Abstract: The FASB recently voted against changing the unit level at which goodwill should be tested for impairment. A change would have caused fewer impairments to be recognized. This article summarizes the current rules and why FASB members decided to maintain the status quo. A sidebar explains the FASB’s recent decision not to delay the credit loss standard, despite pressure from community banks and credit unions.
On January 26, the Financial Accounting Standards Board (FASB) tentatively voted 4 to 3 against changing the unit level at which goodwill should be tested for impairment. If the board were to change from testing at the reporting level to the more aggregated operating segment level, it could cause fewer impairments to be recognized. This decision is considered a win for investors who want robust information about a company’s financial results.
Evaluating goodwill
Internally generated goodwill isn’t reported on a company’s balance sheet. Goodwill is only recorded when a company merges with or acquires another business. It’s associated with the premium the buyer of a business or asset pays over its fair value. It’s an intangible asset that may be linked to things like 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 are interested in goodwill because it enables them to see how an acquisition fared in the long run.
In 2014, the FASB decided to give private companies the option to amortize goodwill over a period not to exceed 10 years. However, public companies aren’t allowed to amortize goodwill. Instead, they must test it annually for impairment. In addition, all companies may need to test for impairment if a so-called “triggering event”— such as the loss of the major customer or a natural disaster — happens. Goodwill becomes impaired if its fair value declines below the carrying value.
Impairment write-downs reduce the carrying value of goodwill on the balance sheet. They also lower profits reported on the income statement.
Differentiating between reporting units and operating segments
The FASB recently discussed whether the impairment testing for goodwill should stay at the reporting unit level or be changed to the operating segment level in the context of an earlier decision to amortize goodwill. An operating segment is a component of a public entity:
- That engages in business activities,
- That has its operating results regularly reviewed by the chief operating decision maker, and
- For which discrete financial information is available.
A reporting unit is an operating segment or one level below an operating segment. Retaining the reporting unit for impairment testing would align with the preference expressed by some companies that the impairment testing should be performed at the most disaggregated level possible.
Keeping investors informed
Unfortunately, goodwill and impairment are accounting constructs that don’t necessarily translate well with investors. There are significant differences between how investors view the topic vs. how accountants view it.
“Investors lose hundreds of billions of dollars of market cap as a result of loan acquisitions either through paying too much or poor execution,” said FASB member Fred Cannon who represents the interests of investors. “I think it’s critically important to maintain as robust an impairment model as possible,” he added.
Three FASB members — including Cannon and Christine Botosan who represents the academic side of the board — voted to continue testing for impairment at the reporting unit level. Botosan said: “We’re making a number of significant cost-reducing changes to the subsequent accounting for goodwill. So I believe that leaving a few teeth in the impairment test like testing at a lower level is a reasonable compromise between preparers’ cost concerns and users concerns about losing information content from impairments becoming much less frequent.”
Simplifying the financial reporting process
Conversely, three FASB members who represent financial statements preparers and practitioners voted in favor of changing the testing level from the reporting unit to the operating segment. They preferred aligning the impairment test with information about operating results already provided in the financial statements, stating that reporting units aren’t used in financial reporting outside of the goodwill impairment test.
In addition, they said that the FASB’s decision to bring back goodwill amortization is responsive to recognizing the cost of an acquisition over time. This change would help address investor concerns about too little impairment information being given too late.
The actual acquisition date is “the only point in time at which the purchased goodwill could with any degree of specificity be identified,” said FASB Vice Chair James Kroeker, who agreed with staff recommendations to change the level of impairment testing to the operating segment. “Any subsequent point in time is arbitrary and is very difficult to identify if not impossible to that individual acquisition.”
Casting the tie-breaking vote
After listening to both sides of the debate, FASB Chair Richard Jones sided with arguments posed by investors and academics. “I don’t think the impairment model does a good job of reflecting the declining value of what we ascribe to goodwill at the date of acquisition, and I think that’s why I’m interested in the amortization model,” Jones said. “That being said, I do think in accounting we have a perception issue that one level gives a more precise calculation and until that is overcome [FASB staff] didn’t make the case for change.”
Sidebar: FASB won’t budge on deadline for credit loss standard
In early February, the Financial Accounting Standards Board (FASB) voted against deferring the effective date of credit loss accounting rules for nonpublic entities. This means small public companies, private companies and not-for-profits must adopt the current expected credit losses (CECL) standard by 2023.
Accounting Standards Update (ASU) No. 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, requires banks and other financial entities to forecast into the foreseeable future to predict losses over the life of a loan and then immediately book those losses. Measuring losses is challenging in today’s uncertain marketplace.
The CECL rules were issued in 2016 in response to the 2007–2008 financial crisis to require a more-timely reporting of credit losses. The updated guidance was deferred twice before. Recently, community banks and credit unions had petitioned the FASB for a third deferral — or for a full exemption.
Organizations that favored a third deferral said the new rules are complex, require onerous data collection and have punitive capital implications. They also argued that the CECL rules were originally developed to provide public company stakeholders with more decision-useful information and, therefore, shouldn’t be applicable to entities with no shareholders and that prepare financial statements primarily for prudential regulators.
FASB members were sympathetic to the challenges smaller financial institutions faced when applying the rules. But many simplifications have already been made. They also prefer a unified standard applicable to those most impacted by the CECL rules. However, FASB Chair Richard Jones and Vice Chair James Kroeker signaled they were open to granting private companies the option to adopt the rules — or not.
Jones favored allowing exemptions for nonpublic entities, stating that many are commercial companies with only trade receivables that aren’t covered by the CECL rules. Kroeker’s view that a private company option should be granted was influenced by a letter from the National Credit Union Administration (NCUA). NCUA, which insures and regulates credit unions, said the compliance cost associated with implementing a CECL model overwhelmingly exceeds the benefit.
Currently, the CECL standard is under post-implementation review, the FASB’s process to determine whether a standard worked as intended for organizations that previously implemented the changes. Staff members have been doing outreach to facilitate the adoption of the rules. If you’re struggling to on-board the changes, contact your CPA for assistance and the latest developments on this topic.
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