Michael Haghighat and Raymond Rath, both Managing Directors at Globalview Advisors, had their article published titled “Update on Accounting for Goodwill” in the February 2020 Issue of the OC-FEI Newsletter. The article discussed the Financial Accounting Standards Board’s (“FASB”) assessment in regards to the accounting rules for goodwill under ASC 350, Intangibles—Goodwill and Other. On July 9, 2019, the FASB issued an Invitation to Comment, Identifiable Intangible Assets and Subsequent Accounting for Goodwill (the “ITC”). The ITC asked interested parties whether goodwill should continue to be held with an in-definite life and periodically tested for impairment or whether goodwill should be amortized over a period of years. In previous outreach on this topic, the FASB staff received mixed feedback from users, preparers, and practitioners of financial reports. The FASB believes it is unclear whether the benefits of the current impairment model for goodwill justify the costs for public business entities (PBEs).  For more information, see Globalview’s Comments on this subject.

As a quick refresher, from an accounting perspective, goodwill represents the excess of the cost of an acquired business over the aggregate amount assigned to the identifiable net assets acquired. The current accounting for public business entities and private entities differs. ASC 350 provides that public companies are required to test goodwill for impairment on an annual basis or whenever there is a potential for goodwill impairment as a result of a triggering event. Private company accounting for goodwill was changed in January 2014 when the FASB issued Accounting Standard Update (ASU) 2014-02.

ASU 2014-02 provides private companies with an optional election for alternative accounting for goodwill subsequent to its initial recognition. ASU 2014-02 is based on recommendations from the Private Company Council (PCC) and is intended to simplify the accounting for goodwill. Private companies electing the accounting alternative will amortize goodwill on a straight-line basis over 10 years or a period of less than 10 years if it can demonstrate that another useful life is more appropriate.

Business appraisers note their belief that there is a lack of understanding of exactly what goodwill represents and that this misunderstanding leads some to support goodwill amortization. Some believe that goodwill is a wasting asset. An International Valuation Standards Council (“IVSC”) perspectives paper, Is Goodwill a Wasting Asset? works through the complexities of business models and cash flows and clearly demonstrates that residual goodwill is not a wasting asset as measured in the current accounting model. This paper is available at ivsc.org.

In addition to confusion on whether goodwill is a wasting asset, there are also different opinions of the period over which goodwill diminishes in value. The PCC election provides for goodwill amortization over 10 years or less. U.S. tax rules under IRC 197 provide a 15-year amortization period for goodwill and acquired intangible assets. Reportedly some FASB board members believe a short life of less than five years is appropriate, whereas, other Board members believe an appropriate amortization period is 30 to 40 years.

Arguments made in support of a move to goodwill amortization include:

  1. Reduced costs due to the elimination of periodic goodwill impairment testing procedures.
  2. Belief that goodwill impairment is a lagging rather than a leading indicator of value diminution.
  3. The complexity of the current accounting model for goodwill and the ability to accurately measure goodwill value diminution.

Key arguments made for continuing to test goodwill for impairment include:

  1. Amortization of goodwill is not decision-useful – Goodwill amortization would reduce the meaningfulness of balance sheets. Amortization charges will be incurred even in situations where the value of goodwill is maintained or increases. Movement to an amortization model will ultimately eliminate $5.6 trillion of goodwill which is currently on public company books. Financial metrics such as return on assets and return on equity will see their meaningfulness decline as amortization shrinks the asset and equity bases of companies.
  2. Ability to value its business operations is a core requirement for public entities – Public business entities should have the skill sets necessary to perform and document business valuations of their business operations and reporting units. Securities analysts and other stakeholders expect this knowledge. Management teams that cannot defend their valuations may see a lack of investor confidence.
  3. Backward Move in Relevance of Financial Reporting – Intangible assets and goodwill are increasingly important elements of the value of public and private companies. Accounting models should address these factors in an appropriate manner.
  4. Undue cost and burden of impairment model not demonstrated – An empirical analysis of the costs of performing goodwill impairment tests has not been performed.

Discussion of this topic will continue. The IASB will publish its inquiry on the topic in the future. The FASB has addressed complexities of goodwill impairment in the past and simplified the goodwill accounting model to what many believe is a workable model. A qualitative impairment model was made available as an option as a result of ASU 2011-08. Also, the goodwill impairment model was simplified by ASU 2017-04 which eliminated Step Two of the goodwill impairment test.

We are pleased to answer any questions pertaining to this issue. For more information, please contact Michael Haghighat, ASA at +1 (949) 475-2801 or mhaghighat@globalviewadvisors.com or Raymond Rath, ASA, CEIV, CFA®  at +1 (949) 475-2808 or rrath@globalviewadvisors.com.

Globalview Advisors has been a proud sponsor of the OC-FEI since 2013. The OC-FEI is the premier organization for financial executives in the Orange County area. OC-FEI promotes interaction among its members and holds programs and workshops to enhance their professional knowledge and qualification.

Established in 1973, the Financial Accounting Standards Board (FASB) is the independent, private-sector, not-for-profit organization based in Norwalk, Connecticut, that establishes financial accounting and reporting standards for public and private companies and not-for-profit organizations that follow Generally Accepted Accounting Principles (GAAP). The FASB is recognized by the Securities and Exchange Commission as the designated accounting standard setter for public companies. FASB standards are recognized as authoritative by many other organizations, including state Boards of Accountancy and the American Institute of CPAs (AICPA). The FASB develops and issues financial accounting standards through a transparent and inclusive process intended to promote financial reporting that provides useful information to investors and others who use financial reports. The Financial Accounting Foundation (FAF) supports and oversees the FASB. Established in 1972, the FAF is the independent, private-sector, not-for-profit organization based in Norwalk, Connecticut responsible for the oversight, administration, financing, and appointment of the FASB and the Governmental Accounting Standards Board (GASB).