Chapter 2 — Subsequent Accounting for Goodwill (After Adoption of ASU 2017-04)

2.5 When to Test Goodwill for Impairment

ASC 350-20

35-28 Goodwill of a reporting unit shall be tested for impairment on an annual basis and between annual tests in certain circumstances (see paragraph 350-20-35-30). The annual goodwill impairment test may be performed any time during the fiscal year provided the test is performed at the same time every year. Different reporting units may be tested for impairment at different times.

The goodwill in each reporting unit must be tested for impairment at least annually as well as in between annual tests if an event occurs or circumstances change that may more likely than not reduce the fair value of a reporting unit below its carrying amount. An entity may select any date throughout the year on which to perform its annual impairment test as long as this selection is applied consistently each year. Election of the qualitative assessment does not change the annual testing date. In addition, an entity is not required to use the same date for each reporting unit (see the next section) or the same date for both its reporting units and its indefinite-lived intangible assets; however, we have observed that entities often do so.

Further, when selecting an annual assessment date, public entities should be mindful of quarterly reporting requirements and filing deadlines to ensure that they have enough time to complete the testing before the financial statements are issued. For this reason, public entities often avoid choosing the end of an annual or quarterly reporting period. Public companies often select the first day of their fourth quarter as their annual testing date since (1) they will have the carrying amounts from the last day of the prior quarter available, (2) they have the entire quarter to perform the necessary valuation work, and (3) this timing is often aligned with the timing of the preparation of their budgets and forecasts for the next year. Another common date is the first day of the second month of the fourth quarter (i.e., November 1 for calendar-year-end companies) since that date may be even better aligned with preparation of budgets and forecasts and yet still give the entity enough time to complete testing before the financial statements are issued.

2.5.1 Testing Different Reporting Units on Different Dates

ASC 350-20-35-28 states that an entity can elect different annual testing dates for different reporting units (i.e., all reporting units do not have to be tested as of the same date). However, we observe that entities often select the same date for all of their reporting units (and often for all of their indefinite-lived intangible assets as well).

In selecting a date for its annual impairment test for its various reporting units, an entity may want to consider the following factors:

For public companies, external reporting requirements and filing deadlines.
Seasonality of different reporting units.
Time and effort involved in each annual assessment.
Timing and availability of information used in the assessment (e.g., availability of annual budgets and forecasts).
Impairment testing of other indefinite-lived intangibles.

Regardless of the date chosen, an entity needs to apply the date consistently to each reporting unit unless it changes the testing date as described in Section 2.5.4.

2.5.2 Performing the Goodwill Impairment Test When the Amount of Recently Acquired Goodwill Has Only Been Determined Provisionally

As discussed in Section 2.5.5.2, an entity must test recently acquired goodwill as part of its next annual goodwill impairment testing date, even if the accounting for the acquisition is still provisional. We believe that if the entity recognizes any significant adjustments during the measurement period, any impairment test performed before the adjustments were recognized should be updated for the adjusted carrying amounts of the reporting unit and goodwill amount to determine whether the outcome of the impairment test would be different. If measurement-period adjustments lead to either an incremental impairment charge or a reduction of an impairment charge as a result of retrospectively updating the annual impairment test, we believe that the incremental charge (increase or decrease) should be recorded in the current period and disclosed. However, an entity should not delay finalization of the accounting for the business combination to avoid recognition of an impairment charge.

2.5.3 Goodwill Impairment Testing Must Be Completed Before Financial Statements Are Issued

Before the adoption of ASU 2017-04, ASC 350-20 provided an accommodation if an entity was unable to complete step 2 of the goodwill impairment test before issuing its financial statements. In that case, if the loss was probable and could be reasonably estimated, the best estimate of the loss was recognized in the financial statements in accordance with ASC 450. Entities were required to disclose that the measurement of the impairment loss was an estimate. Any adjustment to that estimated loss that resulted from the completion of step 2 was recognized in the subsequent period. However, because ASU 2017-04 eliminated step 2 from the goodwill impairment test, that guidance was eliminated. Accordingly, an entity is no longer permitted to record an estimate of the goodwill impairment loss and must complete its goodwill impairment testing before it issues its financial statements.

2.5.4 Changing the Date of the Annual Goodwill Impairment Test

An entity is permitted to change the date of its annual goodwill impairment test. Section II.G.2 of the SEC staff’s Current Accounting and Disclosure Issues in the Division of Corporation Finance (updated November 30, 2006) states the following about a registrant’s ability to change the annual assessment date:

SFAS 142 [codified in ASC 350-20] requires that goodwill be tested, at the reporting unit level, for impairment on an annual basis. An impairment test also could be triggered between annual tests if an event occurs or circumstances change. A reporting unit is required to perform the annual impairment test at the same time every year, however, nothing precludes a registrant from changing the date of the annual impairment test. If a registrant chooses to change the date of the annual impairment test, it should ensure that no more than 12 months elapse between the tests. The change in testing dates should not be made with the intent of accelerating or delaying an impairment charge. The staff will likely raise concerns if a registrant is found to have changed the date of its annual goodwill impairment test frequently.

Any change to the date of the annual goodwill impairment test would constitute a change in the method of applying an accounting principle, as discussed in paragraph 4 of SFAS 154 [ASC 250-10-45-1], and therefore would require justification of the change on the basis of preferability. The registrant is required by Rule 10-01(b)(6) of Regulation S-X to disclose the date of and reason for the change.

While this guidance specifically applies to SEC registrants, we believe it is equally relevant for nonregistrants. Thus, an entity that wants to change its goodwill impairment testing date must (1) account for the change as a change in accounting principle under ASC 250-10, (2) determine that the change is preferable, (3) ensure that no more than 12 months elapse between the tests, and (4) ensure that the change is not made with the intent of delaying or accelerating a goodwill impairment charge.

Under ASC 250-10-45-5, an entity must “report a change in accounting principle through retrospective application of the new accounting principle to all prior periods, unless it is impracticable to do so.” ASC 250-10-45-9 lists conditions under which retrospective application of the effects of a change in accounting principle would be impracticable. These conditions include situations in which an entity is required to make “assumptions about management’s intent in a prior period that cannot be independently substantiated” or “significant estimates of amounts [that would be] impossible to distinguish objectively” without the use of hindsight. Accordingly, we observe that entities often apply a change in goodwill testing date prospectively because either (1) they determine that retrospective application would be impracticable or (2) the change does not have a material effect on the financial statements given the existing requirements in ASC 350-20 to assess goodwill for impairment between annual tests upon the occurrence of a triggering event. (See Section 5.2.8 for information about the disclosures an entity is required to provide when it changes its annual testing date.)

An SEC registrant that voluntarily changes an accounting principle is generally required to include a preferability letter issued by its independent registered public accounting firm as Exhibit 18 to its first periodic report filed after the accounting change. However, in the case of a change in the goodwill assessment date, an SEC registrant is only required to obtain and file a preferability letter with the Commission when the registrant determines that a reported change in the date of the annual impairment test is material. Specifically, at the 2014 AICPA Conference on Current SEC and PCAOB Developments, Carlton Tartar, associate chief accountant in the SEC’s Office of the Chief Accountant, addressed changes in the goodwill impairment test date. Specifically, Mr. Tartar stated, in part:

Absent any changes to [U.S.] GAAP, the staff has observed that some registrants may view a change in goodwill impairment testing date to not represent a material change to a method of applying an accounting principle, even if goodwill is material to the financial statements, because the change in impairment testing date is not viewed to have a material effect on the financial statements in light of the registrant’s internal controls and requirements under Topic 350 to assess goodwill impairment upon certain triggering events. The staff acknowledges that judgment is required when assessing materiality and the assessment of whether a change in accounting principle is material may include considerations beyond the quantitative significance of the financial statement line items. Accordingly, if a registrant determines that a change in goodwill impairment testing date does not represent a material change to its method of applying an accounting principle, the staff will no longer request a preferability letter to be obtained and filed, provided that such change is prominently disclosed in the registrant’s financial statements. The staff also reserves the right to ask questions based on the registrant’s specific facts and circumstances, which may include situations where it appears that a registrant’s goodwill impairment testing date is frequently changed.

As noted in the above remarks, the SEC staff acknowledges that (1) “judgment is required when assessing materiality” and (2) “the assessment of whether a change in accounting principle is material may include considerations beyond the quantitative significance of the financial statement line items.” That is, because the SEC has not provided more specific guidance on assessing materiality, each registrant will need to reach its own conclusions in performing this assessment. We expect that because a materiality assessment is not limited to quantitative significance, many registrants will be able to conclude that a change in the annual impairment testing date is immaterial on the basis of factors such as the following:

The new and old testing dates are in close proximity (e.g., within the same quarter or within a few months of one another).
The goodwill is not at significant risk for impairment given factors such as the size of an existing “cushion” (excess of the reporting unit’s fair value over its carrying amount) or limited volatility in its fair value.
The change is not expected to produce different impairment results. This might be the case, for example, when a registrant accelerates an end-of-a-quarter impairment test to earlier in the quarter to lessen accounting and valuation resource restraints during period-end reporting but (1) plans to use the same or very similar valuation assumptions and (2) expects carrying value to be relatively stable.

As discussed in Mr. Tartar’s remarks, even if a registrant determines that it is unnecessary to obtain and file a preferability letter related to a change in the annual impairment testing date because the change is immaterial, the staff would still expect the registrant to prominently disclose the change within the applicable filing (e.g., Form 10-K, Form 10-Q).

2.5.5 Assessing Goodwill for Impairment Between Annual Testing Dates

ASC 350-20

35-30 Goodwill of a reporting unit shall be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Paragraph 350-20-35-3C(a) through (g) includes examples of such events and circumstances. Paragraphs 350-20-35-3F through 35-3G describe the process for making these evaluations.

Under ASC 350-20-35-30, the examples of events and circumstances used to assess whether it is more likely than not that goodwill is impaired are the same as those used to perform the qualitative assessment (see Section 2.3.1). Specifically, ASC 350-20-35-3C indicates that an entity should consider the following events and circumstances (not all-inclusive) in determining whether goodwill of a reporting unit should be assessed for impairment between annual testing dates:

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).

Other events and changes in circumstances may also trigger a requirement to test goodwill for impairment between annual dates. At the 2008 AICPA National Conference on Current SEC and PCAOB Developments, Steven Jacobs, associate chief accountant in the SEC’s Division of Corporation Finance, suggested that entities consider the following indicators or “triggering events” in addition to those cited above:

Cash or operating losses at the reporting unit.
Consecutive operating results that are significantly lower than those predicted in analysts’ or internal forecasts.
Significant revisions to internal or external forecasts.
A new restructuring plan (an entity should also consider whether such a restructuring would constitute a reorganization of the entity’s reporting structure and whether a reallocation of goodwill would be required).
Market capitalization that is below book value.
A negative long-term outlook for the industry in which the reporting unit operates.
An increase in deferred tax valuation allowances at the reporting unit, which could result from a reduction in the reporting unit’s projected taxable income.

In addition, goodwill impairment testing must be performed in conjunction with the disposal of all or a portion of a reporting unit. See Section 2.11 for additional information.

To evaluate whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, an entity should consider (1) the expected impact of all identified events or changes in circumstances on the reporting unit’s fair value and (2) the amount by which the fair value exceeded the carrying amount as of the date of the last quantitative impairment test. The entity may need to use judgment in performing this evaluation. If a reporting unit’s fair value was only marginally higher than its carrying amount as of the date of the last quantitative impairment test, any event or circumstance that would result in a decrease in the fair value of the reporting unit since the last test would most likely lead an entity to conclude that it should perform a quantitative test.

2.5.5.1 Market Capitalization as an Impairment Indicator

One of the events and circumstances in ASC 350-20-35-3C that may indicate that it is more likely than not that a goodwill impairment exists is “a sustained decrease in share price . . . in both absolute terms and relative to peers.” A decline in market price may suggest that the fair value of one or more of the entity’s reporting units has fallen below its carrying amount; accordingly, the entity should seek to identify the underlying cause of the decline (e.g., a deterioration in general economic conditions). In performing this assessment, the entity should consider both the severity and the duration of the decline. If the entity concludes that the underlying cause of the decline qualifies as an event or a change in circumstances that would more likely than not reduce the fair value of the reporting unit below its carrying amount, the entity should perform an interim goodwill impairment test at the time of the decline.

An entity should not assume that a decline in the market price is temporary and that its stock price will recover. Moreover, even if an entity’s own shares have not decreased significantly in value, if the market capitalization of peer companies in the industry has declined, the entity should still consider whether it is more likely than not that the reporting unit’s fair value may be less than its carrying amount.

2.5.5.2 Timing of Testing Goodwill Related to a Recent Acquisition

An entity is not required to test goodwill for impairment as of the acquisition date. Any recently acquired goodwill should be tested for impairment as of the entity’s next annual testing date — or sooner if an impairment indicator exists — regardless of whether the accounting for the acquisition is still provisional. It is possible that an entity might need to impair goodwill that has only been recently acquired; however, such a scenario is unusual. It typically occurs when there is an “overpayment” for the acquired business, as described in paragraph B382 of the Basis for Conclusions of FASB Statement 141(R):

The Boards acknowledged that overpayments are possible and, in concept, an overpayment should lead to the acquirer’s recognition of an expense (or loss) in the period of the acquisition. However, the Boards believe that in practice any overpayment is unlikely to be detectable or known at the acquisition date. That is, the Boards are not aware of instances in which a buyer knowingly overpays or is compelled to overpay a seller to acquire a business. Even if an acquirer thinks it might have overpaid in some sense, the amount of overpayment would be difficult, if not impossible, to quantify. Thus, the Boards concluded that in practice it is not possible to identify and reliably measure an overpayment at the acquisition date. Accounting for overpayments is best addressed through subsequent impairment testing when evidence of a potential overpayment first arises.

Therefore, we believe that if an impairment indicator exists shortly after the business combination, the entity should test the acquired goodwill for impairment before its next annual testing date. In addition, if the entity’s annual goodwill testing date is shortly after the acquisition date, the acquirer must perform a goodwill impairment test for the recently acquired goodwill to ensure that more than one year does not elapse between tests. As discussed in Section 2.5.2, this is the case even if the amount of goodwill was determined only provisionally.

2.5.6 Order of Testing Goodwill and Other Assets for Impairment

ASC 350-20

35-31 If goodwill and another asset (or asset group) of a reporting unit are tested for impairment at the same time, the other asset (or asset group) shall be tested for impairment before goodwill. For example, if a significant asset group is to be tested for impairment under the Impairment or Disposal of Long-Lived Assets Subsections of Subtopic 360-10 (thus potentially requiring a goodwill impairment test), the impairment test for the significant asset group would be performed before the goodwill impairment test. If the asset group was impaired, the impairment loss would be recognized prior to goodwill being tested for impairment.

35-32 This requirement applies to all assets that are tested for impairment, not just those included in the scope of the Impairment or Disposal of Long-Lived Assets Subsections of Subtopic 360-10.

ASC 350-20 includes guidance on the order of testing assets for impairment. As discussed below, the order changes if the long-lived assets in the group are classified as held for sale in accordance with ASC 360-10.

2.5.6.1 Order of Impairment Testing When Long-Lived Assets Are Classified as Held and Used

ASC 360-10-35-27 states:

Other than goodwill, the carrying amounts of any assets (such as accounts receivable and inventory) and liabilities (such as accounts payable, long-term debt, and asset retirement obligations) not covered by this Subtopic that are included in an asset group shall be adjusted in accordance with other applicable generally accepted accounting principles (GAAP) before testing the asset group for recoverability. Paragraph 350-20- 35-31 requires that goodwill be tested for impairment only after the carrying amounts of the other assets of the reporting unit, including the long-lived assets covered by this Subtopic, have been tested for impairment under other applicable accounting guidance.

When testing goodwill for impairment, an entity must compare the fair value of a reporting unit with its carrying amount. Assets that represent smaller units of account are tested for impairment — and their carrying amounts are adjusted for impairment losses, if necessary — before larger units of account. Therefore, in accordance with ASC 350-20-35-31, if goodwill and any other asset that is held and used must be tested for impairment at the same time, an entity should complete impairment tests of all other assets (e.g., inventory, long-lived assets, or indefinite-lived intangible assets) and reflect them in the carrying amount of the reporting unit before performing the goodwill impairment test.

For additional details, see Section 2.3.7 of Deloitte’s Roadmap Impairments and Disposals of Long-Lived Assets and Discontinued Operations.

2.5.6.2 Order of Impairment Testing Long-Lived Assets That Are Classified as Held for Sale

ASC 360-10-35-39 states:

The carrying amounts of any assets that are not covered by this Subtopic, including goodwill, that are included in a disposal group classified as held for sale shall be adjusted in accordance with other applicable GAAP prior to measuring the fair value less cost to sell of the disposal group. Paragraphs 350-20-40-1 through 40-7 provide guidance for allocating goodwill to a lower-level asset group to be disposed of that is part of a reporting unit and that constitutes a business. Goodwill is not included in a lower-level asset group to be disposed of that is part of a reporting unit if it does not constitute a business.

When an entity has met the criteria to classify long-lived assets as held for sale, the disposal group may include not only long-lived assets that are within the scope of ASC 360-10 but also other assets such as receivables, inventory, indefinite-lived intangible assets, or goodwill. As indicated above, when assets are tested for impairment, those that represent smaller units of account are tested — and their carrying amounts adjusted for impairment losses, if necessary — before larger units of account. When a disposal group qualifies for held-for-sale classification, the disposal group, including the long-lived assets within the scope of ASC 360-10, becomes the unit of account. Since the disposal group that includes goodwill is a larger unit of account than just the goodwill assigned to the disposal group, this required order ensures that the carrying amounts of any assets, including goodwill, that are smaller units of account, are adjusted for any impairment losses before the carrying amount of the disposal group is determined. The process for testing assets for impairment does not change when such assets are included in a disposal group; that is, an entity should test the assets for impairment in accordance with the relevant GAAP. However, expectations about the amount to be obtained as part of the sale transaction for the disposal group may serve as additional evidence of the disposal group’s fair value. For additional details, see Section 3.5.1 of Deloitte’s Roadmap Impairments and Disposals of Long-Lived Assets and Discontinued Operations. Also see Section 2.11 for information about assigning goodwill to a disposal group.

Confidential and Proprietary — for Use Solely by Authorized Personnel

This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.