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As described in BCG 9.5, the quantitative goodwill impairment test is performed through either a one step (after adoption of ASU 2017-04) or two step (prior to adoption of ASU 2017-04) impairment test. Step one remains unchanged upon adoption of ASU 2017-04.

9.8.1 Step one: fair value of reporting unit (pre ASU 2017-04)

Step one compares the fair value of the reporting unit with the reporting unit’s carrying amount (book value), including goodwill, to identify any potential impairment. The book value in step one is the reporting unit’s carrying amount after all of the reporting unit’s other assets (excluding goodwill) have been adjusted for impairment, if necessary, under other applicable GAAP. Note that this assumes the reporting unit is not a disposal group or part of a disposal group under ASC 360, Property, plant, and equipment. See BCG 9.10.1 for further information.
  • If the fair value of the reporting unit is greater than its carrying amount, the reporting unit’s goodwill is considered not impaired, and step two is not performed.
  • If the carrying amount of the reporting unit is greater than its fair value, the reporting unit’s goodwill may be impaired, and step two must be completed to measure the amount of the goodwill impairment loss, if any, that may exist.

9.8.1.1 Step one: other considerations (pre ASU 2017-04)

Step one of the goodwill impairment test serves as a “screening process” for determining whether goodwill might be impaired. As a result, the recorded amount of a reporting unit’s goodwill may sometimes be “shielded” from an impairment loss, even if its implied value has decreased. This shielding in step one can arise from the fact that the carrying amount of the reporting unit does not reflect the value of any of the reporting unit’s unrecognized assets, such as internally developed intangible assets, or any appreciation in the fair value of the reporting unit’s recognized assets, such as real estate. However, such unrecognized assets, or assets recorded at less than their fair value, will increase the goodwill impairment loss if the performance of step two becomes necessary.
An entity is required to perform step one of the goodwill impairment test before performing step two, even if the entity believes goodwill is impaired. If a reporting unit passes step one, the entity does not proceed to step two. Example BCG 9-16 illustrates how unrecognized assets could shield an entity from a goodwill impairment charge.
EXAMPLE BCG 9-16
Shielding of goodwill with internally developed intangible assets
Company A operates in the pharmaceutical industry and has various reporting units based on geographic and operational criteria. Reporting Unit X encompasses its European operations, including sales and significant research and development (R&D) efforts. Reporting Unit Y is predominantly represented by the large manufacturing facilities in the United States.
Goodwill assigned to the two reporting units arose from an acquisition several years ago. An acquired product line, including brand names and customer relationships, has since deteriorated and is no longer a high market performer. This might indicate that the acquired goodwill has also lost some of its value and its implied fair value may have declined compared to its carrying amount.
In determining the fair values of the two reporting units for applying step one of the goodwill impairment test, management considered the following:
  • Reporting Unit X has some promising new products arising from its internal R&D efforts, which are expected to drive significant cash flows over the next few years. The anticipated cash flows from the new products cause the fair value of the reporting unit to increase significantly without a corresponding asset recorded for the internally developed technology.
  • Reporting Unit Y owns substantial parcels of land that are used for its manufacturing facilities or kept as a reserve for future expansion. A significant increase in the value of land in the region has resulted in an increase in the fair value of the reporting unit, without any recognition of the increase in land values in the reporting unit’s carrying amount.
Should Company A recognize goodwill impairment for Reporting Units X and Y?
Analysis
Based on these facts, it is likely that management would conclude that the fair values were in excess of the carrying amounts of the reporting units, including goodwill. Thus, both reporting units would pass step one of the goodwill impairment test and management would not perform step two, even though there were indications that the goodwill’s implied fair value was less than its book value.

9.8.1.2 Step one: other considerations (post ASU 2017-04)

There are certain incremental changes to consider with regard to how the quantitative test is performed under ASU 2017-04 related to the finalization of the goodwill impairment assessment and the impact of foreign currency translation adjustments.
Question BCG 9-24 and Question BCG 9-25 address considerations impacting the carrying value of a reporting unit.
Question BCG 9-24
A company is performing its annual goodwill impairment test under ASU 2017-04. Can the company record a preliminary impairment in one period and determine the final amount of the impairment in a later period?
PwC response
No. Prior to the adoption of ASU 2017-04, the guidance permitted an entity to record a preliminary impairment in one period and determine the final amount of the impairment in a later period. This was permitted by the guidance because of the complexity involved in completing step two of the goodwill impairment test. This will no longer be allowed under the revised guidance.

Question BCG 9-25
How should foreign currency translation adjustments be treated when determining the carrying value of a reporting unit?
PwC response
The effect of translating assets and liabilities from a foreign currency can affect the difference between a reporting unit’s fair value and its carrying amount. The revised guidance clarifies that foreign currency translation adjustments should not be attributed to a reporting unit from accumulated other comprehensive income.

The revised guidance simplifies financial reporting because it eliminates the need to determine the fair value of individual assets and liabilities of a reporting unit to measure any goodwill impairment. The amount of impairment recognized under the revised guidance could be larger or smaller than under today’s model, largely depending on the difference between the carrying amount and fair value of assets and liabilities of the reporting unit.
As illustrated in Figure BCG 9-5, an entity with significant unrecognized intangible assets or significantly appreciated assets may recognize a smaller goodwill impairment than today, whereas an entity with significant property, plant, and equipment with carrying amounts in excess of fair value (that did not trigger an impairment under ASC 360) may recognize a larger goodwill impairment than today.
Additionally, under today’s guidance, some companies may not recognize an impairment when they fail step one due to the mechanics of step two. Under the revised guidance, failing step 1 will always result in some goodwill impairment.
Figure BCG 9-5
The impact of the revised guidance on the amount of goodwill impairment

9.8.1.3 Zero or negative carrying amounts (post ASU 2017-04)

Under the revised guidance, the one-step impairment test will be applied to all reporting units, including those with zero or negative carrying amounts. The step two concept no longer exists even for reporting units with zero or negative carrying amounts. Due to this change, goodwill attributed to these reporting units generally will not be impaired as the fair value of a reporting unit is rarely negative.
The adoption of the revised guidance should not by itself trigger changes to the valuation premise used to fair value a reporting unit. However, the FASB has indicated that it might be appropriate to change from the equity premise to the enterprise premise for a reporting unit with a negative carrying amount if it results in a more representative impairment evaluation under step one.
The revised guidance includes a new requirement to disclose the amount of goodwill attributed to reporting units with zero or negative carrying amounts. This additional disclosure, especially for reporting units that are performing poorly, may increase scrutiny from both investors and regulators.

9.8.2 Step two: implied fair value (pre ASU 2017-04)

Step two compares the implied fair value of the reporting unit’s goodwill to its carrying amount. If the carrying amount is greater than the implied fair value, an impairment loss must be recognized for the excess (i.e., recorded goodwill must be written down to the implied fair value of the reporting unit’s goodwill).
After a goodwill impairment loss for a reporting unit is measured and recognized, the adjusted carrying amount of the reporting unit’s goodwill becomes the new accounting basis. A subsequent reversal of previously recognized goodwill impairment losses is prohibited.
Figure BCG 9-6 provides a basic example of the goodwill impairment test.
Figure BCG 9-6
Basic goodwill impairment test
The following illustrates the application of the basic two-step goodwill impairment test approach to two hypothetical Reporting Units A and B (in millions):
Step one:
Reporting Unit A
Reporting Unit B
Fair value of reporting unit
$1,000
$500
Carrying amount of reporting unit (including $200 goodwill each for A and B)
600
600
Difference
$400
$(100)
Passed
Failed
View table
Step two:
Reporting Unit A
Reporting Unit B
Fair value of reporting unit
n/a
$500
Fair value of reporting unit’s identifiable assets and liabilities determined in accordance with ASC 805
(425)
Implied fair value of goodwill
75
Carrying amount of reporting unit’s goodwill
200
Goodwill impairment loss
$(125)1
View table
1 Step two calculation does not consider deferred taxes.

9.8.2.1 Application of step two of the goodwill impairment test

When an entity performs step two of the goodwill impairment test, it must determine the implied fair value of the reporting unit’s goodwill. The fair value of goodwill can be measured only as a residual amount and cannot be determined directly. As a result, the implied fair value of a reporting unit’s goodwill should be calculated in the same manner as the amount of goodwill that would be recognized in a business combination pursuant to ASC 805. This process involves measuring the fair value of the reporting unit’s assets and liabilities (both recognized and unrecognized) at the time of the impairment test, using the guidance in ASC 805.
The difference between the reporting unit’s fair value and the fair values assigned to the reporting unit’s individual assets and liabilities (both recognized and unrecognized), is the implied fair value of the reporting unit’s goodwill. It is important to note that this assignment process is performed only for the purpose of determining the implied fair value of the reporting unit’s goodwill when testing goodwill for impairment. The carrying amount of the entity’s other assets and liabilities should not be adjusted and previously unrecognized assets and liabilities should not be recognized. See FV 7.2 for the determination of the fair value of reporting units.
Question BCG 9-26 and Question BCG 9-27 address scenarios regarding step two of the goodwill impairment test.
Question BCG 9-26
If a company has concluded that a market participant would assume the pension obligations associated with the employees within a reporting unit if the reporting unit was sold, how should the pension obligation be measured when completing step two of the goodwill impairment test?
PwC response
When completing step two of the goodwill impairment test, a company is required to perform a hypothetical purchase price allocation as if the reporting unit was acquired on the test date. Therefore, the company should measure the projected benefit obligation and the fair value of the plan assets in accordance with ASC 715, Compensation–retirement benefits, as of the date of the test.
Question BCG 9-27
In completing step two of the goodwill impairment test, would it be appropriate for a company to use the current carrying amounts of the assets and liabilities on its balance sheet as a proxy for fair value when determining the implied fair value of goodwill?
PwC response
No. The implied fair value of a reporting unit’s goodwill should be calculated in the same manner as the amount of goodwill that is recognized in a purchase price allocation in a business combination. This process involves measuring the fair value of the reporting unit’s assets and liabilities (both recognized and unrecognized) at the time of the impairment test to perform a hypothetical purchase price allocation. The current carrying amounts of assets and liabilities may not approximate their fair values when completing step two of the goodwill impairment test.

9.8.2.2 Step two may not always result in an impairment loss

In some cases, a reporting unit that has failed step one of the goodwill impairment test may not have a goodwill impairment loss to recognize in step two because the implied fair value of goodwill exceeds its carrying amount. For example, a reporting unit may fail step one because the carrying amounts of the long-lived assets exceed their fair values, but an impairment on the long-lived assets is not recognized because their carrying amounts are recoverable on a held and used basis (i.e., through undiscounted cash flows). In these cases, the implied fair value of goodwill may still exceed its carrying amount, and no goodwill impairment loss would be necessary.
We expect instances of a reporting unit failing step one but not recording a goodwill impairment test to be infrequent. Consideration should be given to whether all assets and liabilities have been appropriately considered for impairment prior to performing the goodwill impairment test.

9.8.2.3 Consistency of fair value in impairment tests

Indefinite-lived intangible assets are tested for impairment based on their appropriate unit of accounting. If the unit of accounting of the indefinite-lived intangible assets is assigned to a single reporting unit, its associated fair value should be used for purposes of performing step two of the goodwill impairment test. If the unit of accounting of the indefinite-lived intangible assets is assigned to multiple reporting units, judgment should be applied to attribute the fair value of the intangible asset among the reporting units when performing step two of the goodwill impairment test.

9.8.2.4 Consistency of FV in ASC 805 and goodwill impairment test

The valuation methods used to determine the fair value of a reporting unit’s individual assets and liabilities for purposes of step two of the goodwill impairment test should be consistent with the valuation methods that were applied in the determination of fair value as of the acquisition date. However, an entity is not precluded from using a different valuation method if there are specific facts and circumstances that support a conclusion that another valuation method is equally or more representative of fair value in the circumstances. This may be the case in instances where new markets develop, new information becomes available, information previously used is no longer available, or valuation techniques improve.
Example BCG 9-17 illustrates the goodwill impairment test prior to adoption of ASU 2017-04.
EXAMPLE BCG 9-17
Detailed example of the goodwill impairment test (pre ASU 2017-04)
Assume Company A is performing its annual impairment test for goodwill, and management determines the fair value of Reporting Unit X to be $1,000. Reporting Unit X’s carrying amount is $1,050. Because the carrying amount of the reporting unit exceeds its fair value, Company A has failed step one and will proceed to step two of the impairment test. All assets and liabilities have been tested for impairment under the applicable GAAP prior to testing goodwill for impairment. For simplicity, all tax effects have been ignored.
Book value
Fair value
Working capital
$80
$80
Real estate
700
850
Notes receivable
100
100
Patent (finite-lived intangible)
50
40
Trade name (indefinite-lived intangible)
40
95
Notes payable
(200)
(185)
Net assets
770
980
Goodwill
280
Total carrying amount of Reporting Unit X
$1,050
Fair value of Reporting Unit X
1,000
Implied fair value of goodwill
20
Carrying amount of goodwill
280
Goodwill impairment loss
$(260)
View table
What amount of impairment loss, if any, should Company A recognize for Reporting Unit X?
Analysis
The implied fair value of goodwill is equal to the fair value of Reporting Unit X of $1,000, less the recorded value of its net assets of $980 measured in accordance with ASC 805. Based on the results of step two of the impairment analysis, a goodwill impairment charge of $260 is recognized. Note that in this scenario, the amount of the goodwill impairment is greater than $50, which is simply the difference between the total carrying amount of the reporting unit and its fair value ($1,050 – $1,000) due to differences between the book value and fair value of other net assets of $210 ($980 – $770). If the fair value of the reporting unit had exceeded its carrying value, a detailed determination of the fair values of the individual assets and liabilities would not be necessary and no goodwill impairment would be recorded. Company A should also reassess the useful life of the patent because the decline in value may be the result of factors that also suggest the patent will have a shorter useful life.

9.8.2.5 Impairment estimate incomplete before issuing financials

Because of the significant effort that may be required to determine the implied fair value of a reporting unit’s goodwill in step two of the goodwill impairment test, there may be situations in which an entity is unable to complete this process before issuing its financial statements. ASC 350-20-35-18 states that when such a situation occurs and a goodwill impairment loss is probable and can be reasonably estimated, the best estimate of the loss should be recognized in the financial statements using the guidance in ASC 450, Contingencies. The fact that the amount of a goodwill impairment loss is an estimate and the reasons why it is an estimate must be disclosed in the financial statements. Upon completion of the measurement of the impairment loss, any adjustment made to the estimated loss should be recognized in the subsequent reporting period and the nature of the adjustment should be disclosed in accordance with ASC 350-20-35-19 and ASC 350-20-50-2(c). The provision does not apply after adoption of ASU 2017-04 (see BCG 9.8.1.2).
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