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9.3 Assigning assets and liabilities to reporting units
Publication date: 30 Sep 2020 (updated 30 Nov 2021)
us Business combinations guide
To apply the provisions of the goodwill impairment test (as further discussed in BCG 9.6 and BCG 9.8), an entity needs to assign the appropriate assets and liabilities to the respective reporting units. Assets and liabilities are required to be assigned to a reporting unit if both of the following criteria in ASC 350-20-35-39 are met:
- The asset will be employed in or the liability relates to the operations of a reporting unit.
- The asset or liability will be considered in determining the fair value of the reporting unit.
Assigning assets and liabilities to reporting units inherently involves judgment. The objective of the assignment of identifiable assets and liabilities to a reporting unit is to achieve symmetry (i.e., an “apples to apples” comparison) between the assets and liabilities that are assigned to the reporting unit and the net assets that are considered in the determination of a reporting unit’s fair value. To achieve this symmetry, it is critical for the entity to (1) understand the factors behind and drivers of a reporting unit’s fair value, and (2) employ a methodology for assigning assets and liabilities to a reporting unit that is reasonable, supportable, and consistent with how it determines the reporting unit’s fair value.
A reporting unit should be assigned all of the assets and liabilities necessary to operate as a business because it is those net assets that will generate the cash flows used to determine the fair value of the reporting unit. However, the assignment of assets and liabilities does not need to result in a full balance sheet for an operating segment or component to qualify as a separate reporting unit. An operating segment does not need to constitute a business to be a reporting unit. Once an entity has established an appropriate methodology for assigning assets and liabilities to a reporting unit, it should be applied consistently from period to period.
The process of assigning assets and liabilities to reporting units is only for the purpose of impairment testing and the resulting information is usually not reflected in the actual ledgers or financial statements of the entity. Such information is usually maintained on separate detailed schedules as part of the accounting records that support the financial statement balances and conclusions reached as a result of impairment testing.
9.3.1 Assigning assets/liabilities of multiple reporting units
Some assets or liabilities may be employed in or relate to the operations of multiple reporting units. This may include intangible assets, such as trade names, technology, patents, and customer lists; tangible assets, such as shared manufacturing facilities; or liabilities, such as debt and pension obligations for active employees. In developing a reasonable and supportable methodology to assign such assets and liabilities to reporting units, an entity may consider the relative benefit received by the different reporting units or the relative fair values of the different reporting units. Other criteria may include specific measurable relationships. In the case of some pension items, for example, a pro rata assignment based on payroll expense might be used.
An entity’s methodology to assign to reporting units those assets and liabilities that are employed in multiple reporting units should be consistent and established in tandem with how the entity determines the reporting units’ fair values. An entity normally should base its determination of a reporting unit’s fair value on assumptions that market participants would use to estimate fair value. These assumptions include the likely structure of a sale of that reporting unit, and whether (and if so how) an asset employed in multiple reporting units would be included in the transaction. If the asset would not be included in the sale but its continued use would be necessary to maximize the value of the reporting unit, the cash flow projections used to estimate the fair value of the reporting unit may need to include a cash outflow representing the payment at fair value for the continued use of the asset (similar to a rental or usage fee). This would be the case even if the entity does not presently have intercompany charges for the usage across reporting units.
Conversely, if the asset is included in the reporting unit, it may be necessary to include cash inflows as payments at fair value from the entity’s other reporting units that use the asset. The objective is to ensure that the approach to assigning assets and liabilities to reporting units is consistent with how the fair value of the reporting unit is determined. Otherwise, an entity may determine inappropriately that it has passed or failed step one of its goodwill impairment test.
Question BCG 9-1
If a company has multiple reporting units, how should pension assets and liabilities be attributed to its reporting units?
If a company has multiple reporting units, how should pension assets and liabilities be attributed to its reporting units?
PwC response
The objective is to ensure that the approach of assigning assets and liabilities to reporting units is consistent with how the fair value of the reporting unit would be determined. In making this assessment, it is necessary to understand the assumptions a market participant would make in determining the fair value of the reporting unit and whether it is likely that the pension asset or liability would be included in a transaction to sell the reporting unit. The allocation of pension expense to reporting units does not automatically mean that pension assets and liabilities should also be attributed to reporting units. For example, if a reporting unit participates in a multi-employer plan, pension expense would be allocated to the reporting unit; however, no pension asset or liability would be attributed to the reporting unit as a pension asset or liability would not transfer to an acquirer in a sale of the reporting unit.
Example BCG 9-2 illustrates a method for assigning the carrying amount of an intangible asset employed in multiple reporting units.
EXAMPLE BCG 9-2
Assignment of an intangible asset employed in multiple reporting units
Assignment of an intangible asset employed in multiple reporting units
A parent company owns an acquired trade name that is used by several of its reporting units. The parent company is determining the appropriate assignment of the trade name’s recorded amount to the reporting units that use the name (i.e., the trade name is maintained at the parent company level but the trade name benefits multiple reporting units). The parent company may not sell that trade name if the parent company were to sell only one of the reporting units to a market participant. Rather, in exchange for a royalty on future product sales, the parent company might grant an acquirer the right to continue using the trade name. The parent company has determined that the assignment should be driven by the assumptions applied in establishing the fair value of the reporting units.
How should the value of the trade name employed in multiple reporting units be assigned to each reporting unit?
Analysis
It is likely that an estimate of the reporting unit’s fair value would be based on the assumption that the trade name will be licensed to the acquirer instead of sold. Therefore, the parent company generally would not assign a portion of the trade name’s carrying amount to the reporting unit. Instead, a royalty at fair value would be imputed as a cash outflow of the reporting unit that uses the trade name for purposes of determining the reporting unit’s fair value. Further, assuming the trade name is not a corporate asset but is assigned to another reporting unit, that reporting unit would impute royalty income as a cash inflow from the reporting unit using the trade name.
In certain circumstances, depending on the facts, there may be other methods to performing this assignment, such as assigning based on the relative fair values of the reporting units or benefits received by the reporting units. In determining whether the carrying amount of an asset that is used in multiple reporting units should be assigned to one or more reporting units, an entity will need to evaluate the relevant facts and circumstances in light of how the fair values of its reporting units are being estimated.
9.3.2 Assigning corporate assets and liabilities
Assets and liabilities that an entity considers part of its corporate-level assets and liabilities should be assigned to a specific reporting unit if the criteria discussed in BCG 9.3 are met. When corporate-level assets and liabilities relate to several or all of the entity’s reporting units, they are usually not assigned to specific reporting units. Pursuant to the guidance of ASC 350-20, not all assets and liabilities of an entity need to be assigned to specific reporting units. However, if corporate items are included and reflected in the fair value of a reporting unit, they may need to be assigned to that unit. This may include balances arising from pension plans, taxes, and general debt obligations. In instances where a reporting unit benefits from the corporate items, but such items are not assigned to the reporting unit, the determination of the reporting unit’s fair value should consider the fair value of the use of the corporate-level assets and liabilities.
9.3.3 Segment reporting interaction with reporting units' assets
ASC 280-10-50-20 through ASC 280-10-50-29 provides that an entity must include in its segment disclosures those assets that are included in the measure of a segment’s assets, as used by the CODM. ASC 350-20 does not affect ASC 280 and does not require that all of the assets that an entity assigns to reporting units for purposes of goodwill impairment testing be reflected in an entity’s reported segment assets. Thus, an entity should report its segment assets in accordance with the guidance in ASC 280. In addition to the required segment disclosures in ASC 280, an entity is required by ASC 350-20-50-1 to disclose the carrying amount of goodwill for each of its reportable segments and provide a detailed reconciliation of the changes in those amounts for each period.
9.3.4 “Full” allocation for entities with a single reporting unit
Generally, an entity is not required to assign all of its assets and liabilities to its reporting units. However, for entities that are narrowly focused in their operations and that identify only one operating segment and one reporting unit, it is difficult to assert that any corporate assets or liabilities were not involved with the single reporting unit’s operations. In that case, all of the entity’s assets and liabilities would be included in that reporting unit for the purpose of goodwill impairment testing.
9.3.5 Guidance for specific balance sheet components- updated November 2021
Assets and liabilities should be assigned to a reporting unit if (1) the asset will be employed in, or the liability relates to, the operations of a reporting unit, and (2) the asset or liability will be considered in determining the fair value of the reporting unit as discussed in ASC 350-20-35-39. The following are considerations for assigning specific assets or liabilities to a reporting unit:
- Working capital: Companies generally include a working capital balance in the valuation of their reporting units. When comparing a reporting unit’s carrying amount to its fair value, it is important to understand the working capital assumptions used in the fair value measurement to ensure they are consistent with the entity’s assignment of working capital to the reporting unit when determining its carrying amount. Similarly, intercompany accounts may reflect the working capital of a reporting unit and need to be considered when determining the fair value and carrying amount of a reporting unit.
- Cash/cash equivalents: Entities may maintain cash that is not related to a specific reporting unit as a corporate asset. Generally, corporate-level cash would not be assigned to an entity’s reporting units. On the other hand, an entity would assign cash to the related reporting unit if the entity considered the cash in determining the fair value of the unit. Because the carrying amount of cash and cash equivalents would be expected to approximate fair value, its assignment to reporting units generally would not have an impact on the goodwill impairment test, as long as it had been appropriately considered in the fair value of the reporting unit.
- Investments: Determining whether investments in debt and equity securities (including equity-method investments) should be assigned to and included in the carrying amount of reporting units may be challenging. Investments maintained at a corporate level generally would not be employed in the operations of a reporting unit and therefore would not be assigned to reporting units. In some cases, however, investments may be an integral part of the operations of a reporting unit. In those cases, if an entity demonstrates that its investments would likely be transferred to a market participant if the reporting unit were to be sold, it may be appropriate to assign investments to the reporting unit and consider them in determining the reporting unit’s fair value.
- Debt: An entity should assign debt to the reporting unit if that debt relates directly to the operations of the unit and is likely to be transferred to a market participant if the reporting unit were to be sold. For example, debt issued to construct a manufacturing plant and secured by the plant would typically be assigned to the reporting unit that includes the plant because the debt is specific to the plant and would likely be assumed by an acquirer of the reporting unit. Similarly, for leases accounted for by a lessee under ASC 842, Leases, if the leased asset is employed in the operations of a reporting unit, both the right-of-use asset and the lease liability should be assigned to the reporting unit. On the other hand, an entity would not typically assign general corporate debt to its reporting units. An entity should evaluate intercompany debt to determine if it should be treated in a manner similar to external debt.
- Contingent consideration: Determining whether a contingent consideration obligation or asset should be assigned to and included in the carrying amount of reporting units may be challenging. If the reporting unit is obligated to pay contingent consideration or the right to receive contingent consideration is held by the reporting unit, the contingent consideration generally would be assigned to that reporting unit. It would also be appropriate to include intercompany contingent consideration obligations or assets in a reporting unit’s carrying amount if an acquiring market participant would assume that obligation or asset.
- Deferred taxes other than for net operating losses (NOLs): The deferred taxes originating from temporary differences related to the reporting unit’s assets and liabilities should be included in the carrying amount of the reporting unit, regardless of whether the fair value of the reporting unit is determined by assuming it would be sold in either a taxable or nontaxable transaction following the guidance in ASC 350-20-35-7. (See Question BCG 9-2.)
- Deferred taxes arising from NOLs and credit carryforwards: ASC 350-20 does not specifically address whether deferred tax assets arising from NOL and credit carryforwards, which are not related to particular assets or liabilities of a reporting unit, should be assigned to a reporting unit. However, entities should apply the criteria in ASC 350-20-35-39. That is, as the NOL and credit carryforwards could be used by the reporting unit, they should be assigned to a reporting unit if they were included in determining the fair value of the reporting unit. For example, if the reporting unit is a separate legal entity and the assumption used in determining the fair value of the reporting unit was that it would be sold in a nontaxable transaction in which the carryforwards would transfer to the buyer, then the deferred tax assets from the carryforwards generated by that entity should be assigned to the reporting unit in determining the reporting unit’s carrying value. (See Example BCG 9-3 and Example BCG 9-4.)
- Cumulative translation adjustments: Under ASC 830, Foreign currency matters, an entity records a cumulative translation adjustment (CTA) as part of its accumulated other comprehensive income when it translates the financial statements of a foreign subsidiary that has a functional currency that differs from the entity’s reporting currency. When testing the goodwill of a reporting unit for impairment, the question arises as to whether the carrying value of the reporting unit should include the CTA associated with the reporting unit. The carrying amount of the reporting unit should include assets and liabilities at their currently translated amounts in accordance with ASC 350-20-35-39A (see Example BCG 9-5).
- Although ASC 830-30-40-1 and ASC 830-30-45-13 only address the treatment of CTA, we believe that the treatment of other amounts in accumulated other comprehensive income (e.g., unrealized gains or losses on investments classified as available for sale, unrealized employee benefit plan gains or losses) should analogize to this guidance. Refer to PPE 5.3.3.4 for further details.
Question BCG 9-2
If a company has a valuation allowance on deferred tax assets and files a consolidated tax return, should the valuation allowance be assigned to its reporting units in step one of the goodwill impairment test?
If a company has a valuation allowance on deferred tax assets and files a consolidated tax return, should the valuation allowance be assigned to its reporting units in step one of the goodwill impairment test?
PwC response
If a company files a consolidated tax return and has established a valuation allowance against its deferred tax assets at the consolidated level, it should attribute the valuation allowance to each reporting unit based on the deferred tax assets and liabilities assigned to each reporting unit. It would not be appropriate for the company to evaluate each reporting unit on a “separate” return basis and thereby assess the need for a valuation allowance for each individual reporting unit.
Example BCG 9-3 and Example BCG 9-4 consider whether deferred tax assets arising from NOL and credit carryforwards should be assigned to a reporting unit.
EXAMPLE BCG 9-3
Assignment of deferred tax assets arising from NOL and credit carryforwards to a reporting unit
Assignment of deferred tax assets arising from NOL and credit carryforwards to a reporting unit
Assume that one of Company A’s reporting units is a separate legal entity, Sub X. Sub X has generated NOL and tax credit carryforwards for which Company A has recognized deferred tax assets. No valuation allowance is deemed necessary because Sub X is expected to generate future taxable income sufficient to realize the carryforward benefits. Company A believes that it would be feasible to sell the shares of Sub X in a nontaxable transaction, which would allow the transfer of Sub X’s NOL and tax credit carryforwards. In addition, Company A believes that market participants would base their estimates of the fair value of Sub X on a nontaxable transaction, and Company A has determined that it would receive the highest economic value if it were to sell Sub X in a nontaxable transaction.
Should the deferred tax assets arising from NOL and tax credit carryforwards be assigned to the reporting unit Sub X?
Analysis
In this fact pattern, the deferred tax assets related to Sub X’s NOL and tax credit carryforwards meet the criteria in ASC 350-20-35-39 as the deferred tax assets will be employed in the operations of the reporting unit and were considered in determining the fair value of the reporting unit. Therefore, the deferred tax assets should be included in the carrying amount of the reporting unit.
EXAMPLE BCG 9-4
No assignment of deferred tax assets arising from NOL and credit carryforwards to a reporting unit
No assignment of deferred tax assets arising from NOL and credit carryforwards to a reporting unit
Assume that Company B has NOL and tax credit carryforwards for which it has recognized deferred tax assets. Company B’s NOL and tax credit carryforwards can only be used at the consolidated level because Company B’s reporting units are not separate legal entities and none of those reporting units could be sold in a nontaxable transaction. Therefore, in determining the fair value of its reporting units, Company B assumes that its reporting units would be sold in taxable transactions that do not provide for the transfer of tax attributes, such as NOLs and tax credit carryforwards, to a market participant acquirer.
Should Company B assign its deferred tax assets arising from its NOL and tax credit carryforwards to its reporting units?
Analysis
In this fact pattern, Company B should not assign the deferred tax assets for the NOL and credit carryforwards to its reporting units because they were not considered in determining the fair value of the reporting unit, and thus do not meet the criteria in ASC 350-20-35-39.
Example BCG 9-5 provides an example of how a company would consider CTA when determining the carrying amount of a reporting unit.
EXAMPLE BCG 9-5
Consideration of CTA in determining the carrying amount of a reporting unit
Consideration of CTA in determining the carrying amount of a reporting unit
Assume that a foreign subsidiary that is a reporting unit has the following balances after currency translation by its US parent company (in millions):
Dr/(Cr) |
|
Total assets (including goodwill of $300) |
$1,000 |
Total liabilities |
(750) |
Total net assets |
$250 |
Paid-in capital and retained earnings |
$(200) |
Cumulative translation adjustment |
(50) |
Total equity |
$(250) |
What would be the carrying amount of the reporting unit used for goodwill impairment testing?
Analysis
The carrying amount of this reporting unit for purposes of step one of the goodwill impairment test would be $250 million, which represents the net assets of the reporting unit at their currently translated amounts.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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