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

2.7 Assigning Assets and Liabilities to a Reporting Unit

ASC 350-20

35-39 For the purpose of testing goodwill for impairment, acquired assets and assumed liabilities shall be assigned to a reporting unit as of the acquisition date if both of the following criteria are met:

The asset will be employed in or the liability relates to the operations of a reporting unit.
The asset or liability will be considered in determining the fair value of the reporting unit.

Assets or liabilities that an entity considers part of its corporate assets or liabilities shall also be assigned to a reporting unit if both of the preceding criteria are met. Examples of corporate items that may meet those criteria and therefore would be assigned to a reporting unit are environmental liabilities that relate to an existing operating facility of the reporting unit and a pension obligation that would be included in the determination of the fair value of the reporting unit. This provision applies to assets acquired and liabilities assumed in a business combination and to those acquired or assumed individually or with a group of other assets.

35-40 Some assets or liabilities may be employed in or relate to the operations of multiple reporting units. The methodology used to determine the amount of those assets or liabilities to assign to a reporting unit shall be reasonable and supportable and shall be applied in a consistent manner. For example, assets and liabilities not directly related to a specific reporting unit, but from which the reporting unit benefits, could be assigned according to the benefit received by the different reporting units (or based on the relative fair values of the different reporting units). In the case of pension items, for example, a pro rata assignment based on payroll expense might be used. A reasonable allocation method may be very general. For use in making those assignments, the basis for and method of determining the fair value of the acquiree and other related factors (such as the underlying reasons for the acquisition and management’s expectations related to dilution, synergies, and other financial measurements) shall be documented at the acquisition date.

Under ASC 350-20-35-39, before an entity can assess its reporting units for goodwill impairment, the entity needs to assign the assets and liabilities to determine the carrying amount of its reporting units. In addition, while ASC 350-20-35-39 only refers to acquired assets and assumed liabilities, assets and liabilities that the entity generates or incurs, respectively, should also be assigned to reporting units if (1) the “asset will be employed in or the liability relates to the operations of a reporting unit” and (2) the “asset or liability will be considered in determining the fair value of the reporting unit.”

Note that only assets and liabilities that meet both of these criteria need to be assigned to a reporting unit. For example, some corporate assets or liabilities (e.g., a corporate headquarters, the assets and liabilities of some administrative departments, corporate debt) might not be assigned to a reporting unit (see Section 2.7.1.7 for more information). Paragraph B116 of FASB Statement 142 addressed this topic and stated, in part:

The Board concluded that the objective of the assignment process should be to ensure that the assets and liabilities that are assigned to a reporting unit are the same net assets that are considered in determining the fair value of that unit — an “apples-to-apples” comparison. Therefore, to the extent corporate items are reflected in the value of a reporting unit, they should be assigned to the reporting unit. For example, pension liabilities related to active employees would normally be assumed when acquiring a business; thus, that type of liability generally would be considered in determining the fair value of a reporting unit.

Paragraph B117 of FASB Statement 142 provided further clarification:

[A]nother objective of the exercise is to assign to a reporting unit all of the assets and liabilities that would be necessary for that reporting unit to operate as a business. Board members noted that it is those net assets that will generate the cash flows used to determine the fair value of a reporting unit.

While an entity should assign to a reporting unit all the assets and liabilities necessary to operate the unit as a business, such an assignment does not necessarily result in a full GAAP balance sheet for an operating segment or component to qualify as a reporting unit. The assignment of assets and liabilities to reporting units is only for goodwill impairment testing and may not be aligned with the entity’s legal structure. Such information may be maintained in separate records or schedules. However, if an entity only has one reporting unit, all the entity’s assets and liabilities should be assigned to that reporting unit (see Section 2.7.3).

An entity’s method for assigning assets and liabilities to reporting units should be reasonable and supportable as well as consistent with how the entity determines the fair value of the reporting unit. Although the identification of a reporting unit or the assets and liabilities assigned to a reporting unit may change over time, ASC 350-20-35-40 states that the approach used to determine the amount of those assets or liabilities “shall be applied in a consistent manner.”

2.7.1 Assigning Assets and Liabilities to Reporting Units

As described in ASC 350-20-35-39 above, an asset or liability should be assigned to a reporting unit if both of the following criteria are met:

The asset will be employed in or the liability relates to the operations of a reporting unit.
The asset or liability will be considered in determining the fair value of the reporting unit.

The sections below address the assignment of specific balance sheet items.

2.7.1.1 Cash or Cash Equivalents

An entity may have a cash function that is centralized so that cash or cash equivalents are not related to a specific part of the business. In that case, the cash or cash equivalents may represent a corporate asset that would not be assigned to any reporting unit. Alternatively, if cash is needed to satisfy certain working capital or regulatory requirements, the appropriate amount of cash should be allocated to the applicable reporting unit. However, since the carrying amount of cash and cash equivalents would be expected to approximate fair value, assigning it to a reporting unit would not be expected to affect the quantitative goodwill impairment test since the fair value of the reporting unit should be determined on the basis of the assets and liabilities assigned to that unit (i.e., the fair value of the reporting unit would increase by the amount of cash assigned to it).

2.7.1.2 Working Capital

Entities generally include a normal amount of working capital in the valuation of their reporting units since most entities are sold with a reasonable amount of working capital. When comparing a reporting unit’s carrying amount with its fair value, it is important for an entity to understand the working capital assumptions used in the fair value measurement to ensure that they are consistent with the entity’s assignment of working capital to the reporting unit in the determination of its carrying amount.

2.7.1.3 Investments

It may be challenging to determine whether investments in debt and equity securities (including equity method investments) should be assigned to a reporting unit. Investments maintained at a corporate level that are not related to the reporting unit’s operations may be corporate assets and not assigned to any reporting unit. In some cases, however, investments may be an integral part of the unit’s operations. If an entity determines that the investments would most likely be transferred if the reporting unit were sold, it may be appropriate for the entity to assign investments to the reporting unit and consider them in determining the unit’s fair value.

2.7.1.4 Deferred Taxes

ASC 350-20

35-7 In determining the carrying amount of a reporting unit, deferred income taxes shall be included in the carrying amount of the reporting unit, regardless of whether the fair value of the reporting unit will be determined assuming it would be bought or sold in a taxable or nontaxable transaction.

See Section 11.3.2.4.2 of Deloitte’s Roadmap Income Taxes for more information about the requirement to include deferred taxes in the determination of a reporting unit’s carrying amount.

2.7.1.5 Contingent Consideration

It can be challenging to determine whether a contingent consideration liability (or asset) should be assigned to a reporting unit. If the reporting unit is legally obligated to pay the contingent consideration liability (or has the right to receive a contingent consideration asset) and determines that the contingent consideration would most likely be transferred if the reporting unit were sold, it would be appropriate to assign the contingent consideration to the reporting unit and consider it in determining the unit’s fair value.

2.7.1.6 Debt

As with other assets and liabilities, the determination of whether debt should be assigned to a reporting unit should be based on the criteria in ASC 350-20-35-39. Therefore, debt would be assigned to a reporting unit if the debt (1) is related to the unit’s operations and (2) is likely to be transferred if the unit is sold. Accordingly, general corporate debt typically is not assigned to a reporting unit; however, a mortgage on real estate that is included in the reporting unit and would be transferred if the reporting unit were sold would be assigned.

Further, the entity’s conclusion about whether to assign debt to the reporting unit should be consistent with the method used to determine the unit’s fair value (i.e., equity versus enterprise premise). See Section 2.4.4 for additional discussion.

2.7.1.7 Corporate Assets and Liabilities

ASC 350-20-35-39 states, in part:

Assets or liabilities that an entity considers part of its corporate assets or liabilities shall also be assigned to a reporting unit if both [the criteria in this paragraph] are met. Examples of corporate items that may meet those criteria and therefore would be assigned to a reporting unit are environmental liabilities that relate to an existing operating facility of the reporting unit and a pension obligation that would be included in the determination of the fair value of the reporting unit.

Therefore, corporate assets and liabilities (e.g., environmental obligations, pension obligations, corporate headquarters, a corporate jet, or corporate debt) are assigned to reporting units if the criteria in ASC 350-20-35-39 are met. Paragraph B116 of FASB Statement 142 stated, in part:

Therefore, not all corporate or entity-wide assets and liabilities must be assigned to a reporting unit, but the approach taken in the determination of the reporting unit’s carrying amount should be consistent with that used in the determination of its fair value. However, see Section 2.7.3 for information about assigning assets and liabilities to entities that are a single reporting unit.

2.7.1.8 Cumulative Translation Adjustment and Other Items of Accumulated Other Comprehensive Income

ASC 350-20

35-39A Foreign currency translation adjustments should not be allocated to a reporting unit from an entity’s accumulated other comprehensive income. The reporting unit’s carrying amount should include only the currently translated balances of the assets and liabilities assigned to the reporting unit.

ASC 830-30

45-11 After a business combination, the amount assigned at the acquisition date to the assets acquired and the liabilities assumed (including goodwill or the gain recognized for a bargain purchase in accordance with Subtopic 805-30) shall be translated in conformity with the requirements of this Subtopic.

In January 2017, the FASB issued ASU 2017-04, which eliminates the requirement for entities to calculate the implied fair value of goodwill (i.e., step 2) when measuring a goodwill impairment loss. The ASU amended ASC 350-20 to clarify that a reporting unit’s carrying amount should only include the currently translated assets and liabilities and would not contain any allocated cumulative translation adjustment (CTA) from an entity’s accumulated other comprehensive income. However, in paragraph BC56 of the ASU, the FASB points out that the CTA guidance in ASC 830 indicates that “an entity should include some or all of the [CTA] as part of the carrying amount of an investment in a foreign entity when testing that investment for impairment if the entity has committed to a plan to dispose of that investment.” For more information, see Sections 5.2.1.3 and 5.5.1 of Deloitte’s Roadmap Foreign Currency Matters and Sections 2.3.6 and 3.4.2 of Deloitte’s Roadmap Impairments and Disposals of Long-Lived Assets and Discontinued Operations.

Although the guidance cited above only addresses the treatment of CTA, we believe that it is appropriate to analogize to this guidance for all items of accumulated other comprehensive income (e.g., unrealized gains or losses on investments classified as available for sale or gains or losses on unrealized employee benefit plan).

2.7.1.9 Assets and Liabilities Used in Multiple Reporting Units (Shared Assets)

ASC 350-20

ASC 350-20 does not prescribe a specific approach for allocating assets and liabilities used in multiple reporting units. However, under ASC 350-20-35-40, the approach should be reasonable, supportable, and applied consistently. For example, employee-related items, such as pension obligations, could be assigned on the basis of specific identification, payroll expense, or headcount. Another example is a trade name recognized at the corporate level and used by all the entity’s reporting units. In such circumstances, the entity could assign on the basis of:

An assumed rental of the trade name by each reporting unit — Under this approach, the trade name would not be assigned to a reporting unit (i.e., the trade name would be a corporate asset). Instead, each reporting unit would be assigned a reasonable amount of expense for the use of the trade name.
An assumed ownership by one reporting unit and rental by the other reporting units — Under this approach, one reporting unit would be assigned the full carrying amount of the trade name. That reporting unit would include a cash inflow related to the use of the trade name by the other reporting units. Similarly, the fair value of the reporting units that are not assigned the trade name would include a cash outflow related to the use of the trade name.
Benefits received — An entity could assign the carrying amount of the trade name to the reporting units on the basis of the benefits received by each (e.g., EBITDA as a percentage of total EBITDA or gross margin as a percentage of total gross margin).
Relative fair values of the reporting units — An entity could assign the carrying amount of the trade name to the reporting units on the basis of their relative fair values.

Whichever method the entity chooses should be applied consistently and should not be changed to either avoid or accelerate a goodwill impairment loss.

Connecting the Dots

Assigning shared assets or corporate assets to reporting units under ASC 350-20 differs from assigning them to asset groups under ASC 360-10. Under ASC 360-10, an entity is not permitted to allocate an asset that supports more than one asset group across those asset groups. Rather, to test a shared or entity-wide asset for impairment under ASC 360-10, the entity identifies additional higher-level asset groups that are tested for impairment after its lower-level asset groups. For further details, see Section 2.3.1 of Deloitte’s Roadmap Impairments and Disposals of Long-Lived Assets and Discontinued Operations.

2.7.2 Example Illustrating the Assignment of Assets and Liabilities to Reporting Units

Example 2-12

This example illustrates the assignment of assets and liabilities to reporting units in accordance with the guidance in ASC 350 on the basis of a hypothetical and limited set of facts and circumstances. Because facts and circumstances vary by entity, conclusions also will vary.

Company H Reporting Unit Structure

Company H has identified the following three reporting units:

Company H maintains a corporate function that holds the following assets and liabilities:

Assignment of Corporate-Level Assets and Liabilities to Reporting Units

(a) Building — Net

Company H owns a 100,000 square-foot building that serves as the manufacturing facility for Reporting Unit 1 (RU-1). If H were to sell RU-1, the building would most likely be included in the overall sales agreement. In accordance with the criteria of ASC 350-20-35-39, the building will be assigned to RU-1 because the building (a) is employed in the operations of RU-1, and (b) would be considered in the determination of the fair value of RU-1.

(b) Trademark — Net

In 20X0, H acquired a trademark that Reporting Unit 2 (RU-2) continues to use. In accordance with the criteria of ASC 350-20-35-39, the trademark will be assigned to RU-2 because the trademark (a) is employed in the operations of RU-2, and (b) would be considered in the determination of the fair value of RU-2.

Company H recently acquired a large amount of inventory for Reporting Unit 3 (RU-3) to use in producing finished goods. The inventory purchase resulted in $10 million of accounts payable. When RU-3 received the inventory, H recorded the account payable and a corresponding receivable from RU-3. RU-3 recorded the inventory and a corresponding payable to H. Since the receivable from RU-3 and the related accounts payable relate to the same reporting unit and net to zero, no amounts require assignment. In other words, if the accounts payable were assigned to RU-3, the receivable from RU-3 would be eliminated along with the corresponding payable by RU-3 to H. Thus, the assignment would have no net effect on RU-3.

(d) Environmental Liability

In May 20X8, H closed a large manufacturing facility in connection with discontinuing a product line. At the time of the closure, the facility was under inspection by the Environmental Protection Agency. The inspection revealed land contamination requiring remedial action that is not yet complete. The estimated cost of completing the remedial action is recorded by H.

In accordance with the criteria of ASC 350-20-35-39, since the environmental liability will not be employed in or related to the operations of H’s current reporting units and will not be considered in determining the fair value of any of the current reporting units, the $7 million liability will not be assigned to a specific reporting unit.

(e) Pension Obligation

Company H has established several defined benefit pension plans that cover all employees. The benefits are based on years of service and average compensation. The liability for the pension obligation is maintained only at the corporate level, but applies to all employees. ASC 350-20-35-39 indicates that a pension obligation is an example of a corporate item that (1) may relate to the operations (the workforce) of all reporting units and (2) may also be included in the determination of the fair value of the reporting units. In this example, assume H has determined that the criteria for allocating the pension obligation are met.

ASC 350-20-35-40 provides that “[s]ome assets or liabilities may be employed in or relate to the operations of multiple reporting units. The methodology used to determine the amount of those assets or liabilities to assign to a reporting unit shall be reasonable and supportable and shall be applied in a consistent manner.” Because the pension benefits are based on years of service and average compensation, payroll expense would appear to be a reasonable and supportable method of calculating a pro rata allocation of the liability to each of the three reporting units.

Company H should also consider whether any pension or employee benefit trust assets should be assigned to the reporting unit.

2.7.3 Entities With a Single Reporting Unit

ASC 350-20-35-39 states that an asset or a liability should be assigned to a reporting unit if (1) “[t]he asset will be employed in or the liability relates to the operations of a reporting unit” and (2) “[t]he asset or liability will be considered in determining the fair value of the reporting unit.” As a result, an entity is not required to assign all of its assets and liabilities to its reporting units. However, if an entity identifies only one operating segment and one reporting unit, it would be challenging for the entity to assert that any of its assets or liabilities do not meet the criteria in ASC 350-20-35-39 to be assigned to the reporting unit.

As discussed in Section 2.7.1, assignment of debt to a reporting unit depends on whether the entity uses an equity premise or an enterprise premise in determining the carrying amount and, accordingly, the fair value of a reporting unit. Therefore, we believe that if an entity uses an enterprise premise, debt would not be assigned, even to an entity with a single reporting unit.

Connecting the Dots

The SEC continues to focus on the appropriate identification of operating segments and may challenge a registrant that identifies a single operating (or reportable) segment. As discussed in Section 2.6, an entity must have at least as many reporting units as it has operating segments. Accordingly, if the entity incorrectly identifies its operating segments, it may incorrectly identify its reporting units.

2.7.4 Interaction Between Assigning Assets and Liabilities to Reporting Units and Segment Reporting

ASC 350-20

35-44 This Subtopic does not require that goodwill and all other related assets and liabilities assigned to reporting units for purposes of testing goodwill for impairment be reflected in the entity’s reported segments. However, even though an asset may not be included in reported segment assets, the asset (or liability) shall be allocated to a reporting unit for purposes of testing for impairment if it meets the criteria in paragraph 350-20-35-39.

ASC 350-20-35-44 clarifies that when an entity assigns an asset to a reporting unit to determine the unit’s carrying amount, the entity does not necessarily have to include that asset in its segment disclosures. An entity is only required to disclose asset information by reportable segment under ASC 280 if the asset is included in the segment assets reviewed by the CODM or the CODM receives such information. However, ASC 350-20-50-1 requires that entities disclose a rollforward, in total and by reportable segment (if the entity discloses segment information under ASC 280), of the carrying amount of goodwill at the beginning of the reporting period to the carrying amount at the end of the reporting period (see Section 5.5.1 for more information), even if such information is not provided to the CODM.

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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.