Chapter 2 — Accounting Considerations Related to a Carve-Out Entity’s Statement of Financial Position

2.2 Goodwill

If the parent entity has recorded goodwill and if the carve-out entity constitutes a business as defined in ASC 805-10-55, management must use a reasonable approach to determine the amount of goodwill to include in the carve-out financial statements. Because the intent of carve-out financial statements is to segregate balances and transactions within the parent’s financial statements that are related to the carve-out entity, when the carve-out entity represents a reporting unit of the parent entity, the goodwill balance of the reporting unit is generally included in the carve-out financial statements.

When only a portion of one or more reporting units of the parent is included in the carve-out entity’s financial statements, goodwill of the reporting unit(s) is typically included in the carve-out entity’s statement of financial position on the basis of the guidance in ASC 350-20-35-45 and 35-46, which provides for a relative fair value allocation approach that is consistent with that used by the parent when a portion of a reporting unit is disposed of.

Sometimes a recent acquisition of the parent is included in the carve-out entity but is part of a larger reporting unit of the parent. To avoid underreporting the historical goodwill of the carve-out entity, management may need to consider the goodwill resulting from the recent acquisition when it allocates goodwill to the carve-out entity. In such a case, goodwill resulting from the acquisition might be included in the carve-out financial statements, along with the net assets of the acquisition, before management performs a relative fair value allocation. Similarly, when a recent acquisition included in a larger reporting unit of the parent will not be included in the carve-out entity, goodwill, along with the net assets of the acquisition, might be excluded before management performs a relative fair value allocation.

The appropriateness of the specific identification of goodwill from a prior acquisition within a larger reporting unit of the parent and the inclusion of that goodwill in (or the exclusion of it from) the carve-out financial statements is expected to be affected by the length of time since the prior acquisition occurred given that a more recent acquisition offers less likelihood that the goodwill will have lost its connection to the prior acquisition. The goodwill resulting from a prior acquisition may also have lost its connection to the prior acquisition when the goodwill of the prior acquisition has been included with other goodwill in a reporting unit of the parent that has experienced impairments or has undergone a reorganization.

Note that the amount of goodwill included in the carve-out financial statements might differ from the amount of goodwill the parent entity derecognizes from its financial statements when the parent entity divests of a carve-out entity (see Section 2.2.4).

We believe that in the absence of specific guidance regarding the allocation of goodwill to a carve-out entity, an entity needs to use judgment in determining which goodwill allocation approach to use. As with judgments related to the allocation of certain other assets, liabilities, and expenses, the entity should also evaluate whether this judgment is reasonable and supportable given the specific facts and circumstances.

2.2.1 Identifying Operating Segments and Reporting Units

The carve-out entity’s operating segments may differ from those identified in the parent entity’s reporting structure. As defined by ASC 280-10-50-1, an operating segment has the following characteristics:

The segment recognizes revenue and incurs expenses from participating in business activities.
The chief operating decision maker (CODM) regularly reviews operating results to assess performance and makes decisions about resources to be allocated to the segment.
Discrete financial statement information about the segment is available.

The CODM is the person or function that will be responsible for reviewing discrete financial statement information about the carve-out entity’s segments. As a result, the discrete financial statement information for the carve-out entity may be different from that used for the segment reporting related to the consolidated parent’s historical financial statements. Management must carefully evaluate the carve-out entity’s facts and circumstances to appropriately identify its operating segments.

Even if the carve-out entity will not be required to disclose segment information, determining the carve-out entity’s operating segments is still necessary because this determination is the first step in identifying the reporting units to which goodwill should be allocated in the carve-out entity’s structure. Management should evaluate components of an operating segment to determine whether the components have similar economic characteristics and thus should be aggregated into a single reporting unit. This evaluation may result in reporting units for the carve-out entity that differ from what was identified in the parent’s reporting structure.

For more information, see Section 4.5 as well as Deloitte’s Roadmap Segment Reporting.

2.2.2 Goodwill Impairment Testing

As discussed in Section 2.2, we believe that when goodwill allocated to the carve-out entity is derived from the goodwill balances of the parent, such goodwill carries with it the results of the parent’s previously performed goodwill impairment tests. Accordingly, upon allocation, an entity is not required to perform impairment testing for historical periods in the carve-out financial statements even if different reporting units are identified going forward for the carve-out entity. This approach is consistent with the view that the formation of the carve-out entity is akin to a reorganization of the parent entity’s reporting units for which retrospective testing of goodwill under the reorganized structure is not required by U.S. GAAP. While ASC 350-20-35-48 requires that goodwill recognized in a subsidiary’s separate financial statements be tested for impairment at the subsidiary level, we do not believe that this guidance is intended to apply to carve-out financial statements for operations that were not previously included in separate subsidiary financial statements. However, future goodwill impairment testing should be performed for the carve-out entity on the basis of its reporting unit structure as of the date of each subsequent test.

Because there is no authoritative guidance on impairment testing of goodwill presented in a carve-out entity’s historical financial statements, we are aware of diversity in practice related to the belief by some that the goodwill included in the carve-out entity should be subjected to testing in each historical period presented, as if the carve-out entity had been a separate subsidiary of the parent in all such historical periods. Entities may find support for this approach in the aforementioned guidance in ASC 350-20-35-48.

Entities evaluating an approach in which goodwill included in the carve-out entity is subjected to testing in each historical period presented will need to assess the potential impracticalities of (1) identifying reporting units for prior periods in the carve-out financial statements when a CODM or operating segment and reporting unit structure may not have been in place in those periods and (2) developing the necessary business and valuation assumptions for goodwill impairment testing for each presumed reporting unit in each historical period. Entities will also need to carefully consider the overall framework for preparing carve-out financial statements. For example, using a framework that is more consistent with that used for preparing an initial issuance of financial statements might affect the allocation of goodwill to the carve-out entity (see Section 2.2) as well as the evaluation of subsequent events in the carve-out financial statements (see Section 4.7). Given the additional complexities associated with subjecting the goodwill included in the carve-out entity to historical impairment testing in each historical period presented, carve-out entities that use this approach are encouraged to consult with their accounting advisers.

2.2.3 Disclosure Considerations

A carve-out entity’s financial statements that include goodwill must meet the disclosure requirements in ASC 350-20-50-1 for presenting changes in the carrying amount of goodwill. Under these requirements, an entity must separately disclose:

The gross amount and accumulated impairment losses at the beginning of the period
Additional goodwill recognized during the period, except goodwill included in a disposal group that, on acquisition, meets the criteria to be classified as held for sale in accordance with paragraph 360-10-45-9
Adjustments resulting from the subsequent recognition of deferred tax assets during the period in accordance with paragraphs 805-740-25-2 through 25-4 and 805-740-45-2
Goodwill included in a disposal group classified as held for sale in accordance with paragraph 360-10- 45-9 and goodwill derecognized during the period without having previously been reported in a disposal group classified as held for sale
Impairment losses recognized during the period in accordance with [ASC 350-20]
Net exchange differences arising during the period in accordance with Topic 830
Any other changes in the carrying amounts during the period
The gross amount and accumulated impairment losses at the end of the period.

To meet the above disclosure requirements, management may have to allocate amounts previously disclosed in the parent-entity financial statements for these various components, including the gross amount of goodwill and accumulated impairment losses, as well as the changes in net carrying amount of the carve-out entity’s allocated goodwill. This may be challenging if the parent entity has historically presented changes in the goodwill carrying amount in the aggregate rather than by reportable segment (as is the case with entities that are not within the scope of ASC 280).

See Section 4.5 for a discussion of disclosure requirements for reportable segments.

2.2.4 Additional Parent-Entity Considerations

When the parent entity divests of the carve-out entity, it must determine the amount of goodwill to include with the disposal by using the guidance in ASC 350-20-40-1 through 40-6, which may require a relative fair value allocation. Differences may exist between (1) the allocation method used by the parent entity in determining the amount of goodwill to attribute to the net assets disposed of and (2) the method used to identify and attribute goodwill to the financial statements of the carve-out entity. As a result of the use of these two methods, there may be differences between the amount of goodwill that the parent entity (1) derecognizes from its financial statements when it divests of a carve-out entity and (2) includes in the carve-out financial statements (see Section 2.2). In addition, ASC 350-20-40-7 states:

When only a portion of goodwill is allocated to a business or nonprofit activity to be disposed of, the goodwill remaining in the portion of the reporting unit to be retained shall be tested for impairment . . . using its adjusted carrying amount.