ASC 350 - the goodwill impairment testing alternative

 Kristin S. Coffey, The Daily Record Newswire

 

The new goodwill impairment testing alternative for private entities was released in January of this year. The update, released by the Financial Accounting Standards Board, to the Accounting Standards Codification Topic – 350 – Intangibles – Good will and Other (ASC 350) applies only to non-public entities, as public entities are still required to comply with GAAP.

Who should elect this alternative? Primarily small entities with few outside investors and which do not expect to pursue a liquidity event to seek out private equity or venture capital investors. Why make the election? It’s a cost savings. Companies that elect the alternative will no longer have to do annual goodwill impairment tests.

The update to ASC 350 permits private companies that adhere to GAAP to amortize goodwill on a straight line basis over 10 years or less if it can be demonstrated that another useful life is more appropriate. And without required annual impairment tests, the company will only have to test for impairment when a triggering event, such as a substantial decline in financial performance, occurs.

When a triggering event occurs, the company has the option to first assess qualitative factors to determine whether the quantitative impairment test is necessary. This is somewhat sticky; relying on qualitative factors after a triggering event has occurred. Should the qualitative assessment indicate that it is more likely than not that goodwill is impaired, then the company must perform a quantitative analysis similar to a Step I analysis they historically performed to compare the company’s fair value with its carrying amount, including goodwill.

In cases where impairment is identified, it would be recorded simply as the amount by which the book value of an entity exceeds the fair value until the goodwill is gone, eliminating the Step II hypothetical business combination allocation analysis.

An interesting valuation to estimate the FV of a company for financial reporting purposes under ACS 350 recently crossed my desk. The company experienced a change in control that resulted in a business combination transaction as defined by FASB ASC Topic 805, Business Combinations. According to the company’s accountant, as a result of the transaction, the identifiable assets and liabilities of Pure were recorded at their respective fair values with the difference recorded on the company’s balance sheet as goodwill in the amount of approximately $3,000,000.

The company provides a unique product in an economically sensitive industry to a select market. Additionally, it established two payment options from which its customers can choose; a pay upfront model or a revenue share model. Due to these factors, after five years of operations, the company is still in its infancy.

The company’s decline in financial performance, specifically, decreasing revenues and failure to meet annual projections for several consecutive years, was the trigger event which resulted in the qualitative analysis by the accountant. It was after this assessment that we were brought in for the quantitative, Step I analysis. In this case, the company met the suggested criteria, with no plans of being acquired, attracting external investors or going public, and has elected early adoption, as discussed above, and will apply the alternative in its 2013 financial statements. Additionally, with the election, its goodwill will be amortized over 10 years as required. In the end, the company was not impaired and all parties involved have met their professional responsibilities.

Valuation professionals may anticipate fewer impairment engagements with the new alternative and companies electing this alternative can expect a less burdensome process, both financially and administratively. However, careful consideration of the company’s long-term goals and objectives is necessary to avoid the aggravation and expense of restating financial statements in the event of a liquidity event that requires an SEC filing as the alternative is not acceptable.

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Kristin S. Coffey is the senior manager of Business Valuation Services with Mengel, Metzger, Barr & Co. LLP. She can be reached at kcoffey@mmb-co.com.