred tax which, in turn, affects the carrying value of the reporting unit. The new standard includes an example that illustrates this fact pattern.7 If the reporting unit has a zero or negative net book value (i.e. the carrying value of the reporting unit’s liabilities equals or exceeds the carrying value of its assets), no qualitative assessment is required. Further, no impairment will be recorded under the new standard so long as the reporting unit’s fair value equals or exceeds zero. Previously, reporting units with a zero or negative book value performed Step 2 if the outcome of the required qualitative assessment indicated a potential impairment. In other words, under prior GAAP, the mathematical impossibility of “flunking” Step 1 did not preclude the possibility of a goodwill impairment charge. Several important aspects of the goodwill impairment analysis are not changed by the new standard. For example: Companies must continue to annually test whether goodwill is impaired. Companies may continue to qualitatively assess whether it is more likely than not that goodwill is impaired (i.e., Step 0) in connection with the annual test. When quantitatively assessing goodwill for impairment, companies must continue to determine the fair value of the reporting unit whose operations are associated with the goodwill (i.e., Step 1). Companies that experience triggering events or other indicators of impairment at an interim date must continue to quantitatively assess goodwill for impairment. Private companies continue to have the option to elect to amortize goodwill over a period not to exceed 10 years (i.e. the “private company alternative” approach to accounting for goodwill).8 Private companies electing this alternative will continue to use the “one-step” impairment approach when a quantitative impairment assessment is required. 4 © 2017 CCH Incorporated and its affiliates. All rights reserved. Disclosures—Under the new standard, a company that has one or more reporting units with a zero or negative net book value should (a) disclose the amount of goodwill allocated to that reporting unit and (b) identify the reportable segment that includes the reporting unit. Other than the disclosure related to reporting units with a zero or negative book value, the new standard does not add, modify or eliminate disclosure requirements. Companies Likely to be Affected All public companies with goodwill on their books and those private companies that have goodwill on their books but have not adopted the private company alternative for goodwill are affected by this new standard. Companies that are most likely to see a significant difference in the result of their goodwill impairment analysis in comparison to the prior standard include: Financial services companies that have significant amounts of financial assets (e.g. loans or receivables) whose fair value is less than net book value. This fact pattern is not uncommon because the impairment model for financial assets is not based on fair value. Companies whose liabilities at fair value differ significantly from carrying value. Given the lack of significant volatility in interest rates in the past several years, companies that are most likely to have this situation are those that have experienced a significant change in their credit worthiness. Companies with reporting units that have a zero or negative net book value. The FASB believes that this is not a common fact pattern. Companies with reporting units whose fair values are significantly greater than book values (i.e. reporting units with significant cushion) are likely to adopt the new standard early. For these companies, implementation of the new standard will have no effect and will reduce cost and complexity. Companies with one or more reporting units that do not have significant cushion or who currently fail Step 1 but are not reporting impaired goodwill (because of the measurement principles in Step 2) are more likely to delay implementation. As explained below, some financial institutions are in this category. These companies will want to carefully analyze the effects of the new standard in order to manage expectations about the effect of adoption. Companies with reporting units that have a zero or negative book value may choose to adopt early, particularly if a company anticipates that its qualitative assessment of the reporting unit may indicate a possible impairment. Under the new standard, no qualitative assessment or Step 2 computations are required for reporting units with a zero or negative book value. Financial institutions are likely to defer adoption of the new standard until they adopt the new credit loss standard, sometimes referred to by the acronym CECL.9 Why? If a bank with significant financial instruments adopted the new goodwill standard before adopting the new credit loss standard, it might effectively double count credit losses that are inherent in its loan portfolio. © 2017 CCH Incorporated and its affiliates. All rights reserved. 5 Here’s an example of how that might happen. TABLE 2 Assume the fair value of Bank A’s loan portfolio is less than the portfolio’s net book value (i.e. the book value of the loans less the related allowance for loan losses). Also assume the fair value of Bank A (a single reporting unit) is less than its carrying value but that no goodwill impairment has been recorded based on the implied fair value of goodwill measured in Step 2. Finally, assume Bank A’s allowance for loan losses will be larger under the new credit loss standard than under current accounting. Upon early adoption of the goodwill standard, Bank A would record a goodwill impairment charge. Because the hypothetical purchase price allocation in Step 2 recorded the acquired loan portfolio at fair value before arriving at the implied fair value of goodwill, goodwill previously was not impaired. But under the new one-step approach, the entire difference between the reporting unit’s fair value (which includes the unrecognized loss in the loan portfolio) and its carrying value is presumed to be an impairment of goodwill. Upon subsequent adoption of the loan loss standard, Bank A would record a loss to reflect the lifetime expected credit losses that are incremental to the loan loss reserve recorded under the prior GAAP standard. Had Bank A deferred implementing the new goodwill standard until it adopted the credit loss standard, the incremental loan loss reserves to record the lifetime expected credit losses in the portfolio would reduce the carrying value of the reporting unit, thereby narrowing the amount by which the carrying value exceeds the fair value of the reporting unit. The FASB intentionally aligned the effective date of the new goodwill standard with the effective date of the new credit loss standard for this reason. Private companies that adopted the private company alternative for goodwill are not affected by this standard. Effective Date This standard has three separate adoption dates, depending on the public vs. private status of the company. These adoption dates align with the FASB’s new standard on credit losses10 for the reasons discussed above. Public companies that file financial statements with the SEC are required to adopt in annual periods beginning after December 15, 2019, including interim periods within that year. For example, a public company with a calendar year end is required to use the new impairment methodology for its annual or any interim goodwill impairment test that is done on or after January 1, 2020. Companies that meet the definition of a public business entity but do not file financial statements with the SEC are required to adopt in annual periods beginning after December 15, 2020, including interim periods within that year. For example, a company in this category with a calendar year end is required to use the new impairment methodology for its annual or any interim goodwill impairment test that is done on or after January 1, 2021. 6 © 2017 CCH Incorporated and its affiliates. All rights reserved. Private companies are required to adopt in annual periods beginning after December 15, 2021, including interim periods within that year. For example, a private company with a calendar year end is required to use the new impairment methodology for its annual or any interim goodwill impairment test that is done on or after January 1, 2022. All companies are permitted to adopt the new standard early for interim or annual goodwill impairment tests performed after January 1, 2017. A company that has not yet released its December 31, 2016, financial statements must continue to use the prior accounting to measure goodwill impairment in its 2016 financial statements, regardless of the effect that the new standard might have. Transition The new standard is implemented prospectively. In other words, at the time the company adopts the new standard, it will apply the new measurement model to its annual goodwill impairment test and any interim period evaluation that is required due to a triggering event or other impairment indicator. Disclosures required upon transition include the nature and reason for the change in accounting. This disclosure is required upon adoption even if the entity does not perform the quantitative goodwill impairment test during the period of adoption. TABLE 3 For example, assume Company Z, a public company, adopts the new standard in its first quarter ended March 31, 2017. Its annual evaluation date for goodwill is October 1 and there were no impairment indicators during the first quarter. Therefore, Company Z did not perform a quantitative goodwill impairment test during its 2017 first quarter. Company Z should nonetheless disclose the adoption of the new standard in its interim financial statements for the quarter ended March 31, 2017. Keep in mind that if a reporting unit’s fair value was less than its carrying value under Step 1 but the implied fair value of goodwill was greater than its book value under Step 2, that reporting unit would likely have an indicator of impairment at the time it implements the new standard on goodwill. TABLE 4 For example, assume Company PQR is a public company with a calendar year end and an October 1 annual goodwill impairment testing date. As of October 1, 2016, the fair value of one of its reporting units was less than its carrying value. However, goodwill, as measured under Step 2, was not impaired. If Company PQR adopts the new standard in its quarter ended March 31, 2017, it likely has an impairment indicator as of January 1, 2017. Thus, Company PQR likely will need to quantitatively evaluate that reporting unit’s goodwill under the new standard at the time it adopts (i.e., as of January 1, 2017.) © 2017 CCH Incorporated and its affiliates. All rights reserved. 7 Public Company Considerations Under the SEC’s rules and regulations, a public company is required to disclose the date it expects to implement a new accounting standard, the method of adoption and any significant financial reporting consequences.11 A company that is at risk of reporting a goodwill impairment as a result of the new standard’s measurement model should communicate that possibility to users of its financial statements either in MD&A or as part of its footnote disclosure on recently issued new accounting standards. Private Company Considerations A private company that adopted the alternative private company accounting model for goodwill12 but has not adopted the alternative private company accounting model for intangibles13 is permitted to adopt the “public company” accounting model for goodwill (including the new goodwill impairment standard) without addressing whether the change in accounting is to a preferable method. This might be a consideration for a private company that generally prefers to follow the same accounting standards as a public company but adopted the private company model for goodwill in order to reduce costs. Now that both the public and private company models use a one-step approach to measuring impaired goodwill, the cost differential between the two methods may be small. In responding to the FASB’s exposure draft, the Technical Issues Committee (TIC) of the AICPA’s Private Companies Practice Section supported the new guidance because the TIC believed it would reduce costs without negatively affecting financial statements users. The TIC also agreed that the incremental disclosures related to reporting units with zero or negative carrying amounts would benefit users. The TIC believed a one-year transition period would be sufficient and supported giving companies the option to early adopt.14 Recent Developments in GAAP This section of the GAAP Update provides insight into recent decisions by the FASB and alerts you to recently issued new standards and exposure drafts plus other developments that are in the pipeline. New Standards Employee Benefit Plan Master Trust Reporting—This topic addresses the way in which an employee benefit plan reports its interest in a master trust. It applies to any type of benefit plan (defined benefit pension plan, defined contribution plan or health and welfare benefit plan) that has some or all of its assets in a master trust. Under the new standard, the plan’s interest in the master trust and any change in that interest are presented in separate line items in the plan’s financial statements. Additional changes are made to certain disclosures related to investments held by the master trust and the other assets and liabilities of the master trust. The new standard, which reflects a consensus view of the EITF, is effective for fiscal years beginning after December 15, 2018. Early adoption is permitted. The FASB issued a final standard in February 2017 (ASU 2017-06, Plan Accounting: Defined Benefit Pension Plans (Topic 960), Defined Contribution 8 © 2017 CCH Incorporated and its affiliates. All rights reserved. Pension Plans (Topic 962), Health and Welfare Benefit Plans (Topic 965): Employee Benefit Plan Master Trust Reporting). Presentation of Pension and Postretirement Benefit Costs—This topic addresses the line item presentation of pension and postretirement benefit costs in a company’s income statement. The new standard applies to both public and private companies. Companies are required to disaggregate service cost from the other components of net benefit cost. Additionally, only the service cost component of net benefit cost is eligible for capitalization as part of inventory or a self-constructed asset. The service cost component should be classified consistent with the relevant employees’ other payroll costs. The new standard does not dictate the classification of other cost components of pension and postretirement benefits (e.g. interest cost, expected return on assets, gain or loss, prior service cost). However, these other cost components should not be deducted in arriving at operating income, if that subtotal is presented. The new standard is effective for fiscal years beginning after December 15, 2017, for public companies and December 15, 2018, for private companies. Early adoption is permitted as of the beginning of an annual period for which interim or annual financial statements have not yet been issued. Transition is retrospective for income statement presentation and prospective for capitalization. The FASB issued a final standard in March 2017 (ASU 2017-07, Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and net Periodic Postretirement Benefit Cost.) Modifications of Share-Based Awards to Employees—This project is intended to clarify when a company should apply modification accounting to changes that it makes to the terms of share-based awards that previously were granted to employees. The exposure draft was issued in November 2016. 15 comment letters were received. Based on its tentative decisions, the new guidance will be applied prospectively to awards modified on or after the standard is adopted. Early adoption is permitted at any time after the standard is issued. It becomes mandatory for fiscal years beginning after December 15, 2017. The FASB plans to issue a final standard on this topic in the second quarter of 2017. Interest Income on Callable Debt Securities—This project is intended to improve the accounting for the amortization of premiums for purchased callable debt securities. The September 2016 exposure draft resulted in 28 comment letters. Based on its tentative decisions, the new guidance will require that premiums on purchased callable debt securities should be amortized to the earliest call date. The new standard will be implemented via a cumulative-effect adjustment to opening retained earnings. Public companies will be required to adopt for annual periods beginning after December 15, 2018. Private companies will be required to adopt for annual periods beginning after December 15, 2019. All companies will be permitted to adopt early. The FASB plans to issue a final standard on this topic in the second quarter of 2017. Endnotes 1 ASU No. 2014-02, Intangibles – Goodwill and Other (Topic 350): Accounting for Goodwill (A Consensus of the Private Company Council), issued January 16, 2014. 2 SFAS No. 142 was subsequently codified into ASC Topic 350. 3 Refer to paragraph B131 in the Basis for Conclusions of SFAS No. 142. The Basis for Conclusions paragraphs are not included in the Accounting Standards Codification. © 2017 CCH Incorporated and its affiliates. All rights reserved. 9 4 Refer to ASU No. 2014-02, Intangibles – Goodwill and Other (Topic 350): Accounting for Goodwill (A Consensus of the Private Company Council). 5 IAS 36, Impairment of Assets. While the new accounting model for goodwill impairment under US GAAP more closely aligns with IFRS, the two accounting models continue to differ. 6 Paragraph BC24 in ASU No. 2017-04. 7 Refer to Example 2A in paragraphs 350-20-55-23A through 23C. 8 Refer to ASU No. 2014-02, Intangibles – Goodwill and Other (Topic 350): Accounting for Goodwill (A Consensus of the Private Company Council), issued January 16, 2014. 9 The acronym stands for “current expected credit loss” and is a shorthand description of the accounting model in the new credit loss standard. Refer to ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. 10 ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, issued June 16, 2016. 11 See SEC Staff Accounting Bulletin Topic 11M (SAB No. 74), Disclosure of the impact that recently issued accounting standards will have on the financial statements of the registrant when adopted in future periods. 12 ASU No. 2014-02, Intangibles – Goodwill and Other (Topic 350): Accounting for Goodwill (A Consensus of the Private Company Council). 13 ASU No. 2014-18, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination (A Consensus of the Private Company Council). 14 Letter dated July 14, 2016 from the AICPA’s Private Companies Practice Section to the FASB related to the May 12, 2016 Exposure Draft of a Proposed Accounting Standards Update (ASU), Intangibles – Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment. About the Author This edition of the GAAP Update Service was authored by highly credentialed, seasoned CPAs at Financial Reporting Advisors, LLC. Located in Chicago, the firm provides accounting advisory, SEC reporting, litigation support and dispute resolution services. Resumes and more information can be found at www.FinRA.com. 10 © 2017 CCH Incorporated and its affiliates. All rights reserved. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
Purchase answer to see full attachment