As 2023 draws to a close, completing a goodwill impairment analysis may be part of your year-end to-do list.
A thorough goodwill impairment analysis is necessary to understand the impact on your organization’s overall value, manage stakeholder expectations and maintain investor transparency. If you have goodwill on your balance sheet and a triggering event has recently occurred, you need to assess whether there is impairment. However, assigning a dollar value to an intangible asset can be difficult, and any missteps can mean an inaccurate valuation or incorrect balance sheet.
While measuring goodwill is a nuanced, complicated process, there are broader areas to consider to keep your analysis on the right track. Below are six key areas to keep in mind when conducting a goodwill impairment analysis.
Before performing a goodwill impairment analysis, your organization should first perform impairment of other assets; this will affect the carrying amount of a reporting unit. The correct order for impairment testing in accordance with the FASB Accounting Standards Codification (ASC) is as follows:
ASC 350 instructs companies to use one mandatory step and one optional step to measure the impairment of goodwill. An optional qualitative analysis can save time for companies where there is minimal risk of impairment, such as when there is sufficient cushion (i.e., the difference between a reporting unit’s fair value and carrying amount).
In other cases, it may be more efficient to proceed directly to a quantitative analysis. In this step, the fair value of a reporting unit is compared against the carrying amount; if the fair value is less than the carrying amount, the difference is recorded as a goodwill impairment.
Consider the following questions when deciding whether to perform a qualitative analysis:
If there are significant changes in the reporting unit’s outlook or other significant events occurring since the prior testing date, step one may be a better approach. For example, if there is a loss of a major customer that reduces revenue growth and forecasted free cash flow, a quantitative analysis can capture the change in business outlook, even if public company multiples remain similar.
Just because something was always done a certain way doesn’t mean it is still acceptable or consistent with industry practice, right? Performing fair value measurements is no different. It’s important to be mindful of the increased documentation requirements, auditor scrutiny and comments from peer reviewers, the SEC and PCAOB when you determine fair value. In times of market volatility, market participants will pay careful attention to asset impairments.
With the adoption of the Certified in Entity and Intangible Valuations (CEIV) credential and Mandatory Performance Framework (MPF) for valuation specialists and auditors, there are also heightened documentation requirements for credential holders. Emphasis should be placed on prospective financial information (PFI), commonly known as forecasts, and components of the discount rate. Auditors and their specialists may focus on the forecasting process, back testing and forecast accuracy and comparison to guideline companies and the industry.
Goodwill impairment testing is performed at the reporting unit level, which may be operationally different from how the business is run and tracked. Your company should have a reasonable and supportable methodology to assign assets and liabilities in a consistent manner.
The assets assigned to the reporting unit, which are necessary to determine the appropriate carrying amount, should reflect those that are needed to support and generate the expected cash flows of the reporting unit. Assets and liabilities not directly related to a specific reporting unit could be assigned according to the benefit received by different reporting units or based on the relative fair value of different reporting units.
For example, time tracking of employee time and costs may be one way to allocate certain corporate management costs. Whichever allocation methodology is chosen should be carefully documented and well supported.
When performing the income approach in a quantitative analysis, be sure to determine whether a hypothetical sale of the reporting unit would be facilitated through a taxable or nontaxable transaction. Nontaxable transactions typically involve the sale of equity while taxable transactions are often, but not always, associated with asset sales. Your company may look to the form of its prior transactions, legal structure of the reporting unit and practicality of a taxable versus nontaxable sale. In a taxable transaction, a tax amortization benefit (TAB) may need to be applied to reflect a step-up in tax basis and associated amortization benefits.
For public companies, the SEC suggests performing a reconciliation of the market capitalization of the company to the sum of the fair value of reporting units. While this might be a simple exercise for a company with one reporting unit, it quickly becomes more complicated for companies with multiple reporting units.
To assess the implied market participation acquisition premium (MPAP), commonly known as a control premium, compare the market capitalization of your organization to the sum of the fair value of the reporting units. The amount and percentage of the MPAP should be adequately explained and consider the prerogatives of control and other market transactions.
In times of elevated market volatility, MPAPs may decrease, but companies should avoid unsupported “rules of thumb” when supporting the concluded MPAP. Publications like the Appraisal Foundation’s MPAP guide can provide additional information as you assess the MPAP.
One common question that often arises is whether a company can use an averaging technique to measure its market capitalization. Generally, yes, but the use of subsequent stock prices is not advised as they do not reflect conditions that exist as of the testing date. An appropriate averaging period should be well documented and over a reasonable amount of time; that period should not ignore decreases in the company’s stock prices as these declines may be indicative of factors that affect fair value. There may be company-specific factors, such as loss of a major customer or departure of a key executive, which may also affect a company’s stock price. If these factors are relevant as of the testing date, it may be appropriate to include prior stock prices.
Understanding the nuances of a goodwill impairment analysis can be confusing. It can be easy to misstep or miscalculate as you complete the process, which can result in inaccurate or misrepresented financial statements. As you prepare your year-end financial statements, review the items above to help ensure that you are correctly evaluating and measuring goodwill for impairment. Knowing the significance of your goodwill impairment — and how it affects the overall value of your company — can help you determine how to best future-proof your business in 2024 and beyond.
Our team of experts can help you conduct a goodwill impairment analysis and evaluate how that potential impairment may affect your business. Contact our valuation experts for assistance preparing your goodwill impairment analysis and setting your organization up for future success.
