The following section applies to reporting units with a positive carrying amount. See BCG 9.6.5
for guidance regarding impairment testing of reporting units with zero or negative carrying amounts.
The carrying amount of a reporting unit’s goodwill should be tested for impairment at least on an annual basis and in between annual tests in certain circumstances. An entity is permitted to first assess qualitatively whether it is necessary to perform a goodwill impairment test. The quantitative impairment test is required only if the entity concludes that it is more likely than not that a reporting unit’s fair value is less than its carrying amount. In evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, an entity should consider the totality of all relevant events or circumstances that affect the fair value or carrying amount of a reporting unit.
In evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, an entity shall assess relevant events and circumstances. Examples of such events and circumstances include the following:
- Macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets
- Industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (consider in both absolute terms and relative to peers), a change in the market for an entity’s products or services, or a regulatory or political development
- Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows
- Overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods
- Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation
- Events affecting a reporting unit such as a change in the composition or carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing of all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit
- If applicable, a sustained decrease in share price (consider in both absolute terms and relative to peers).
These examples are not all-inclusive as noted in ASC 350-20-35-3F
. An entity should consider other relevant events or circumstances specific to its reporting units when determining whether to perform step one of the impairment test. For example, the AICPA Accounting and Valuation Guide – Testing Goodwill for Impairment
(“AICPA Goodwill Guide”) provides additional examples of events that may require consideration such as (1) market reaction to a new product or service, (2) technological obsolescence, (3) a significant legal development, (4) contemplation of a bankruptcy proceeding, or (5) an expectation of a change in the risk factors or risk environment influencing the assumptions used to calculate the fair value of a reporting unit, such as discount rates or market multiples.
During the assessment, an entity should consider each adverse factor as well as the existence of any positive and mitigating events and circumstances, including the difference between a reporting unit’s fair value and carrying amount if determined in a recent fair value calculation (“cushion”).
Entities should give more weight to those events and circumstances that impact most significantly a reporting unit’s fair value or carrying amount. Some events and circumstances will affect most, if not all, reporting units. For example, many entities likely will determine that it is necessary to perform step one of the impairment test in an unfavorable economic environment. However, the relative importance of the various factors will be different for each reporting unit.
None of the individual examples summarized above are intended to represent standalone triggering events that would require an entity to perform step one of the goodwill impairment test. Similarly, the existence of positive and mitigating events and circumstances would not represent a rebuttable presumption that an entity does not need to perform step one of the goodwill impairment test.
If, after assessing the totality of events or circumstances such as those described above, an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then a quantitative goodwill impairment test would be needed to identify potential goodwill impairment and measure an impairment loss, if any. If the entity determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, no further impairment testing is necessary.
Example BCG 9-14 illustrates the application of the qualitative goodwill impairment assessment by a company with two reporting units.
EXAMPLE BCG 9-14
Goodwill impairment assessment by a company with two reporting units
Company A has two reporting units: Reporting Unit X and Reporting Unit Y. The most recent annual step one impairment test, completed one year ago, resulted in a 40% cushion (i.e., fair value exceeded carrying amount by 40%) for Reporting Unit X and a 10% cushion for Reporting Unit Y. During the current year, macroeconomic trends have improved and the markets in which Reporting Units X and Y operate have remained stable. Company A has experienced increased access to capital at lower rates and market capitalization has trended higher. Analysts reported a positive outlook for Company A. While there was limited deal activity in the industry, the deals that were completed had multiples consistent with the multiples used by Company A in the valuation of its reporting units in the prior year. Demand has grown for Reporting Unit X’s products as evidenced by a better-than-expected increase in revenue, lower costs, and higher profit margins, resulting in Reporting Unit X’s operating results exceeding budget. Demand for Reporting Unit Y’s products, on the other hand, has been soft due to intense competition. As a result, Reporting Unit Y’s revenue and profit margins were flat as compared to the prior year, but below budget. Company A had no change in management.
Should Company A perform a qualitative or quantitative assessment for Reporting Units X and Y?
In this fact pattern, Company A would likely perform a qualitative assessment for Reporting Unit X. The starting cushion of 40%, positive macroeconomic and market indicators, and the current year results exceeding budget indicate that the entity’s management may be able to conclude, absent other significant negative information, that it is more likely than not that the fair value of Reporting Unit X exceeds its carrying value.
In contrast, Company A would likely proceed directly to step one for Reporting Unit Y. The lack of significant beginning cushion combined with the adverse impact of intense competition on revenue and profit margins makes it more difficult for Company A to conclude, solely using a qualitative assessment, that no further impairment testing is necessary. Because small changes in the assumptions or inputs could impact the valuation of Reporting Unit Y, management would likely be unable to conclude, based solely on a qualitative assessment, that it is more likely than not that the fair value of Reporting Unit Y exceeds its carrying value.