On June 15, the Financial Accounting Standards Board (FASB) unanimously voted to drop its project on the subsequent accounting of goodwill and other identifiable intangible assets — for now. This was a surprising move that comes after several years of research and tentative decisions. In the meantime, the FASB plans to keep an eye on changes to the disclosure model that are being considered by the International Accounting Standards Board.
What is goodwill?
Internally generated goodwill isn’t reported on a company’s balance sheet, but goodwill may be reported as a result of a business combination. It’s typically associated with the premium the buyer of a business or asset pays over its fair value. Goodwill is an intangible asset that may be linked to such things as a target company’s customer loyalty or business reputation.
The value of goodwill is determined by deducting, from the cost to buy a business, the fair value of tangible assets, identifiable intangible assets and liabilities obtained in the purchase. Investors may be interested in tracking goodwill because it enables them to see how an acquisition fares in the long run.
Under U.S. Generally Accepted Accounting Principles (GAAP), public companies that report goodwill on their balance sheets can’t amortize it. Instead, they must test goodwill at least annually for impairment. When impairment occurs, the company must write down the reported value of goodwill.
Testing should also happen for all entities whenever a “triggering event” occurs that could lower the value of goodwill. Examples of triggering events include the loss of a key customer, unanticipated competition or negative cash flows from operations. Impairment may also occur if, after an acquisition has been completed, there’s an economic downturn that causes the parent company or the acquired business to lose value.
Impairment write-downs reduce the carrying value of goodwill on the balance sheet. They also lower profits reported on the income statement.
How do the rules differ for private companies?
Impairment testing can be complicated, especially when a company’s stock isn’t actively traded in the public markets. So, the FASB has granted private companies some practical expedients to simplify the subsequent accounting of goodwill and other intangibles. Specifically, Accounting Standards Update (ASU) No. 2014-02 gave private companies the option to amortize acquired goodwill over a useful life of up to 10 years.
The test private businesses have to perform to determine whether goodwill has lost value was also simplified in 2014. Instead of automatically testing for impairment every year, private companies are required to test only when there’s a triggering event. This indicates the company has evidence that the fair value of the acquired business is less than the carrying amount on the balance sheet.
What changes have been considered?
In October 2018, the FASB added a project on the subsequent accounting of goodwill to its technical agenda. In 2019, the FASB issued an invitation for public comment and subsequently held roundtable discussions.
In deliberations, the FASB had previously leaned toward requiring that all entities apply an impairment-with-amortization model. This is where an entity would amortize goodwill over a 10-year default period that would be limited to a 25-year cap. Under the proposed changes, reassessing the amortization period would be prohibited, and goodwill would be tested for impairment only upon a triggering event. Companies would continue to test goodwill for impairment at the reporting unit level. In addition, customer-relationship intangible assets that aren’t separable would be subsumed into goodwill.
These changes, if approved, would have put huge write-downs on corporate balance sheets. So, companies understandably pushed back on the models that required amortization.
Why was the project abandoned?
During a June meeting, FASB members indicated that the current impairment-only model needs improvement and doesn’t necessarily reflect the economics of M&A transactions. However, after reviewing feedback from stakeholders, they weren’t convinced that the changes the FASB had pursued on the subsequent accounting of goodwill would improve the current rules. Much of the FASB’s tentative leanings on the project had passed by narrow margins, with little enthusiasm to warrant making major changes.
FASB Vice Chair James Kroeker said that the project’s direction gave him pause to consider, “Are we trading one set of challenges with a different set of challenges?” This topic has been debated for more than 75 years, so it might not be an easy matter to fix.
Wait and see
The FASB’s decision to drop its goodwill project means it won’t be seeking any additional stakeholder feedback, but it will consider international developments on the matter. FASB Chair Richard Jones recently confirmed that the FASB will continue to monitor the International Accounting Standards Board’s project on goodwill disclosures, which had been temporarily delayed during the pandemic. Contact your CPA for any new developments.
Sidebar: Long History of Unresolved Debates
The post-acquisition accounting of goodwill has been challenging for the Financial Accounting Standards Board (FASB), because the accounting profession doesn’t collectively hold clear views on the matter. In fact, the appropriate accounting treatment of acquired goodwill — whether to immediately write it off, to capitalize and amortize it, or to capitalize and test it for impairment — has been debated since the 1940s.
The current impairment-only model was introduced by the FASB in 2001. Since 2010, the following seven accounting standards updates (ASUs) have been adopted by the FASB to reduce the cost of impairment testing:
- ASU 2010-28, Intangibles — Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts,
- ASU 2011-08, Intangibles — Goodwill and Other (Topic 350): Testing Goodwill for Impairment
- ASU 2014-02, Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill (a consensus of the Private Company Council)
- ASU 2014-18, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination (a consensus of the Private Company Council),
- ASU 2017-04, Intangibles — Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment,
- ASU 2019-06, Intangibles — Goodwill and Other (Topic 350), Business Combinations (Topic 805), and Not-for-Profit Entities (Topic 958): Extending the Private Company Accounting Alternatives on Goodwill and Certain Identifiable Intangible Assets to Not-for-Profit Entities, and
- ASU 2021-03, Intangibles — Goodwill and Other (Topic 350): Accounting Alternative for Evaluating Triggering Events.
The FASB has now decided to stay the course, even though the current impairment-only model may be flawed. This time around, there just wasn’t enough of a case made for the change, which would have been significant. But the project won’t just disappear. “We may be able to bring it back again one day,” said FASB Chair Richard Jones.
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