Recording goodwill impairment just got easier. With an unprecedented number of businesses negatively impacted by the COVID-19 pandemic, the Financial Accounting Standards Board (FASB), approved Accounting Standards Update 2021-03 (ASU) in March 2021 to help businesses get their financial statements in sync with their current economic condition. Any private company or non-profit that shows a higher value on their books than what they could get by selling the business today needs to evaluate whether they can—and if they should—take advantage of this new accounting option.
Ambitious business leaders often choose to grow their business through acquisitions. Whether it is a one-time purchase of a single, perfectly located storefront or an expansive network of offices acquired over several years, when each business is added, a goodwill entry is recorded. The goodwill assets that remain on financial statements often no longer reflect the real value of the business. Fortunately, the ASU approved in March is both less complex and less costly than the traditional method of valuing and recording impairments.
What is goodwill?
Accountants record goodwill during mergers and acquisitions (M&A) to show the value paid for the new business over the amount shown on its balance sheet. It is an intangible asset that quantifies the benefit received for the business name, brand recognition and reputation. Other intangibles can include copyrights, patents, licensing agreements and client lists that are also recorded in journal entries. Goodwill is distinctive from those intangible assets in that it cannot be sold separately from the business as a whole.
Recording goodwill—valuing, testing and amortizing it—has always been a contentious topic in the accounting and business world. Managing goodwill accounting entries to ensure accuracy has traditionally been complex and costly. The initial entry is clear: it is the price paid in excess of the book value of the business. The challenges exist in everything that happens after that.
In 2014, FASB gave private companies the option to amortize goodwill over a period of up to 10 years. Since goodwill is an asset, as you amortize it, you are recording an expense (1/10 of the amount, for example) and reducing the book value of the asset. When you amortize, since your expenses are higher, your taxes are reduced. Showing a lower amount of goodwill could impact the perceived value of the business to investors, potential buyers and lenders. It could also make your business more attractive to a buyer who values the tax deduction.
Private companies also need to ensure that they are following IRS tax regulations for intangible assets. Generally, in tax accounting, goodwill is amortized over 15 years and is tax deductible. This tax and GAAP (Generally Accepted Accounting Principles) disparity is one reason why some companies may choose to not elect the alternative accounting option of amortizing goodwill on a financial accounting basis.
Goodwill impairment and what has changed
In situations where economic downturn or other conditions have resulted in a business being worth less than it previously was, any goodwill on the balance sheet needs to be adjusted. FASB requires private companies to perform tests for impairment when a triggering event occurs. If any impairments are found, they must determine the impact and record adjusting entries.
The pandemic prompted FASB to fast-track its decision-making process, as a vast number of businesses have experienced hardships due to shifts in buying habits, quarantine restrictions and labor challenges. The ASU 2021-03 guidance addressed both the triggering event analysis and the valuation process.
Before, the exact date of a triggering event had to be determined. Companies who adopt the election should use the end date of a reporting period. This bypasses the need to analyze exactly when goodwill became impaired. Moving the trigger date to the end of the period also reduces the need to do valuation calculations on a rolling basis throughout the period, which was a difficult, costly process.
Goodwill impairment considerations
If you carry goodwill entries and your business is not worth as much as your balance sheet indicates because of the current economic conditions, a series of activities need to happen.
- Whether you previously chose the accounting alternative to amortize goodwill or not, you can now make a one-time election to adopt the accounting alternative for a goodwill impairment triggering event.
- If elected, and you do amortize goodwill, the triggering event evaluation should be performed only as of the end reporting date when the triggering event occurred.
- If elected, and you don’t amortize goodwill, your existing annual goodwill impairment test could impact when your triggering event evaluation should occur.
- If your assessment of other assets for impairment (i.e., long-lived or other intangible assets) results in a goodwill impairment triggering event, you’ll need to consider it at both your annual goodwill impairment date and the reporting date.
- Impairment valuations will continue to be extensive, though much less complicated than with the rolling basis requirement.
- Selection and adoption of the accounting alternative for a goodwill impairment triggering event evaluation will be on a prospective basis and should not be applied to periods that have previously been reported.
The impairment guidelines do not require specific disclosures or footnotes regarding the triggering events, which should be a consideration if you are the one purchasing or lending to a company with goodwill on their books.
This is good news
New FASB directions often add analysis and reporting requirements to already full plates. This ASU, in contrast, gives those companies that need it most the option to streamline the impairment recognition process. It also allows them to expedite implementation and move on to address other business needs. Simplifying accounting requirements to make the reporting costs outweigh the benefits will always be welcome.
If your company could benefit from assistance in assessing your goodwill accounting process or by performing an impairment valuation, our financial experts at Paro are ready to assist you.
At Paro, we leverage our proprietary AI technology to build flexible, focused teams of remote experts that help companies solve problems and drive growth. Our laser focus on finance allows us to quickly identify experts across the U.S. with the right mix of skills, credentials, and experience to achieve each company’s specific goals. Reach out to us today so you get one step closer to gaining the accounting standards expertise you need.