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9.9 Other goodwill impairment assessment considerations
Publication date: 31 May 2024
us Business combinations guide
Additional complexities often arise in performing the quantitative impairment test.
9.9.1 Deferred taxes: impact on reporting unit carrying and fair values
An acquiring entity must recognize a deferred tax asset or liability for the differences between the assigned values and income tax bases of the recognized assets acquired and liabilities assumed in a business combination in accordance with ASC 805-740-25-2. An acquiring entity’s tax bases in the assets acquired and liabilities assumed in a business combination are generally based on whether the combination was a taxable transaction (which results in new tax bases) or a nontaxable transaction (which results in carryover tax bases). Therefore, the amount of deferred income taxes recorded in a business combination and, in turn, the amount of goodwill recorded, can be significantly impacted by whether the combination was a nontaxable or taxable transaction. See TX 10.2.1 for further information on determining whether the business combination was a nontaxable or taxable transaction.
When an entity tests goodwill for impairment, a question arises as to how the entity should consider recorded deferred tax balances that relate to differences between the book and tax bases of assets and liabilities assigned to reporting units. Specific considerations include how deferred taxes impact a reporting unit’s fair value and carrying amount for applying the quantitative goodwill impairment test.
ASC 350-20 provides guidance on how deferred income taxes should be considered in determining the fair value and carrying amount of a reporting unit. ASC 350-20-35-25 notes that the determination of the fair value of the reporting unit should include an assumption as to whether the reporting unit would be bought or sold in a taxable or nontaxable transaction. Whether the reporting unit would be bought or sold in a taxable or nontaxable transaction is a matter of judgment that depends on the relevant facts and circumstances and must be evaluated carefully on a case-by-case basis as outlined in ASC 350-20-35-25 through ASC 350-20-35-27.
Before estimating the fair value of a reporting unit, an entity shall determine whether that estimation should be based on an assumption that the reporting unit could be bought or sold in a nontaxable transaction or a taxable transaction. Making that determination is a matter of judgment that depends on the relevant facts and circumstances and must be evaluated carefully on a case-by-case basis (see Example 1 [paragraphs 350-20-55-10 through 55-23]).
In making that determination, an entity shall consider all of the following:
- Whether the assumption is consistent with those that marketplace participants would incorporate into their estimates of fair value
- The feasibility of the assumed structure
- Whether the assumed structure results in the highest and best use and would provide maximum value to the seller for the reporting unit, including consideration of related tax implications.
In determining the feasibility of a nontaxable transaction, an entity shall consider, among other factors, both of the following:
- Whether the reporting unit could be sold in a nontaxable transaction
- Whether there are any income tax laws and regulations or other corporate governance requirements that could limit an entity's ability to treat a sale of the unit as a nontaxable transaction.
When evaluating whether a reporting unit would be sold in a taxable or nontaxable transaction, the AICPA Goodwill Guide states that it may be useful to consider the (1) structure of observed comparable transactions in the market, (2) type of buyer, and (3) tax status of a market participant.
Question BCG 9-25 addresses income tax considerations when performing the quantitative goodwill impairment test.
Question BCG 9-25
How should income taxes be considered when determining the fair value of a reporting unit for the quantitative goodwill impairment test?
How should income taxes be considered when determining the fair value of a reporting unit for the quantitative goodwill impairment test?
PwC response
An entity should determine whether the fair value of a reporting unit should be based on an assumption that the reporting unit would be sold in a nontaxable or taxable transaction. This assumption is a matter of judgment that depends on the relevant facts and circumstances in accordance with ASC 350-20-35-25. The assumed structure of the transaction can affect the price a buyer is willing to pay for the reporting unit and the seller’s tax cost on the transaction. For example, in a taxable transaction, the net assets of the entity are considered sold, and the buyer records a fair value tax basis in the net assets. The buyer may be willing to pay more to acquire a reporting unit in a taxable transaction if the transaction provides a step-up in the tax basis of the acquired net assets. In a nontaxable transaction, the stock of the company is sold and the buyer records a fair value tax basis in the acquired stock, but carryover (or predecessor) tax basis in the net assets. The buyer may be willing to pay more to acquire a reporting unit in a nontaxable transaction if the reporting unit has significant net operating loss or other carryforwards that the buyer would be able to utilize.The gross proceeds expected to be realized from a sale must be reduced by the seller’s tax cost when determining economic value. The seller’s tax cost should reflect, and can vary with, the structure of the transaction. For example, in a nontaxable sale, the seller’s gain (or loss), and thus the seller’s tax cost, is measured by reference to its tax basis in the stock of the reporting unit; in a taxable sale, the seller’s taxable gain (or loss) is measured by reference to the tax basis in the net assets of the reporting unit. The effect of existing tax attributes of the seller would be considered in measuring the seller’s tax cost.
The type of transaction that is consistent with market participant assumptions, is feasible, and provides the highest economic value to the seller should be used in determining the fair value of a reporting unit.
ASC 350-20-35-7 requires that the carrying amount of the reporting unit for purposes of the quantitative goodwill impairment test should include deferred tax assets and liabilities arising from assets and liabilities assigned to the reporting unit, regardless of whether the fair value of the reporting unit will be determined assuming the reporting unit would be bought or sold in a taxable or nontaxable transaction.
Example BCG 9-16 demonstrates the analysis of determining a goodwill impairment loss in a taxable versus nontaxable transaction.
EXAMPLE BCG 9-16
Determining the goodwill impairment loss in a taxable versus nontaxable transaction
Determining the goodwill impairment loss in a taxable versus nontaxable transaction
Company A is testing a reporting unit for impairment. A sale of the reporting unit would be feasible in both a taxable and nontaxable transaction.
- The carrying amount of net assets, excluding goodwill and deferred taxes, is $1,300.
- The tax basis of net assets is $900 and Company A’s tax basis in the shares of the reporting unit is $1,125. There is no tax-deductible goodwill.
- The nondeductible book goodwill is $500.
- The net deferred tax liabilities are $160 ($1,300 carrying amount of net assets, excluding goodwill and deferred taxes, less $900 tax basis of net assets at a 40% tax rate).
- In a taxable transaction, the reporting unit could be sold for $1,600.
- In a taxable transaction, at a 40% tax rate, current taxes payable resulting from the transaction would be $280 ($1,600 fair value less $900 tax basis of net assets at a 40% tax rate).
- In a nontaxable transaction, the reporting unit could be sold for $1,500.
- In a nontaxable transaction, current taxes payable resulting from the transaction are assumed to be $150 ($1,500 fair value less Company A’s tax basis in the shares of $1,125 at 40%).
After determining if a taxable or nontaxable sale is the more feasible option, how would Company A conduct an impairment test on its reporting unit?
Analysis
Determination of taxable or nontaxable sale:
Taxable |
Nontaxable |
||
|---|---|---|---|
Gross proceeds from sale (fair value)
|
$1,600
|
$1,500
|
|
Tax arising from transaction
|
(280)
|
(150)
|
|
Economic value from the reporting unit
|
$1,320
|
$1,350
|
The highest economic value could be realized in a nontaxable transaction. A nontaxable sale is assumed to be feasible for purposes of testing the reporting unit’s goodwill for impairment.
Performance of the quantitative goodwill impairment test:
Nontaxable |
|
|---|---|
Fair value of reporting unit
|
$1,500
|
Net assets (excluding goodwill and deferred taxes)
|
1,300
|
Goodwill
|
500
|
Deferred taxes
|
(160)
|
Reporting unit carrying amount
|
1,640
|
Difference—Goodwill impairment loss
|
$(140)
|
For the quantitative goodwill impairment test, the fair value of the reporting unit is compared to its carrying amount. Fair value is determined using the pretax proceeds that would be realized from a nontaxable sale and not the economic value that would be received after tax. Because the reporting unit’s carrying amount exceeds its fair value, there is a goodwill impairment loss for the reporting unit.
To illustrate the determination of an impairment loss in a taxable sale, assume that the company had determined that the highest economic value could be realized in a taxable transaction. In that case, the fair value of the reporting unit of $1,600 is compared to the carrying amount of the reporting unit of $1,640, which would result in a goodwill impairment loss of $40 under the quantitative goodwill impairment test.
Taxable business combinations can generate goodwill that is deductible for tax purposes. This can give rise to what is called component-1 and component-2 goodwill in ASC 805-740-25-8. When such goodwill is impaired for financial reporting purposes, there may be an impact on deferred taxes. See BCG 9.9.6 for guidance on the simultaneous equation method as well as the allocation of the impairment loss to component-1 and component-2 goodwill.
9.9.2 Impairment of goodwill shortly after acquisition
An impairment of goodwill shortly after an acquisition is possible but rare.
ASC 805 requires that the value of equity securities issued as consideration in the acquisition of a business be measured on the date of the business combination. As a result, the acquisition date fair value of the consideration transferred may differ from the fair value of the consideration as of the date the acquisition was agreed to if an acquirer’s share price has increased or decreased significantly prior to the closing of the acquisition. If there is a significant increase in the fair value of the acquirer’s share price, then more goodwill would be recognized on the date of acquisition—this may be viewed as an overpayment. In connection with its deliberations of ASC 805, the FASB acknowledged that overpayments are possible, however, the Board believed that it would be unlikely that the amount would be known or measurable at the acquisition date and that overpayments are best addressed through subsequent impairment testing. Therefore, any impairment charge would need to follow the guidance in ASC 350-20, including assigning the goodwill to reporting units and evaluating if a triggering event has occurred based on changes in economic conditions relative to the business acquired that evidence impairment.
An acquirer’s conclusion that goodwill is impaired within a short period of time after the acquisition should be supported by an analysis of the underlying events and circumstances. Such an analysis would need to consider a number of factors, including a review of the fair value determinations at the “agreed to and announced” date and acquisition date, any adjustments to provisional amounts recorded during the measurement period, the method for assigning goodwill to reporting units, and changes in economic conditions relative to the business acquired that evidence impairment. Given the subjective nature of these judgments and the infrequency of reporting a goodwill impairment loss immediately upon or shortly after the acquisition, a decision to impair goodwill shortly after an acquisition may attract considerable attention.
9.9.3 Interaction with impairment testing for other assets
Goodwill and other assets of a reporting unit that are held and used may be required to be tested for impairment at the same time, for instance, when certain events trigger interim impairment tests under ASC 350-20 and ASC 360-10. In such situations, other assets, or asset groups, should be tested for impairment under their respective standards (e.g., ASC 360-10, ASC 350-30, and ASC 323-10) and the other assets’ or asset groups’ carrying amounts should be adjusted for impairment before testing goodwill for impairment in accordance with ASC 350-20-35-31. Note, however, the ordering for impairment testing will differ if goodwill is included as part of a disposal group that is classified as “held for sale” under ASC 360-10. See PPE 5.2.2 and PPE 5.3.2 for further information on impairment testing of other assets under the held and used and held for sale approaches, respectively.
A reporting unit may include assets, or asset groups, whose fair values are less than their carrying amounts but for which an impairment is not recognized. This would be the case if these assets’ or asset groups’ book values were determined to be recoverable under ASC 360-10 (i.e., the undiscounted cash flow test was sufficient to recover the carrying amount of the asset or asset group). In such a case, no adjustment to the carrying amounts would be permitted for the purpose of the quantitative goodwill impairment test under ASC 350-20.
A goodwill impairment loss would be measured as the difference between the reporting unit’s fair value and its carrying amount, not to exceed the carrying amount of the goodwill. If the difference between the reporting unit’s fair value and its carrying amount is greater than the carrying amount of the goodwill, the excess is not recorded as an impairment against other assets in the reporting unit if those assets were not impaired under their respective accounting standards.
9.9.4 Impairment testing when an NCI exists
ASC 805 requires that the acquirer record all assets and liabilities of the acquiree at their fair values with limited exceptions and record goodwill associated with the entire business acquired. This means that in a partial business combination in which control is obtained, the acquiring entity will recognize and measure 100% of the assets and liabilities, including goodwill attributable to the noncontrolling interest, as if the entire entity had been acquired. Therefore, in terms of goodwill recognition and the amount of any subsequent impairment loss, no difference exists between acquiring a partial controlling interest in a business and the acquisition of an entire business accounted for in accordance with ASC 805.
The fair value of the reporting unit should be compared to its carrying amount inclusive of any interest attributable to noncontrolling shareholders. Any impairment loss measured in the goodwill impairment test must be allocated to the controlling and noncontrolling interests on a rational basis.
Example BCG 9-17 and Example BCG 9-18 illustrate acceptable methods to allocate a goodwill impairment loss to the controlling and noncontrolling interests.
EXAMPLE BCG 9-17
Allocation of a goodwill impairment loss to the noncontrolling interest when the acquired entity is assigned to a new reporting unit
Allocation of a goodwill impairment loss to the noncontrolling interest when the acquired entity is assigned to a new reporting unit
Company A acquires 80% of the ownership interests in Company B for $800 million. Company A determines that the fair value of the noncontrolling interest is $200 million. The aggregate value of the identifiable assets acquired and liabilities assumed, measured in accordance with ASC 805, is determined to be $700 million. Company A’s determination of goodwill related to the acquisition of Company B for purposes of allocating a goodwill impairment loss is as follows (in millions):
Fair value of the consideration transferred
|
$800
|
Fair value of the noncontrolling interest
|
200
|
1,000
|
|
Values of 100% of the identifiable net assets
|
(700)
|
Goodwill recognized
|
$300
|
Goodwill attributable to the noncontrolling interest
|
$60 1
|
Goodwill attributable to the controlling interest
|
$240 2
|
1 The goodwill attributable to the noncontrolling interest is the difference between the fair value of the noncontrolling interest and the noncontrolling interest’s share of the recognized amount of the identifiable net assets ($60 = $200 less 20% of $700).
2 The goodwill attributable to the controlling interest is the difference between the fair value of the consideration transferred measured in accordance with ASC 805 and the controlling interest’s share of the recognized amount of the identifiable net assets ($240 = $800 less 80% of $700). |
|
For purposes of Company A’s goodwill impairment testing, all of Company B’s assets (including goodwill) and liabilities are assigned to a new reporting unit, Reporting Unit X.
Subsequent to the acquisition, another entity unexpectedly introduces a product that competes directly with Reporting Unit X’s primary product. As a result, the fair value of Reporting Unit X falls to $900 million and Company A tests Reporting Unit X’s goodwill for impairment. For simplicity, assume that the carrying amount of Reporting Unit X did not change between the acquisition date and the goodwill impairment testing date. Further, assume that Reporting Unit X’s net assets other than goodwill do not require adjustment in accordance with other GAAP (e.g., ASC 360-10). For simplicity, all tax effects have been ignored.
How would a goodwill impairment loss at Reporting Unit X be allocated to the controlling and noncontrolling interest?
Analysis
Company A’s goodwill impairment test for Reporting Unit X is as follows (in millions):
Quantitative goodwill impairment test: |
|||
|---|---|---|---|
Fair value of reporting unit
|
$900
|
||
Carrying amount of reporting unit
|
(1,000)
|
||
Goodwill impairment loss
|
$(100)
|
||
Goodwill impairment loss allocated to the noncontrolling interest
|
$(20) 1
|
||
Goodwill impairment loss allocated to the controlling interest
|
$(80) 2
|
||
1The goodwill impairment loss allocated to the noncontrolling interest is determined based on the total amount of the impairment loss of $100 multiplied by the 20% ownership interest of the noncontrolling interest. The impairment loss would be the same if it was allocated based on the relative interest of the goodwill prior to impairment ($60 attributable to the noncontrolling interest of $300 of total goodwill). Note, however, that the full impairment loss of $100 would be recorded in the income statement.
2The goodwill impairment loss allocated to the controlling interest is determined based on the total amount of the impairment loss of $100 multiplied by the 80% ownership interest of the controlling interest. The impairment loss would be the same if it was allocated based on the relative interest of the goodwill prior to impairment ($240 attributable to the controlling interest of $300 of total goodwill). |
|||
In Example BCG 9-17, the goodwill impairment loss was allocated based on the relative ownership interests of the controlling and noncontrolling interests. The allocation would not have changed if it was determined using the relative interests in goodwill. However, as discussed in BCG 9.4.3, the fair value of the noncontrolling interest may not merely be an extrapolation of the consideration transferred for the controlling interest and, therefore, the fair value of the noncontrolling interest may have to be independently derived. In such cases, it is possible that the goodwill recorded in the acquisition may not be attributed to the controlling and noncontrolling interests based on their relative ownership interests.
EXAMPLE BCG 9-18
Allocation of a goodwill impairment loss to the controlling and noncontrolling interests when a premium is attributable to the controlling interest
Allocation of a goodwill impairment loss to the controlling and noncontrolling interests when a premium is attributable to the controlling interest
Company A acquires an 80% ownership interests in Company B for $1,000. The value of the identifiable assets and liabilities measured in accordance with ASC 805 is determined to be $700, and the fair value of the noncontrolling interest is determined to be $200. Company A’s determination of goodwill related to the acquisition of Company B is as follows:
Fair value of the consideration transferred
|
$1,000
|
Fair value of the noncontrolling interest
|
200
|
1,200
|
|
Fair values identifiable net assets
|
(700)
|
Goodwill recognized
|
$500
|
Goodwill attributable to the noncontrolling interest
|
$60 1
|
Goodwill attributable to the controlling interest
|
$440 2
|
1 The goodwill attributable to the noncontrolling interest is the difference between the fair value of the noncontrolling interest and the noncontrolling interest’s share of the recognized amount of the identifiable net assets ($60 = $200 less 20% of $700).
2 The goodwill attributable to the controlling interest is the difference between the value of the consideration transferred measured in accordance with ASC 805 and the controlling interest’s share of the recognized amount of the identifiable net assets ($440 = $1,000 less 80% of $700). |
|
Because Company A paid a premium to acquire a controlling interest in Company B, Company A’s interest in goodwill is 88% ($440 / $500). This is higher than Company A’s 80% ownership interest in Company B. Because the noncontrolling interest is always recorded at fair value, any control premium paid that does not also provide benefit to the noncontrolling interest is embedded in the controlling interest’s share of goodwill.
For purposes of Company A’s goodwill impairment testing, all of Company B’s assets (including goodwill) and liabilities are assigned to a new reporting unit, Reporting Unit X.
Subsequent to the acquisition, another entity unexpectedly introduces a product that competes directly with Reporting Unit X’s primary product. As a result, the fair value of Reporting Unit X falls to $1,100 and Company A tests Reporting Unit X’s goodwill for impairment. For simplicity, assume that the carrying amount of Reporting Unit X did not change between the acquisition date and the goodwill impairment testing date. Further, assume that Reporting Unit X’s net assets other than goodwill do not require adjustment in accordance with other GAAP (e.g., ASC 360-10). For simplicity, all tax effects have been ignored.
How would a goodwill impairment loss at Reporting Unit X be allocated to the controlling and noncontrolling interest?
Analysis
Company A’s goodwill impairment test for Reporting Unit X is as follows:
Quantitative goodwill impairment test: |
||
|---|---|---|
Fair value of reporting unit
|
$1,100
|
|
Carrying amount of reporting unit
|
(1,200)
|
|
Goodwill impairment loss
|
$(100)
|
|
Goodwill impairment loss allocated to the noncontrolling interest
|
$(12) 1
|
|
Goodwill impairment loss allocated to the controlling interest
|
$(88) 2
|
|
1 The goodwill impairment loss allocated to the noncontrolling interest is determined based on the carrying amount of the goodwill attributable to the noncontrolling interest prior to impairment of $60 relative to the total goodwill of $500 ($12 = ($60 / $500) × $100). Note, however, that the full impairment loss of $100 would be recorded in the income statement.
2 The goodwill impairment loss allocated to the controlling interest is determined based on the carrying amount of the goodwill attributable to the controlling interest prior to impairment of $440 relative to the total goodwill of $500 ($88 = ($440 / $500) × $100). |
||
The allocation of any goodwill impairment loss to the controlling interest and the noncontrolling interest will not change unless there is a change in the relative ownership interests. If there is a change in ownership interests, any subsequent goodwill impairment loss is allocated to the controlling and noncontrolling interests on a rational basis.
Impact of legacy FAS 141 guidance on calculations of impairment
If a company has a partially-owned subsidiary, and only recorded goodwill related to the controlling interest in accordance with the prior guidance in FAS 141, the noncontrolling interest was not recorded at fair value and an impairment test using fair value for the entire reporting unit may be perceived to not be a like comparison. Several methodologies may be appropriate when performing the goodwill impairment test.
One methodology would be to gross up the carrying amount of the reporting unit to reflect recorded goodwill associated with the controlling interest and the notional amount of goodwill allocable to the noncontrolling interest (equaling the grossed-up goodwill and other net assets) based on the acquisition date ownership interests and compare the reporting unit’s adjusted carrying value to the fair value of the reporting unit determined in accordance with ASC 350-20. A second methodology would be to compare the carrying amount of the reporting unit, without adjustment, to its fair value — this may result in a cushion because the carrying amount of the reporting unit will only reflect a partial step-up of goodwill in the net assets of the subsidiary, but the fair value will consider the full value of the subsidiary. Any impairment loss should be allocated entirely to the parent's controlling interest if the goodwill was recognized in accordance with the prior guidance in FAS 141.
9.9.4.1 Fair value of NCI based on where NCI is recorded
The fair values of controlling and noncontrolling interests may differ on a per share basis. An understanding of whether and to what extent the noncontrolling interest benefits from synergies, rights, and preferences that benefit the reporting unit as a whole is needed when determining the fair value of the noncontrolling interest. A noncontrolling interest may exist above the reporting unit while in other cases it may exist within the reporting unit. For example, the reporting unit could be partially owned by its parent.
Figure BCG 9-4 illustrates a structure where a noncontrolling interest exists above the reporting unit.
Figure BCG 9-4
Noncontrolling interest above the reporting unit
Noncontrolling interest above the reporting unit
Figure BCG 9-5 illustrates a structure where a wholly-owned reporting unit consolidates an entity that is partially owned by the reporting unit.
Figure BCG 9-5
Wholly-owned reporting unit that consolidates an entity that is partially owned by the reporting unit
Wholly-owned reporting unit that consolidates an entity that is partially owned by the reporting unit
The fair value of a reporting unit refers to the price that would be received for selling the unit as a whole. When a noncontrolling interest exists above the reporting unit (similar to Noncontrolling interest A in Figure BCG 9-4), the fair value of the controlling interest and the noncontrolling interest would likely be the same on a per-share value basis as both would likely participate in the exchange transaction for the sale of the reporting unit at the same per share price absent any rights or restrictions to the contrary. Conversely, when a noncontrolling interest exists within a reporting unit (similar to Noncontrolling interest B in Figure BCG 9-5), the sale of the reporting unit as a whole could leave the noncontrolling interest outstanding. If the noncontrolling interest is not expected to participate in the sale of a reporting unit, there may be a difference in the per-share fair value of the controlling and noncontrolling interests.
9.9.4.2 Other impairment considerations related to NCI
When a noncontrolling interest exists, a number of complex scenarios may arise when goodwill is tested for impairment. For example, a reporting unit that includes a partially owned subsidiary could have operations and goodwill from another acquisition assigned to it, or the net assets and goodwill of a partially owned subsidiary might be assigned to more than one reporting unit. When goodwill in a reporting unit was generated from multiple acquisitions, including a partial acquisition, the tracking of acquisition-related goodwill may be necessary to appropriately allocate goodwill impairment losses between the controlling and noncontrolling interests.
The exposure draft on business combinations released by the FASB in 2005 proposed to amend ASC 350-20 to provide guidance on how to determine and allocate subsequent impairment losses to the controlling and noncontrolling interests. While the final standard did not include an amendment to provide guidance for allocating a goodwill impairment loss, we believe the exposure draft guidance may provide one acceptable alternative for allocating any such loss. The allocation approach provided was as follows:
- If the partially owned subsidiary is part of a reporting unit, the portion of the impairment loss allocated to that subsidiary would be determined by multiplying the goodwill impairment loss by the portion of the carrying amount of the goodwill assigned to that partially owned subsidiary over the carrying amount of the goodwill assigned to the reporting unit as a whole.
- The amount of the impairment loss allocated to the partially owned subsidiary would then be allocated to the controlling and noncontrolling interests pro rata based on the relative carrying amounts of goodwill attributed to those interests.
Example BCG 9-19 provides an example of this allocation approach.
EXAMPLE BCG 9-19
Allocation of a goodwill impairment loss to the noncontrolling interest when the reporting unit contains multiple acquisitions
Allocation of a goodwill impairment loss to the noncontrolling interest when the reporting unit contains multiple acquisitions
Reporting Unit X includes a partially owned Subsidiary Z previously acquired in a business combination. The annual goodwill impairment test for Reporting Unit X resulted in an impairment loss of $200 million. At the time of the acquisition of Subsidiary Z, the carrying amount of goodwill in Reporting Unit X was $500 million, of which $300 million is attributable to partially-owned Subsidiary Z, and of that amount, $75 million is attributable to the noncontrolling interest.
How should the impairment loss be allocated to the noncontrolling interest in Subsidiary Z?
Analysis
The impairment loss of $200 million should be allocated to the controlling and noncontrolling interest based on the pro rata carrying amounts of goodwill as follows (in millions):
Step one: Allocate the impairment loss to the partially owned subsidiary
Partially owned Subsidiary Z:
$200 × ($300 / $500) = $120
The residual $80 ($200 - $120) of the impairment loss that is not related to the partially owned subsidiary is included in the impairment loss allocated to the controlling interest of Reporting Unit X.
Step two: Allocate the impairment loss related to the partially-owned subsidiary to the controlling and noncontrolling interests
Controlling interest of Subsidiary Z:
$120 × ($225 / $300) = $90
Noncontrolling interest of Subsidiary Z:
$120 × ($75 / $300) = $30
Step three: Sum the controlling and noncontrolling interests’ allocations
Impairment loss allocated to the controlling interest of Reporting Unit X:
$80 + $90 = $170
Impairment loss allocated to the noncontrolling interest of Reporting Unit X = $30
The allocation of an impairment loss to the noncontrolling interest effectively results in an allocation of goodwill to entities below the reporting unit level. As described in Example BCG 9-19, an acquired partially owned subsidiary may be combined in a reporting unit with other acquired entities for which goodwill has been recorded. In this case, the goodwill impairment loss is allocated between the partially and wholly owned subsidiaries. Such allocations could represent additional operational challenges to management when other organizational changes are made that result in changes to reporting units.
9.9.4.3 Impairment: separate subsidiary financial statements
When a subsidiary of an entity issues separate financial statements that are prepared in accordance with US GAAP, ASC 350-20-35-48 requires that all goodwill that is recognized in those financial statements must be tested for impairment as though the subsidiary were a standalone entity. This includes goodwill arising from the parent’s acquisition of the subsidiary, which may be recognized under push-down accounting, any acquisitions by the subsidiary, and any acquisitions by the parent that have been transferred to, and included in, the subsidiary’s financial statements.
A subsidiary should test its recognized goodwill for impairment based on subsidiary-specific reporting units. The reporting units of the subsidiary must be determined from the perspective of the subsidiary’s operating segments and an analysis of the components of those operating segments. We would expect the CODM and segment managers at the subsidiary level to review different information than the CODM at the consolidated level. Accordingly, the determination of operating segments, pursuant to ASC 280-10, could differ.
9.9.4.4 Impact of impairment at subsidiary level to the parent
Any goodwill impairment loss that is recognized at the subsidiary level would not necessarily be recognized in the parent company’s consolidated financial statements. Instead, the consolidated entity’s reporting units that includes a subsidiary’s reporting units with impaired goodwill should be tested for impairment if it is more likely than not that the event or circumstance that gave rise to the goodwill impairment loss at the subsidiary level would reduce the fair values of the consolidated entity’s reporting units below the carrying amount of the reporting units. In other words, an impairment loss at the subsidiary level may represent a triggering event for an interim impairment test at the consolidated level. The consolidated entity should recognize a goodwill impairment loss only when goodwill is impaired from the perspective of the consolidated entity’s reporting units.
Even when a subsidiary is a single reporting unit from the perspective of the consolidated entity, the subsidiary may have two or more of its own reporting units for purposes of testing its goodwill for impairment. If such a subsidiary recognized a goodwill impairment loss within one of its two reporting units, the impairment loss may be shielded at the consolidated level due to the consideration of the subsidiary as a whole as a single reporting unit by the consolidated entity. In another example, the subsidiary may consist of a single reporting unit, consistent with the consolidated entity; however, the balance of goodwill in the consolidated entity’s reporting unit may not mirror the goodwill recorded by the subsidiary. Such instances could arise because the consolidated entity’s reporting unit may also include goodwill assigned from other acquisitions or the goodwill may be reduced due to the assignment of goodwill to other reporting units due to synergies from the acquisition.
Example BCG 9-20 demonstrates consideration of the impact of a subsidiary impairment loss at the consolidated level.
EXAMPLE BCG 9-20
Considering a subsidiary impairment loss at the consolidated level
Considering a subsidiary impairment loss at the consolidated level
Subsidiary A is issuing standalone financial statements. Subsidiary A has goodwill of $300 million. At Parent X, Subsidiary A and Subsidiary B combine to form one reporting unit, which includes goodwill of $300 million (all Subsidiary A goodwill). Based on the completion of the annual quantitative goodwill impairment test at Parent X, no goodwill impairment is indicated.
As a result of completion of the goodwill impairment tests at Subsidiary A, a goodwill impairment loss of $100 million is determined.
How would goodwill impairment be recognized in Parent X and Subsidiary A’s financial statements?
Analysis
In this situation, Subsidiary A would record a goodwill impairment charge of $100 million in its standalone financial statements. No goodwill impairment charge would be recorded in Parent X’s consolidated financial statements because, at the Parent X level, there was no impairment of goodwill as a result of performing the annual quantitative goodwill impairment test.
9.9.5 Equity method: goodwill not subject to impairment test
Although equity method investments are accounted for under ASC 323-10 rather than ASC 805, the difference between the acquisition cost of an equity method investment and the amount of the investor’s underlying equity in the net assets of the investee should be accounted for as if the investee were a consolidated subsidiary. Therefore, a portion of the difference may be attributable to goodwill (equity method goodwill), which is not separately reported outside the equity method investment. Equity method goodwill is not amortized unless a private company/not-for-profit entity makes an accounting policy election to apply the accounting alternative for amortizing goodwill (see BCG 9.11). As described in ASC 350-20-35-59, equity method goodwill should not be tested for impairment in accordance with ASC 350-20; rather, the total carrying amount of the equity method investment should be reviewed for impairment in accordance with ASC 323. ASC 323-10-35-32 states that the impairment standard for an equity method investment is “a loss in value of an investment that is other than a temporary decline.” When a determination is made that an other-than-temporary decline exists, the equity method investment should be written down to its fair value, which then establishes a new cost basis.
An equity method investor should not separately test an investee’s underlying assets, including goodwill, for impairment. However, the investor generally should record its share of any impairment recognized by the investee and consider the effect, if any, of the impairment on its basis difference in the assets giving rise to the investee’s impairment. In the case of goodwill, the investee will be testing its own goodwill under the provisions of ASC 350-20 because it controls the underlying businesses that gave rise to the goodwill. An investor, on the other hand, does not control the businesses or underlying assets of an equity method investee that gave rise to the goodwill of the investee. Therefore, an equity method investor should recognize its proportionate share of a goodwill impairment loss recorded by an investee because the investee’s goodwill would not be subject to direct impairment testing by the investor in its reporting unit structure. After an investor records its share of any impairment of the investee, the remaining investment should be tested for an other-than-temporary decline.
Under ASC 350-20 an entity may include equity method investments within the overall net assets of a reporting unit for the purpose of performing a goodwill impairment test on the reporting unit as a whole, provided that the equity method investment is appropriately assigned to the reporting unit. See BCG 9.3.5 for further information. In such cases, when the criteria in ASC 350-20-35-39 are met, the equity method investment should be treated the same as any other asset within the reporting unit and, therefore, should be included in both the carrying amount and the fair value of the reporting unit when performing the goodwill impairment test. The equity method investment would be tested for impairment under ASC 323-10 prior to performing the reporting unit’s goodwill impairment test. Any adjusted carrying amount should be recorded as the new carrying value of the investment and included in the carrying amount of the reporting unit.
9.9.6 Allocation of impairment to goodwill components for tax purposes
As more fully discussed in TX 10.4, ASC 805-740-25-2 states that an acquirer should recognize and measure deferred tax assets and liabilities arising from the assets acquired and liabilities assumed in a business combination in accordance with ASC 740-10. Some business combination transactions, particularly taxable business combinations, can result in goodwill that is deductible for tax purposes (also referred to as “tax-deductible goodwill”). The amount assigned to goodwill for book and tax purposes could differ due to different valuation and allocation rules and differences in determining the amount of consideration transferred (e.g., different treatment of costs incurred for the transaction).
ASC 740, Income taxes, describes the separation of goodwill into components at the acquisition date to assist in determining the appropriate deferred tax accounting. The first component (component-1) equals the lesser of (1) goodwill for financial reporting or (2) tax-deductible goodwill. The second component (component-2) equals the remainder of each, that is, (1) the remainder, if any, of goodwill for financial reporting in excess of tax-deductible goodwill or (2) the remainder, if any, of tax-deductible goodwill in excess of the goodwill for financial reporting (ASC 805-740-25-8). See TX 10.8 for further guidance on separating goodwill into its two components.
ASC 805 prescribes the recognition of a deferred tax asset resulting from an excess of tax-deductible goodwill over book goodwill. However, ASC 805 prohibits recognition of a deferred tax liability related to goodwill (or the portion thereof) for which amortization is not deductible for tax purposes (i.e., book goodwill in excess of tax-deductible goodwill).
Any difference that arises between the book and tax bases of component-1 goodwill in future years (e.g., as a result of amortization for tax purposes or impairment for book purposes) is a temporary difference for which a deferred tax liability or asset is recognized, based on the requirements of ASC 740-10. If component-2 is an excess of tax-deductible goodwill over the amount of goodwill for financial reporting, future changes in the entire temporary difference (i.e., both component-1 and component-2 goodwill) are recorded. For example, future amortization of tax-deductible goodwill will reduce the corresponding deferred tax asset until the tax basis is equal to the book basis and will give rise to a deferred tax liability for the basis difference created by tax amortization thereafter (see ASC 805-740-25-9). However, if only a portion of the goodwill is amortizable for tax purposes, then the goodwill impairment must be allocated between component-1 and component-2 book goodwill.
We believe a reasonable methodology to allocate a book goodwill impairment between the components would include a proportionate allocation based on the book carrying amounts of component-1 and component-2 goodwill. We are aware that other approaches may also be acceptable. The approach an entity selects should be applied consistently.
Any goodwill impairment allocated to component-1 book goodwill will either decrease a previously created deferred tax liability or create/increase a deferred tax asset. The amount allocated to component-2 book goodwill will have no current or deferred tax effect (i.e., it is a permanent difference).
As described in ASC 350-20-35-8B, when a reporting unit has tax-deductible goodwill, a goodwill impairment may necessitate an iterative calculation (using what is often referred to as the “simultaneous equations method”) to determine the ultimate goodwill impairment amount and the related deferred tax adjustment.
If a reporting unit has tax deductible goodwill, recognizing a goodwill impairment loss may cause a change in deferred taxes that results in the carrying amount of the reporting unit immediately exceeding its fair value upon recognition of the loss. In those circumstances, the entity shall calculate the impairment loss and associated deferred tax effect in a manner similar to that used in a business combination in accordance with the guidance in paragraphs 805-740-55-9 through 55-13. The total loss recognized shall not exceed the total amount of goodwill allocated to the reporting unit. See Example 2A in paragraphs 350-20-55-23A through 55-23C for an illustration of the calculation.
Example BCG 9-21 demonstrates the tax effect of a goodwill impairment when there is excess goodwill for financial reporting purposes at acquisition over the amount of tax-deductible goodwill.
EXAMPLE BCG 9-21
Deferred tax effect of a goodwill impairment: excess book-over-tax-goodwill at acquisition
Deferred tax effect of a goodwill impairment: excess book-over-tax-goodwill at acquisition
Company A acquired reporting unit X four years ago in a taxable acquisition accounted for as a business combination. As a result of applying acquisition accounting, Company A recognized goodwill of $1,200 million for book purposes; tax deductible goodwill was $900 million and is amortizable for tax purposes over 15 years. In the current period, Company A performs its annual goodwill impairment test and concludes that the carrying value of the reporting unit exceeds its fair value by $400 million. Assume an applicable tax rate of 40%. Company A concludes that a valuation allowance on its deferred tax assets is not necessary both before and after the goodwill impairment.
How should Company A report the pre-tax and tax effects of the goodwill impairment?
Analysis
In order for the carrying amount of the reporting unit to equal its fair value after recognition of the impairment, a net after-tax impairment charge of $400 million will need to be recognized. The iterative calculation described below and referenced at ASC 350-20-35-8B is used to determine the “pre-tax” goodwill impairment and related deferred tax benefit to arrive at a net $400 million charge. Assuming Company A will allocate the impairment between component-1 and component-2 goodwill in proportion to their book bases, the calculation of the pre-tax impairment charge and deferred tax benefit is illustrated as follows:
($ millions) |
Component-1 goodwill |
Component-2 goodwill |
Book basis |
Tax basis |
Deferred taxes |
||||
|---|---|---|---|---|---|---|---|---|---|
Balance at acquisition date
|
$900 1
|
$300
|
$1,200
|
$900
|
$—
|
||||
Tax amortization
|
—
|
—
|
—
|
(240) 2
|
(96) 2
|
||||
Balance before impairment test
|
900
|
300
|
1,200
|
660
|
(96)
|
||||
Impairment loss
|
(428) 3
|
(143) 3
|
(571)3
|
—
|
171
|
||||
Ending balance
|
$472
|
$157
|
$629
|
$660
|
$75
|
||||
1 Component-1 goodwill equals the lesser of (1) goodwill for financial reporting ($1,200) or (2) tax-deductible goodwill ($900). Therefore, component-1 goodwill is $900.
2The tax amortization for the tax basis is calculated as the $900 tax basis amortized for tax purposes over 15 years, multiplied by the number of years of amortization since reporting unit X was acquired (4 years): ($900 / 15) x 4 = $240. The deferred tax liability is calculated as the tax amortization ($240) multiplied by the tax rate (40%): $240 x 40% = $96.
3 The total impairment of $571 would be allocated between the components based on the book balance of goodwill prior to the impairment test (75% to component-1 and 25% to component-2).
|
|||||||||
Calculating the deferred tax effect of the impairment charge involves the following steps (dollar amounts in millions):
Step 1: Determine the ratio of component-1 goodwill to total goodwill: $900 / $1,200 = 75%
Step 2: Determine the “effective” tax rate for the impairment charge by applying the component-1 ratio to the applicable tax rate: 75% × 40% = 30%
Step 3: Calculate the tax rate to apply to the preliminary impairment using the iterative calculation illustrated in paragraphs ASC 805-740-55-9 through ASC 805-740-55-13: 30% / (1- 30%) = 42.86%
Step 4: Apply the rate determined in Step 3 to the preliminary goodwill impairment of $400 to determine the total deferred tax benefit: $400 × 42.86% = $171
Step 5: Add the amount determined in Step 4 to the preliminary goodwill impairment to compute the total pretax impairment: $400 + $171 = $571
Following this approach, the tax benefit of the goodwill impairment equals $171 million ($571 million at an “effective” tax rate of 30%) and the net deductible temporary difference between the tax basis in goodwill of $660 million and the remaining book basis in component-1 goodwill of $472 million is $188 million. Multiplying that amount by the applicable tax rate of 40% results in a deferred tax asset of $75 million.
The following table summarizes the results of the above calculation, including the allocation of the $171 million pre-tax “gross-up” of the goodwill impairment between component-1 and component-2 goodwill:
($ millions) |
Carrying Amount before Impairment |
Carrying Amount after Impairment |
||||
|---|---|---|---|---|---|---|
$
|
%
|
Preliminary Impairment
|
Adjustment for Equation
|
$
|
%
|
|
Component-1 goodwill
|
$900
|
75%
|
$(300)
|
$(128)
|
$472
|
75%
|
Component-2 goodwill
|
300
|
25%
|
(100)
|
(43)
|
157
|
25%
|
Deferred taxes
|
(96)
|
n/a
|
171
|
75
|
n/a
|
|
Example BCG 9-22 illustrates the accounting for a goodwill impairment charge when excess tax-deductible goodwill is present.
EXAMPLE BCG 9-22
Deferred tax effect of a goodwill impairment: excess of tax-deductible goodwill over the amount of goodwill for financial reporting purposes at acquisition
Deferred tax effect of a goodwill impairment: excess of tax-deductible goodwill over the amount of goodwill for financial reporting purposes at acquisition
Company A acquired a business (reporting unit X) in a nontaxable transaction. At the acquisition date, Company A has goodwill for financial reporting purposes of $400 million and tax-deductible goodwill of $900 million (carried over from a prior acquisition). The tax rate is 40%. A deferred tax asset of $200 million is recognized for the excess tax-deductible goodwill at the acquisition date. The tax goodwill is deductible ratably over 10 years.
In year 4, Company A performs its annual goodwill impairment test and concludes that the carrying value of reporting unit X exceeds its fair value by $200 million. Company A concludes that a valuation allowance on its deferred tax assets is not necessary both before and after the goodwill impairment.
How should Company A report the pre-tax and tax effects of the goodwill impairment?
Analysis
In order for the carrying amount of the reporting unit to equal its fair value after recognition of the impairment, a net after-tax impairment charge of $200 million will need to be recognized in year 4. The preliminary goodwill impairment of $200 million would be grossed up using an iterative calculation illustrated in ASC 350-20-35-8B to arrive at the total impairment charge. In this case, the $200 million “preliminary” goodwill impairment would be multiplied by 66.7% (40% / (1 – 40%)), resulting in a gross-up of $133 million, or a pre-tax impairment of $333 million. The resulting deferred tax asset after the impairment would be $189 million ((tax basis of $540 million less book basis of $67 million) ×40%). To arrive at a net after-tax charge of $200 million, a pre-tax goodwill impairment of $333 million and a deferred tax benefit of $133 million would be recognized.
($ millions) Year |
Financial reporting (book basis) goodwill |
Tax basis goodwill |
Annual tax amortization |
Deferred taxes |
|||
|---|---|---|---|---|---|---|---|
At acquisition
|
$400
|
$900
|
$ —
|
$200
|
|||
Year 1
|
400
|
810
|
90
|
164
|
|||
2
|
400
|
720
|
90
|
128
|
|||
3
|
400
|
630
|
90
|
92
|
|||
4
|
400
|
540
|
90
|
56
|
|||
Book impairment loss
|
(333)
|
—
|
—
|
133
|
|||
Post-impairment carrying amount (Year 4)
|
$67
|
$540
|
$ —
|
$189
|
If the goodwill impairment occurred in a later year, it is possible that the tax basis of the goodwill would have been amortized to a point where it was lower than the book basis, giving rise to a deferred tax liability prior to the impairment. Using the same method described above, the total impairment charge may then reduce the book goodwill to a point where it is lower than the tax basis, giving rise to a deferred tax asset that must be assessed for realizability along with all of the company’s other deferred tax assets.
Example BCG 9-21 and Example BCG 9-22 both demonstrate how to apply the simultaneous equations method referenced in ASC 350-20-35-8B when the goodwill impairment impacts component-1 (i.e., tax-deductible) goodwill. However, if the reporting unit’s deferred taxes are subject to a full valuation allowance—meaning the net deferred tax assets (considering the valuation allowance) are zero—both before and after the goodwill impairment, the iterative calculation is not necessary. This is because the tax effect of the goodwill impairment is zero since any impact on deferred tax balances resulting from the goodwill impairment would be offset by an equal change in the valuation allowance.
In a situation when there is no valuation allowance before the goodwill impairment but some amount of valuation allowance will be needed after the goodwill impairment, or when there is a partial valuation allowance before the goodwill impairment (i.e., net deferred tax assets considering the valuation allowance are not zero) and a larger valuation allowance is necessary after the goodwill impairment, we believe the iterative calculation may need to be modified. If the iterative calculation is not modified, the carrying value of the reporting unit after the goodwill impairment (including the gross-up for the tax effects using the simultaneous equation) will typically be less than the fair value of the reporting unit.
9.9.7 Determining goodwill under ASC 740-10 vs. ASC 350-20
The determination of goodwill for tax purposes must be performed on a jurisdictional basis. However, when assigning goodwill for financial reporting purposes, ASC 350-20 requires that goodwill be assigned to reporting units, which in many cases will not align with specific tax jurisdictions. Reporting units may include various tax jurisdictions and legal entities, or only portions of a company’s operations contained in certain tax jurisdictions or legal entities. Consequently, at the reporting unit level, the tax goodwill associated with the reporting unit may be different than the goodwill assigned under ASC 350-20. In the case of goodwill impairments or other changes in goodwill (e.g., dispositions), the entity will need to evaluate the goodwill for financial reporting purposes and the tax basis of goodwill attributable to reporting units for purposes of determining the tax effects of such changes on the reporting units under ASC 740-10.
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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