2.3 Qualitative Assessment (Step 0)
ASC 350-20
Qualitative Assessment
35-3A
An entity may assess qualitative factors to determine
whether it is more likely than not (that is, a likelihood of
more than 50 percent) that the fair value of a reporting
unit is less than its carrying amount, including
goodwill.
35-3B
An entity has an unconditional option to bypass the
qualitative assessment described in the preceding paragraph
for any reporting unit in any period and proceed directly to
performing the quantitative goodwill impairment test. An
entity may resume performing the qualitative assessment in
any subsequent period.
Entities must test goodwill for impairment at least annually and more frequently if
impairment indicators exist. In September 2011, the FASB issued ASU 2011-08 (codified in ASC 350-20), which
gives entities the option of first performing a qualitative assessment (step 0) to
test goodwill for impairment. If an entity concludes, on the basis of the
qualitative assessment, that it is more likely than not (i.e., a likelihood of more
than 50 percent) that the fair value of a reporting unit is less than its carrying
amount, the entity must perform the quantitative impairment test (step 1) (see
Section 2.4). Alternatively, if the entity
concludes that it is not more likely than not that the fair value of a reporting
unit is less than its carrying amount, it does not need to perform the quantitative
impairment test.
Because the qualitative assessment is optional, an entity may bypass it for any of
its reporting units in any periods and may instead perform the quantitative test.
For example, if an entity has two reporting units, it may perform step 0 for one
reporting unit and step 1 for the other on the same measurement date. Further, this
option is unconditional in that an entity may resume performing the qualitative
assessment in any subsequent period. Conversely, if an entity elects to perform the
qualitative assessment, it may then choose to resume performing the quantitative
test in a subsequent period.
Connecting the Dots
We have observed that many entities choose to bypass the
qualitative assessment and proceed directly to performing a quantitative
assessment because comprehensively assessing the qualitative factors in ASC
350-20-35-3C can, at times, take more effort than measuring the fair value
of a reporting unit.
2.3.1 Performing the Optional Qualitative Assessment
ASC 350-20
35-3C 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).
35-3D If,
after assessing the totality of events or circumstances
such as those described in the preceding paragraph, an
entity determines that it is not more likely than not
that the fair value of a reporting unit is less than its
carrying amount, then the quantitative goodwill
impairment test is unnecessary.
35-3E If,
after assessing the totality of events or circumstances
such as those described in paragraph 350-20-35-3C(a)
through (g), 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 the entity shall perform
the quantitative goodwill impairment test.
35-3F The
examples included in paragraph 350-20-35-3C(a) through
(g) are not all-inclusive, and an entity shall consider
other relevant events and circumstances that affect the
fair value or carrying amount of a reporting unit in
determining whether to perform the quantitative goodwill
impairment test. An entity shall consider the extent to
which each of the adverse events and circumstances
identified could affect the comparison of a reporting
unit’s fair value with its carrying amount. An entity
should place more weight on the events and circumstances
that most affect a reporting unit’s fair value or the
carrying amount of its net assets. An entity also should
consider positive and mitigating events and
circumstances that may affect its determination of
whether it is more likely than not that the fair value
of a reporting unit is less than its carrying amount. If
an entity has a recent fair value calculation for a
reporting unit, it also should include as a factor in
its consideration the difference between the fair value
and the carrying amount in reaching its conclusion about
whether to perform the quantitative goodwill impairment
test.
35-3G An
entity shall evaluate, on the basis of the weight of
evidence, the significance of all identified events and
circumstances in the context of determining whether it
is more likely than not that the fair value of a
reporting unit is less than its carrying amount. None of
the individual examples of events and circumstances
included in paragraph 350-20-35-3C(a) through (g) are
intended to represent standalone events or circumstances
that necessarily require an entity to perform the
quantitative goodwill impairment test. Also, the
existence of positive and mitigating events and
circumstances is not intended to represent a rebuttable
presumption that an entity should not perform the
quantitative goodwill impairment test.
To complete a qualitative assessment comprehensively, an entity
should consider using the following approach, which is consistent with the
framework outlined in Chapter 3 of the AICPA Accounting and Valuation Guide Testing
Goodwill for Impairment:
-
Identify relevant inputs that affect fair value.
-
Identify relevant events and circumstances that may affect fair value inputs.
-
Evaluate, both individually and in the aggregate, the impact of events and circumstances on the inputs to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount.
The qualitative factors listed in ASC 350-20-35-3C are the same factors an entity
must consider between annual tests to determine whether it must perform an
interim goodwill impairment test (see Section 2.5.5). ASC
350-20-35-3F also indicates that management should factor additional events and
circumstances into its qualitative assessment as necessary and should evaluate
each event and circumstance, individually and together with other factors, to
assess whether it is more likely than not that the fair value of a reporting
unit is less than its carrying amount.
While not required to do so by ASC 350-20, an entity should consider establishing
conditions under which it would proceed directly to performing the quantitative
test rather than expending the effort to support its qualitative assessment. For
example, an entity may proceed directly to performing a quantitative test if:
-
There was only a small excess of fair value over carrying amount (i.e., cushion) in the last quantitative test.
-
There has been a decline in overall macroeconomic conditions in the region in which the reporting unit operates.
-
The costs incurred by the reporting unit have significantly increased.
-
A significant customer or customers of the reporting unit have been lost.
-
The composition of the reporting unit has changed significantly as a result of acquisitions or dispositions.
If any of these conditions exist, it may be more cost-effective to proceed
directly to the quantitative test. Also, when the qualitative assessment is
performed, a fair value measurement becomes less relevant as more time
passes.
While an entity is not specifically required to perform a quantitative test at
any prescribed interval, conclusions reached solely about qualitative factors
may become more difficult to defend as time elapses between fair
value/quantitative calculations. An entity’s determination of when and how often
to refresh the fair value analysis is based on management’s judgment and will
depend on various factors, including, but not limited to, changes in the
composition of the reporting unit (e.g., if acquisitions or dispositions occur),
financial performance, changes in the operating or market environment,
volatility in the underlying cash flows, and the amount of excess fair value as
of the last quantitative assessment date.
Example 2-1
XYZ Inc. has two reporting units, RU-1 and RU-2. In the
prior year, XYZ performed a quantitative impairment
assessment for both reporting units, resulting in a 6
percent cushion (excess of fair value over carrying
value) for RU-1 and a 60 percent cushion for RU-2. XYZ
noted the following changes in both internal and
external factors in the current year:
-
Higher sales and margin for RU-2 than in the prior year.
-
Lower demand than in the prior year for services sold by RU-1, resulting in lower sales and margin than in the prior year.
-
The actual results for both RU-1 and RU-2 were favorable compared with the current-year budget.
-
XYZ’s market capitalization was greater than in the prior year.
-
Overall industry and market conditions are consistent with those in the prior year.
-
Acquisition activity in XYZ’s industry is flat compared with the prior year, and deal values are in line with those completed in the prior year.
In evaluating these changes, XYZ would most likely elect
to perform a qualitative assessment only for RU-2 in the
current year, since the prior-year cushion (60 percent)
is significant, RU-2’s financial performance has
improved, and the overall market and industry
environment has remained consistent with prior-year
conditions. These factors, when considered in the
aggregate, suggest that XYZ may be able to conclude, on
the basis of a qualitative assessment only, that it is
more likely than not that the fair value of RU-2 exceeds
its carrying value in the current year.
Conversely, XYZ would most likely elect to perform a
quantitative assessment in the current year for RU-1
given the lack of cushion in the prior year (only 6
percent) and the decline in RU-1’s current-year
financial performance. These factors, when considered in
the aggregate, suggest that the fair value of RU-1 may
be more sensitive to changes in the inputs (e.g.,
discount rate or revenue growth rate) and could be
harder to support solely on the basis of a qualitative
assessment. As a result, XYZ may need to perform a
quantitative assessment to determine whether it is more
likely than not that the fair value of RU-1 exceeds its
carrying value.
The sections below address various considerations related to performing each step
of the qualitative assessment.
2.3.2 Identifying Inputs and Assumptions That Most Affect Fair Value
In identifying the relevant inputs that affect the fair value of the reporting
unit, an entity should consider the unit’s key business drivers as well as the
continued applicability of the technique most recently used for valuation of the
reporting unit and any excess of the fair value over the carrying value as of
the most recent quantitative assessment.
A reporting unit’s “key business drivers” can be defined as internal and external
factors that are critical to the reporting unit’s future growth. Key business
drivers are often evaluated as part of the annual budgeting process and can
change from year to year. It is therefore important for an entity to regularly
consider its specific facts and circumstances in determining and evaluating key
business drivers.
Examples of key business drivers may include, but are not limited to, the
following:
-
Expected revenue and revenue growth rates.
-
Expected operating expenses.
-
Expected working capital requirements.
-
Expected operating income and operating income growth rate.
-
Expected operating margin.
-
Expected depreciation and amortization.
-
Expected capital expenditures.
-
Economic and marketplace factors that are critical to the reporting unit.
ASC 820 indicates that valuation techniques such as the market approach, income
approach, cost approach, or a combination can be used to measure fair value. The
entity should note which valuation technique was used to calculate the most
recent step 1 fair value amount, whether the fair value and fair value
assumptions calculated in a prior period remain a good proxy for the current
fair value, and what was the most recent excess of fair value (or “cushion”)
over the carrying amount. While the cushion is just one of many factors to be
considered, in general, the larger the cushion in fair value over the carrying
amount, the more likely it may be that an entity would perform a qualitative
assessment only and would not need to proceed to the quantitative test.
Common assumptions that management may evaluate in this step of
the analysis include, but are not limited to, the following:
-
Discount rate.
-
Corporate income tax rate.
-
Estimated near- and long-term growth rates.
-
Reporting-unit operating margins.
-
Valuation multiples.
The entity may support its position by evaluating whether forecast scenarios used
in the most recent fair value calculation continue to be reasonable in light of
industry events and the entity’s current circumstances. For example, such an
assessment might include a quantitative analysis of the effects of market
conditions, industry changes, and other factors on the cushion. Similarly, an
entity might scrutinize the significant assumptions used in the most recent fair
value calculation, such as projected revenue and revenue growth rates, to
determine whether such assumptions remain appropriate in the current period.
To provide a meaningful analysis of such trends, an entity might consider what
quantitative analysis can be used to support its qualitative assertions. For
example, an entity may document a year-by-year comparison for both budget and
actual results to identify key trends in its financial performance. In addition,
an entity may evaluate whether it continues to have the intent and ability to
take any specific actions that were contemplated at the time of the most recent
fair value calculation. For example, it may compare (1) any planned cost savings
opportunities or other strategic plans that were contemplated in the prior
forecasts with (2) actual results.
Example 2-2
XYZ has a single reporting unit, RU-1. In 20X1, XYZ
performed a quantitative goodwill assessment in which it
applied the income approach. In 20X2, XYZ elected to
perform a qualitative assessment only. In its
current-year determination of the inputs that affect the
fair value of RU-1, XYZ reviewed the 20X1 quantitative
calculation, noting that the fair value of RU-1 was most
sensitive to changes in the discount rate. As a result,
in its 20X2 qualitative assessment, XYZ should review
the assumptions used to determine the 20X1 discount rate
and should update the inputs, as applicable, with
current-period information (e.g., current risk-free
rate, market risk premium). XYZ should then evaluate the
impact, if any, the use of an updated discount rate
would have on the prior-year fair value calculation.
Example 2-3
Assume the same facts as in Example 2-2 except that, in 20X1, XYZ
performed a quantitative assessment under the market
approach to calculate the fair value of the reporting
unit.
As part of its current-year qualitative assessment of
RU-1, XYZ reviewed the 20X1 quantitative calculation,
noting that the fair value of RU-1 was most sensitive to
changes in market/competitor growth multiples. As a
result, in its 20X2 qualitative assessment, XYZ should
consider refreshing the market multiples and should
evaluate the impact, if any, the refreshed multiples
would have on the 20X1 fair value calculation.
2.3.3 Identify Relevant Events and Circumstances That May Have an Impact on the Inputs and Assumptions
Once the entity has identified the relevant inputs to a reporting unit that most
affect fair value, the entity should apply the guidance in ASC 350-20-35-3C(a)
through (g) to identify the relevant events and circumstances that may affect
these inputs.
2.3.3.1 Macroeconomic Conditions
An entity should analyze the impact of the following macroeconomic conditions
on the fair value drivers for the reporting unit:
-
Deteriorations in general economic conditions.
-
Limitations on accessing capital.
-
Fluctuations in foreign exchange rates.
-
External economic data (e.g., U.S. Treasury rates, gross domestic product, movement and volatility in the stock market, inflation).
-
Other developments in equity and credit markets.
The entity should also consider the following as part of this analysis:
-
The implications of attempting to access credit and whether it was successful, if applicable. Unsuccessful attempts to access capital markets may be indicative of a diminished fair value of the entity or individual reporting units.
-
Whether fluctuations in foreign exchange rates affect currencies that mainly influence (1) sales prices for goods and services or (2) labor, material, and other costs of providing those goods or services. These fluctuations may negatively affect the fair value of a particular reporting unit within the entity.
2.3.3.2 Industry and Market Considerations
An entity should analyze the impact of the following industry and market
factors on the fair value drivers of the reporting unit:
-
Deteriorations in the reporting unit’s operating environment.
-
Increases in competition. For example, new competitors may take market share away from the entity, causing a decrease in revenue, which could result in a reduction in the reporting unit’s fair value.
-
A decline in market-dependent valuation multiples or metrics, both in absolute terms and relative to peers. For example, a reporting unit that provides materials to the construction industry may anticipate a decrease in revenue if demand for new housing starts to decline. If revenue is not replaced through sales to other customers or costs are not reduced proportionately, there may be a reduction in the fair value of the reporting unit.
-
Changes in the market for a reporting unit’s products or services. For example, a technological development or obsolescence of products or services could result in a reduction in the fair value of the reporting unit.
-
Regulatory developments. For example, changes in the regulatory environment could cause a reporting unit to incur additional costs of complying with new requirements. This may result in a decrease of net cash flows and a reduction in the fair value of the reporting unit.
-
Political developments. For example, an increase in restrictions on offshore drilling may result in a reduction of revenue.
Further, an entity should determine the reporting unit’s market share and
evaluate how changes in market share and the overall market for the
reporting unit’s products and services may affect fair value (e.g., a stable
or increasing market share may constitute evidence that the fair value of
the reporting unit has increased or has not declined). The entity should
also consider whether the industry, as well as the market assumptions and
judgments, used for the qualitative assessment are consistent with those
used for other purposes (e.g., whether assumptions and judgments supporting
goodwill are consistent with those used to prepare budgets used for
compensation purposes).
2.3.3.3 Cost Factors
With respect to cost factors, an entity should:
-
Consider the impact of increases or decreases in raw materials, labor, and other cost factors that have an effect on earnings and cash flows and potentially the fair value of the reporting unit.
-
Support the assessment by making quantitative analytical comparisons to measure the significance and extent of the impact of the cost factors. Such comparisons might include year-by-year results, budgeted versus actual results, and operating margins and capital expenditures versus prior-period and projected results.
-
Develop a quantitative analysis to support how cost-cutting efforts initiated in the prior year have or have not affected current and projected margins.
-
Consider whether the cost assumptions and judgments used for the qualitative assessment are consistent with those used for other purposes (e.g., whether the assumptions and judgments supporting goodwill are consistent with those used to prepare budgets used for compensation purposes).
2.3.3.4 Overall Financial Performance
When evaluating a reporting unit’s overall financial performance, an entity
should:
-
Consider the impact of the reporting unit’s overall financial performance metrics. Such an evaluation may include, but is not limited to, analysis of the following:
-
Cash flows into and out of the reporting unit(s) to determine whether the reporting unit is using financial resources more quickly than it is able to replace them with profits.
-
Increases or declines in planned or actual revenue or earnings by comparison with projected and actual results for relevant prior periods.
-
Trends in historical revenue growth rates compared with those at peer companies.
-
Working capital needs, including whether the reporting unit’s working capital requirements have changed and, if so, the reasons for the changes and a comparison of these explanations against the industry norms.
-
-
Perform a retrospective review of significant assumptions and fair value drivers used in the most recent fair value calculation, including:
-
Comparing the actual recorded results for the current year with the forecasted results that were used in the most recently performed quantitative analysis.
-
Comparing updated current-period forecasts with the forecasts that were used in the most recently performed quantitative analysis.
-
-
Consider the risk of failing to meet any debt covenants.
-
Analyze key accounting ratios that may be useful to measuring the entity’s business performance trends. These may include:
-
Liquidity ratios, which may indicate the entity’s ability to meet short-term financial obligations.
-
Efficiency ratios, which may indicate how well business assets are being used.
-
Financial leverage ratios, which may indicate the sustainability of exposure to long-term debt.
-
Gross profit margins, which indicate how much money is made after direct costs of sales have been taken into account.
-
2.3.3.5 Other Relevant Entity-Specific Events and Events Affecting a Reporting Unit
In addition, an entity should consider the impact of other events that may
result in an increase or a decline in a reporting unit’s fair value. Such
events may include, but are not limited to, the following:
-
Additions or losses of significant customers or dependence on major suppliers. For example, if any customers have discontinued, or are expected to discontinue, their use of the entity’s products or services at any time, there could be a material adverse effect on the reporting unit’s future results of operations. Further, supply chain shortages could create risk that orders placed by the reporting unit might not be fulfilled, thereby affecting the reporting unit’s ability to meet its contractual commitments in a timely manner.
-
Effects of expiring patents, which could increase competition in the markets and therefore result in reduced revenues for the reporting unit.
-
Technological conditions and influences.
-
Products or industry trends.
-
Future impacts of anticipated acquisitions/integrations, which could result in significantly abnormal returns and negative long-term performance in the post-acquisition integration period.
-
Litigation.
-
Changes in strategy.
-
Expansion to new markets or withdrawal from certain markets.
-
Adverse actions or assessments by regulators.
-
Loss of key management or other personnel.
-
A lack of product acceptance in the market.
-
Commencement of liquidation sale.
-
Natural disasters.
Further, ASC 350-20-35-3C(f) states that the likelihood and the significance
of the following events (not all-inclusive) should be considered:
-
A “change in the composition or carrying amount of [a reporting unit’s] net assets” (e.g., investments in equity method investments, joint ventures, and variable interest entities).
-
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.”
-
“[R]ecognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit.”
Moreover, the entity should consider supplementing the qualitative discussion
with a quantitative analysis or other underlying analysis, if appropriate,
that measures the significance and extent of the impact of the events and
circumstances described above.
2.3.3.6 A Sustained Decrease in Share Price
The entity should consider historical share price trends, which may include,
but are not limited to, the following:
-
Evaluation of stock price trends over a certain period (most notably, a sustained decrease in share price in both absolute terms and relative to peers).
-
Comparisons with industry and peer companies.
-
Comparisons with changes in the overall market.
It may prove beneficial to supplement the qualitative discussion with a
quantitative analysis that measures the significance and extent of the
impact of trends in, and comparisons of, the entity’s share price. Such
quantitative analyses may include sensitivity analyses that evaluate the
potential impact of planned events on the entity’s share price, comparisons
to book value to understand any significant changes and determine the effect
on the qualitative assessment, or evaluations of the market capitalization
over time and compared with that of peer companies.
2.3.4 Evaluate Whether It Is More Likely Than Not That the Fair Value of a Reporting Unit Is Less Than Its Carrying Amount
In accordance with ASC 350-20-35-3F and 35-3G, after identifying the relevant
events and circumstances, an entity should consider the extent to which each of
these events and circumstances could affect the comparison of a reporting unit’s
fair value with its carrying amount. All available evidence, both positive and
negative, should be considered, and management may need to use significant
judgment in weighting the various factors. An entity should more heavily weight
the events and circumstances that most affect a reporting unit’s fair value or
the carrying amount of its net assets. In addition, the entity should consider
positive and mitigating events and circumstances that may affect its
determination of whether it is more likely than not that the fair value of a
reporting unit is less than its carrying amount. If an entity has a recent fair
value calculation for a reporting unit, it should also take into account the
difference between the fair value and the carrying amount in reaching its
conclusion about whether to perform the quantitative goodwill impairment
test.
For each event and circumstance contemplated in the qualitative assessment, the
entity should document a conclusion about whether it represents positive,
neutral, or adverse evidence that it is more likely than not that the fair value
of a reporting unit is less than its carrying amount. No one factor is meant to
be a determinative event that triggers a quantitative calculation. Both the
individual and the total impact of the events and circumstances should be
evaluated. In addition, the entity should consider how heavily (e.g., low,
medium, or high) each identified event or circumstance should be weighed in the
overall assessment (i.e., an entity should place more weight on the events and
circumstances that have the greatest effect on a reporting unit’s fair value or
the carrying amount of its net assets). A more robust analysis should be
performed for those factors considered to be more significant to the overall
analysis.
In evaluating relevant events and reaching the related conclusions, an entity may
find it helpful to perform a quantitative analysis to support a qualitative
conclusion. Examples of quantitative support include the following:
-
Financial modeling or sensitivity calculations.
-
Opinions on or analyses of specific matters for which the expertise of others is required.
-
Projections of financial results.
-
Analysis of prior-year projections compared with actual results.
-
Economic and market data.
If, after assessing the totality of events or circumstances, an entity determines
that it is not more likely than not that the fair value of a reporting unit is
less than its carrying amount, the quantitative goodwill impairment test is
unnecessary. Conversely, if, after assessing the totality of events or
circumstances, an entity determines that it is more likely than not that the
fair value of a reporting unit is less than its carrying amount, the entity must
perform the quantitative goodwill impairment test.
2.3.5 Example Illustrating a Qualitative Assessment
The example below illustrates a scenario in which an entity performs an analysis
of various qualitative factors to determine whether a quantitative assessment is
necessary.
Example 2-4
In performing a qualitative assessment for its single
reporting unit, RU-1, in 20X2, XYZ Inc. identifies the
following factors that may affect its fair value inputs:
-
Carrying amount of RU-1 is 3 percent higher than in the prior year.
-
As a result of declines in industry valuation, XYZ records a goodwill impairment loss for RU-1 on the basis of the quantitative assessment performed in 20X0 (two years ago).
-
On the basis of the quantitative test performed in 20X1 (one year ago), XYZ determines that RU-1’s fair value exceeds its carrying amount by approximately 15 percent.
-
Revenue increased by 8 percent and 9 percent, respectively, in 20X1 and 20X2.
-
Because of rising costs in the industry, gross margin decreased by 3 percent and 4 percent, respectively, in 20X1 and 20X2.
-
In 20X2, RU-1 lost its bid for renewal of a contract with ABC Company, a major customer that accounted for 20 percent of RU-1’s revenues in 20X1. A replacement source of revenue has not yet been identified.
-
XYZ’s stock price has remained relatively flat from 20X1 to 20X2.
-
The overall market and industry outlook remains positive, with relatively steady market activity from 20X1 to 20X2 (e.g., the S&P 500 Index increased by 1 percent during this period).
As a final step in the qualitative assessment, XYZ
evaluates the aggregate impact of the factors identified
to determine whether it is more likely than not that the
fair value of RU-1 exceeds its carrying value. In
performing this analysis, XYZ more heavily weights the
factors determined to most significantly affect RU-1’s
fair value. The following table shows how XYZ ranks and
weights the various factors:
|
Factor Evaluated
|
Adverse
|
Neutral
|
Positive
|
Weighting
|
|---|---|---|---|---|
|
Carrying amount increase
|
X
|
Medium
| ||
|
Prior fair value cushion and impairment
charge
|
X
|
Medium
| ||
|
Financial performance
|
X
|
High
| ||
|
Customer loss
|
X
|
High
| ||
|
Stock price
|
X
|
Low
| ||
|
General market conditions
|
X
|
Low
|
In performing the cumulative analysis of these factors,
XYZ considers the following:
-
Carrying value increase — The 3 percent carrying value increase is determined to have an adverse impact on the analysis since, everything else being equal, this increase would lead to a decrease in RU-1’s cushion of calculated fair value. Further, XYZ assigns this factor a medium weight because — although the determination of carrying value directly affects the amount of excess cushion — XYZ does not consider a 3 percent increase to be significant.
-
Prior fair value cushion and impairment charge — Despite the impairment loss in 20X0, there was a 15 percent excess fair value cushion in the 20X1 assessment, suggesting a clear improvement in the value of the reporting unit after the impairment loss. Accordingly, XYZ determines that this factor positively affects the analysis and assigns it a medium weight because — although the excess improved in the year after the goodwill impairment loss — XYZ does not consider a 15 percent cushion to be significant and the cushion therefore is still somewhat sensitive to change.
-
Financial performance — Although revenues increased during the two-year period from 20X0 to 20X2, gross margin decreased. This suggests that RU-1’s revenue growth is not increasing at the same rate as expenses, potentially indicating an overall decline in value. Accordingly, XYZ determines that this factor has an adverse impact on the analysis and assigns it a high weighting because the reporting unit’s financial performance, as well as its related future projections of performance, directly affect the determination of fair value.
-
Customer loss — Loss of the contract with ABC Company is determined to adversely affect the analysis given that it had contributed 20 percent to the company’s revenue stream. Because XYZ has not yet been able to identify a replacement source of revenue, the customer loss factor is ranked high since it could have a material impact on XYZ’s revenue projections and therefore could trigger a change in the fair value calculation.
-
Stock price — Because XYZ’s stock price has remained relatively flat from 20X1 to 20X2, this factor is determined to have a neutral impact on the analysis. Further, it is assigned a low weighting since the consistent price is unlikely to significantly affect fair value.
-
General market conditions — Because the general market has remained stable from year to year, this factor is determined to have a neutral impact on the analysis. Further, it is assigned a low weighting since the stable market conditions would be less likely to trigger significant increases or decreases in the fair value inputs if XYZ were to complete a quantitative assessment.
After assessing the totality of the qualitative factors,
XYZ determines that the potential impact of the adverse
factors outweighs the positive and neutral factors. As a
result, it is not more likely than not that the fair
value of RU-1 exceeds its carrying value and XYZ will
proceed with performing a quantitative impairment
assessment in 20X2.