Question

Research a good web article on impairment of goodwill or other intangibles. What types of factors might impact the recognition of a write-down? Is it merely the economy, or are there other things that might impact operations?

Answer 1

Goodwill impairment is an accounting charge that companies record when goodwill's carrying value on financial statements exceeds its fair value. In accounting, goodwill is recorded after a company acquires assets and liabilities, and pays a price in excess of their identifiable net value. Goodwill impairment arises when there is deterioration in the capabilities of acquired assets to generate cash flows, and the fair value of the goodwill dips below its book value. Example:-  The most famous goodwill impairment charge was the $98.7 billion reported in 2002 for the AOL Time Warner, Inc. merger. This was, at the time, the largest goodwill impairment loss ever reported by a company.

Goodwill impairment is an earnings charge that companies record on their income statements after they identify that there is persuasive evidence that the asset associated with the goodwill can no longer demonstrate financial results that were expected from it at the time of its purchase. Goodwill is an intangible asset commonly associated with the purchase of one company by another. Specifically, goodwill is recorded in a situation in which the purchase price is higher than the net of the fair value of all identifiable tangible and intangible assets and liabilities assumed in the process of an acquisition. The value of a company’s brand name, solid customer base, good customer relations, good employee relations, and any patents or proprietary technology represent some examples of goodwill.

Annual Test for Goodwill Impairment:-

U.S. generally accepted accounting principles (GAAP) require companies to review their goodwill for impairment at least annually at a reporting unit level. Events that may trigger goodwill impairment include deterioration in economic conditions, increased competition, loss of key personnel, and regulatory action. The definition of a reporting unit plays a crucial role during the test; it is defined as the business unit that a company's management reviews and evaluates as a separate segment. Reporting units typically represent distinct business lines, geographic units, or subsidiaries.

Goodwill impairment is identified in two steps.

1).First, a company must compare the fair value of a reporting unit to its carrying value on the balance sheet. Because observable market values are rarely present to determine the fair value of a reporting unit, management teams typically use financial models for fair value estimation. If the fair value exceeds the carrying value, no impairment exists. Companies are not allowed to write up their goodwill, as goodwill can only be recognized on the purchase of a company. If the fair value is less than the carrying value, the company must perform the second step by applying the fair value to the identifiable assets and liabilities of the reporting unit. The excess balance of the fair value is the new goodwill, and the carrying value of the goodwill must be reduced by booking a goodwill impairment charge.

Other Intangible Assets:-

Intangible assets are those that are non-physical, but identifiable. Think of a company’s proprietary technology (computer software, etc.), copyrights, patents, licensing agreements, and website domain names. These aren’t things that one can touch, exactly, but it is possible to estimate their value to the enterprise. Intangible assets can be bought and sold independently of the business itself.

There’s also a key distinction in how the two asset classes are amended once they’re on the books. Because assets tend to lose some of their value over time, companies sometimes have to make periodic write-downs. Intangible assets are amortized, which means a fixed amount is marked down every year, resulting in a simultaneous charge against earnings. The amortization amount is adjusted if the asset's value is impaired at some point after its acquisition or development.

The FASB provided several factors of events and circumstances entities should consider when comparing a reporting unit’s fair value with its carrying amount:-

1. 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.
2. 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.
3. Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows.
4. 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.
5. Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation.
6. 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 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.
7. If applicable, a sustained decrease in share price.