a. Timing of Annual Impairment Testing

ASC 350-20-35-28 permits the annual goodwill impairment test to be performed at any time during the year as long as it is performed the same time every year, but the Codification is silent on when to conduct the annual impairment test for indefinite-lived intangible assets. Two of the Big 4 accounting firms each take a slightly different view of the timing of the annual impairment test for indefinite-lived intangible assets.

PwC's position appears to stem, at least in part, from SEC guidance concerning the goodwill impairment test. The SEC permits an SEC registrant to change the date of its annual goodwill impairment test as long as no more than 12 months lapses between tests. The Staff also admonishes registrants that the intent behind changing the annual testing date should not be to delay or accelerate the recognition of an impairment loss.¹⁶

b. Timing of Interim Impairment Testing

An entity must conduct an impairment test on an indefinite-lived intangible asset between annual testing dates if events or changes in circumstances indicate that it is more likely than not the asset has been impaired. Prior to ASU 2012-02 (which introduced the qualitative assessment), the Codification instructed an entity to consider the factors listed in ASC 360-10-35 (discussed in Section 4.C) to determine if events or changes in circumstances have occurred that indicate the asset might be impaired.¹⁹ The amendments made by ASU 2012-02 removed the reference to the factors listed in ASC 360-10-35 and changed (or perhaps clarified) the standard for triggering an interim impairment test. The new (or clarified) trigger requires a conclusion that events or circumstances must indicate that it is more likely than not that the asset is impaired.

Even though the FASB removed the references to sample facts and circumstances in ASC 360-10-35 for determining whether interim testing is required, it introduced several examples of events and circumstances that an entity should consider when making the qualitative assessment as to whether it is more likely than not that an impairment has occurred.

The Codification is silent on whether these examples that are relevant to the qualitative assessment are also relevant to the determination of whether a change in facts and circumstances dictate the need for an interim impairment test. However, the Basis for Conclusions section in ASU 2012-02 indicates that the examples of events and circumstances in the amendments replace the previous examples of events and circumstances that an entity should consider between annual impairment tests. The Basis for Conclusions section also states, nevertheless, that the Board does not intend to change the practice of how an entity evaluates an indefinite-lived intangible asset for impairment on an interim basis.²⁰ Therefore, it appears that an entity should consider the examples of events and circumstances relevant to the qualitative test (which are listed in Section 4.B.3.b), but there may be other relevant factors and the entity need not change existing procedures for identifying relevant events and circumstances.

a. Guidelines for Creating Units of Accounting

The grouping of indefinite-lived intangible assets into units of accounting requires an analysis of the appropriate facts and circumstances. However, the Codification establishes some ground rules. First, a unit of accounting may contain only indefinite-lived intangible assets (whether they are acquired or internally developed); however, separately recorded indefinite-lived intangible assets may be combined into a single accounting unit only if they are operated as a single asset and, thus, are essentially inseparable from one another.²⁵ Second, the combined assets cannot collectively constitute a business or a nonprofit activity.²⁶ Finally, although not explicitly stated in the Codification, the grouping of indefinite-lived intangible assets is not an irrevocable election; rather, an entity must re-determine its units of accounting each reporting period if changing facts and circumstances dictate.²⁷

With the previous ground rules in mind, an entity should consider the following factors, which, if present, would indicate that two or more indefinite-lived intangible assets should be combined in one unit of accounting:²⁸

• The assets were purchased to be used together, that is, they form or enhance a single asset (i.e., the “single asset factor”).
• Had the assets been acquired in the same acquisition they would have been recorded as one asset (i.e., a variation of the “single asset factor”).
• The assets as a group represent the highest and best use of the assets (i.e., they would yield the highest price if sold as a group).²⁹
• The marketing or branding strategy provides evidence that the intangible assets are complementary.³⁰

In contrast, the following factors, if present, would indicate that two or more indefinite-lived intangible assets should not be combined into one unit of accounting:³¹

• Each asset generates cash flows independent of any other intangible asset (i.e., the “discrete cash flows factor”).³²
• If sold, each asset likely would be sold separately (i.e., the “separate sale factor”).
• The entity has adopted or is considering a plan to dispose of one or more of the assets separately (i.e., a variation of the “separate sale factor”).
• The assets are used exclusively by different asset groups (i.e., the “asset groupings factor,” which refers to the asset groups under ASC 360-10 used to test tangible and finite-lived intangible assets for impairment).
• The economic or other factors that might limit the useful economic life of one of the intangible assets would not similarly limit the useful economic lives of other intangible assets combined in the unit of accounting.

b. Analysis of Codification Examples

The grouping of indefinite-lived intangible assets is a facts-and-circumstances determination, and thus theoretically, any types of intangibles can be combined if they meet the Codification's guidelines for combination (discussed earlier). However, the issue of whether to combine indefinite-lived intangible assets surfaces frequently when an entity has two or more of the same types of assets, such as multiple trade names or multiple easements. In fact, all three examples in ASC 350-30-55 involve multiple assets of the same type.

These three examples are helpful to varying degrees—with the first example being the least helpful—in illustrating factors that may be relevant in many instances and how to analyze those factors. Although these examples each identify a specific intangible asset, each example could be applied to other types of intangible assets. The examples are important because they identify factors that the FASB considers are definitive in common situations.

The first example involves land easements obtained to build pipelines and begins in ASC 350-30-55-29. It shows how multiple intangible assets contained in the same reporting unit may, nonetheless, need to be broken into more than one unit of accounting when they are tested for impairment. Though all of the easements are in the same reporting unit for goodwill impairment testing purposes, the easements can be broken into two groups—one group is associated with a Northern pipeline in one country and the other group is associated with a Southern pipeline in another country. The example concludes that all of the easements associated with the Northern pipeline are in one unit of accounting and all the easements associated with the Southern pipeline are in another unit of accounting. The definitive factors in determining that all of the easements in each respective pipeline should be in the same unit of accounting are as follows:

The definitive factors in determining that the Northern pipeline easements should be in a separate unit of accounting from the Southern pipeline easements are as follows:

This second example is more helpful. It uses trade names to illustrate its points and begins in ASC 350-30-55-33. The three trade names in this example were acquired in the same business combination but recorded in separate subsidiaries that operated in different countries.³³ The definitive factors in determining that the three trade names should be in the same unit of accounting are as follows:

The third example also is more helpful than the first example. It involves brands and begins in ASC 350-30-55-36. In the example, an entity acquired two brands of cereal (Brand A and Brand B) in a business combination and placed them each in a separate asset group for impairment testing purposes under ASC 360-10. The entity subsequently created a variation of Brand A. Even though this internally generated brand has the same brand manager as Brand A, the entity placed it in an asset group separate from Brand A's asset group. The definitive factors in determining that Brand A and its variation should be in the same unit of accounting are as follows:

The definitive factors in determining that Brand A (along with its variation brand) should be in a separate accounting unit from Brand B are as follows:

c. Effect of Selecting Units of Accounting

If a unit of accounting combines a group of indefinite-lived intangible assets that were previously tested for impairment separately, then the entity must perform the impairment test separately on those assets before combining them.³⁴ Also, if the unit of accounting selected is contained in a single reporting unit and that reporting unit contains goodwill, the same unit of accounting and associated fair value determination must be used when testing the goodwill for impairment.³⁵

d. Removing an Asset from a Unit of Accounting

There is an open issue as to how to determine the carrying amount of an asset that is removed from a unit of accounting if an impairment loss had been previously recognized for that unit of accounting while the asset was a member of the unit. The EITF declined to address this issue.

e. Cash-Generating Units under IFRS

IAS 36 requires that all intangible assets (including goodwill) be grouped by “cash-generating unit.” The definition of a cash-generating units under IFRS is “the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.”³⁷ The cash inflows may be based on “selling” a unit's output internally.³⁸ IAS 36 states that some factors to consider when determining whether cash inflows from a cash-generating unit are largely independent of cash inflows from other units are how management monitors the entity's operations (e.g., by product lines, businesses, individual locations, districts, or regional areas) or how management makes decisions about continuing or disposing of the entity's assets and operations.³⁹

a. Whether to Conduct a Qualitative Assessment

The qualitative assessment is an election that can be made on an asset-by-asset basis. An entity may choose to bypass the qualitative test and simply perform the quantitative impairment test. Moreover, if the entity does not conduct the qualitative assessment on an asset in a particular annual or interim reporting period, it may elect to conduct the qualitative assessment on that asset in any subsequent annual or interim reporting period.⁴⁵

The FASB introduced the qualitative assessment to reduce the burden of performing the quantitative impairment test. Thus, most reporting entities will view the qualitative assessment as a way of avoiding the effort of performing a quantitative impairment test when circumstances indicate an asset is not likely impaired. However, there are some best practices suggested by the Big 4 that an entity can follow when determining whether to elect to perform the qualitative assessment.

Second, it may be difficult to perform the qualitative assessment on an intangible asset with characteristics that create significant uncertainties as to its fair value (such in-process research and development (IPR&D)). Because of the uncertainties, the factors an entity may need to consider in a qualitative assessment might not be reliable enough for the entity to make a positive assertion that there is greater than a 50 percent likelihood that the assets have not been impaired.⁴⁷

b. How to Conduct a Qualitative Assessment

When performing the qualitative analysis, a reporting entity must consider relevant events and circumstances that affect the significant inputs used to determine the asset's fair value.⁵⁰ Thus, the entity must first identify those significant inputs, and then identify events and circumstances that could affect the significant inputs. The FASB Codification lists the following examples of such events and circumstances:⁵¹

• Cost factors (e.g., increases in raw materials, labor, or other costs)
• Overall financial performance (e.g., negative or declining cash flows, decline in actual or projected revenue or earnings compared with actual and projected prior-period results)
• Legal, regulatory, contractual, political, business, or other factors (including asset-specific factors) that could affect significant inputs used to determine that asset's fair value
• Relevant entity-specific events (e.g., changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; litigation)
• Industry and market considerations (e.g., deterioration in the environment in which an entity operates, increased competitive environment, decline in market-dependent multiples or metrics, change in the market for an entity's products or services, regulatory, or political development)
• Macroeconomic conditions (e.g., deterioration of general economic conditions, limitations on access to capital, fluctuations in foreign exchange rates)

In addition to the specific events and circumstances listed above, the entity may consider the following broader factors:⁵²

• Positive and mitigating events and circumstances that could affect the significant inputs the entity used to determine the asset's fair value
• The difference between the asset's fair value and carrying amount in any recent fair value calculations performed on the asset
• Whether there have been any changes to the asset's carrying amount

In the Basis for Conclusions to ASU 2012-02, the FASB noted that it did not include a sustained decrease in share price in the above lists because: (1) it might not be a relevant indicator for identifiable assets whose fair value can be measured on a standalone basis,⁵³ and (2) to the extent it is relevant for this purpose, many of the common reasons contributing to a sustained decrease in share price are reflected in the above lists. Nevertheless, the FASB believes that an entity should not automatically disregard a sustained decrease in share price from its qualitative assessment.⁵⁴

An entity must weigh these and other relevant facts and circumstances to determine if it is more likely than not that the indefinite-lived intangible asset's fair value has fallen below the asset's carrying amount and thus the asset has become impaired. No one event or circumstance is necessarily dispositive.⁵⁵ The more-likely-than-not standard requires that there be a greater than 50 percent likelihood of impairment. Thus, the factors suggesting impairment must at least slightly outweigh the factors suggesting no impairment.

a. Timing of Annual Goodwill Testing

ASC 350-20-35-28 permits the annual goodwill impairment test to be performed at any time during the year as long as it is performed the same time every year. This means that the measurement date must be the same from year to year. There is no requirement, though, that the same measurement date be used for all reporting units. Each reporting unit may have its own annual measurement date as long as that date is used consistently for that reporting unit.

The SEC Staff has indicated that a registrant may change the date of its annual goodwill test, as long as no more than 12 months lapse between tests. However, historically it required a registrant to justify the change on the basis of preferability and treat the change as a change in accounting principle under ASC 250-10 unless goodwill was not material to the registrant. In December 2014, the SEC staff changed its position regarding materiality. Specifically, it stated that the fact that goodwill is a material item to a registrant is not necessarily determinative of whether a change in the annual testing date would be material to the financial statements. Rather, other factors could be significant in this materiality determination. For instance, it notes that many registrants believe that the change in impairment testing date does not have a material effect on the financial statements in light of their internal controls and requirements under ASC 350 to assess goodwill impairment upon certain triggering events.

In December 2014, the SEC Staff further stated, “If a registrant determines that a change in goodwill impairment testing date does not represent a material change to its method of applying an accounting principle, the staff will no longer request a preferability letter to be obtained and filed, provided that such change is prominently disclosed in the registrant's financial statements. The staff also reserves the right to ask questions based on the registrant's specific facts and circumstances, which may include situations where it appears that a registrant's goodwill impairment testing date is frequently changed.”⁹⁰ If a registrant determines that a change in the annual testing date is material, it must (1) disclose the date of and the reason for the change, and (2) file as an exhibit to its Form 10-Q after the date of the change a letter from its auditor indicating whether the change is to a new date that in the auditor's opinion is preferable to the original date (i.e., a preferability letter).

b. Events and Circumstances Indicating That Goodwill May Be Impaired

Goodwill is tested for impairment between annual testing dates if events occur or circumstances change that more likely than not have reduced the fair value of a reporting unit below its carrying amount. If a reporting unit's carrying amount is zero or negative, interim testing is required if events occur or circumstances change that more likely than not have impaired goodwill.⁹¹

Examples of changes in events and circumstances that may indicate goodwill may be impaired include the following:

• 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
• Industry and market considerations such as a deterioration in the economic environment, increased competition, a decline in market multiples, a change in the market for the entity's products and services, or a regulatory or political development
• Cost factors such as an increase in raw materials, labor, or other costs that have a negative impact on earnings
• 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
• Other entity-specific events such as a change in management, key personnel, strategy, or customers; bankruptcy or litigation
• Events affecting a reporting unit such as a change in the composition or carrying amount of its assets, disposing of a portion or all of a reporting unit, an impairment test for a significant asset group within a reporting unit, or recognition of a goodwill impairment loss of a subsidiary that is a component of a reporting unit, a sustained decrease in share price, both in absolute terms and relative to peers, if applicable⁹²

If the reporting unit has a zero or negative carrying amount, an entity must consider the above factors and any other relevant factors to determine if it is more likely than not that the reporting unit's goodwill is impaired. In addition, it should consider whether there are significant differences between the carrying amount and estimated fair value of the unit's assets and liabilities and the existence of significant unrecognized intangible assets.⁹³

a. Identifying Reporting Units

Goodwill impairment testing is performed at the reporting unit level.⁹⁴ So once an entity has acquired goodwill through a business combination, it must identify the reporting units in the acquired business and then allocate the acquired assets (including goodwill) and assumed liabilities to these reporting units.

A reporting unit is an operating segment or one level below an operating segment (also known as a component).⁹⁵ An operating segment is determined in accordance with the rules in ASC 280-10 regarding segment reporting.⁹⁶ Therefore, if an entity is a public company, it will have already identified its operating segments to determine how to present its segment disclosures under ASC 280-10. However, if it is not a public company (or otherwise is not required to disclose segment information), it must apply the rules in ASC 280-10 to identify its operating segments solely for purposes of then identifying reporting units for goodwill impairment testing purposes.⁹⁷ ASC 280-10 defines an operating segment as a component of an entity that engages in business activities from which it earns revenues and incurs expenses, has operating results that are reviewed by management, and has discrete financial information.⁹⁸

Although an operating segment is a component of a business, it may have components itself. If any of an operating segment's components are businesses⁹⁹ (or nonprofit activities) that have discrete financial information and whose operating results are reviewed by segment management,¹⁰⁰ then those components are reporting units.¹⁰¹ Components of an operating segment that qualify as reporting units are combined into one reporting unit if they have similar economic characteristics.¹⁰² Economic characteristics refer to the operating segment's products and services, production processes, customers, distribution channels, and the regulatory environment.¹⁰³

An operating segment can also be a reporting unit in the following three instances: (1) all of its components are reporting units and must be combined because they have similar economic characteristics; (2) none of its components is a reporting unit; or (3) it comprises only a single component.¹⁰⁴

b. Assigning Assets and Liabilities to a Reporting Unit

Once an entity determines its reporting units, it must assign the acquired assets (excluding goodwill, which is assigned using a different method) and assumed liabilities to those reporting units. There are two groups of assets and liabilities that must be assigned to a reporting unit:¹⁰⁵

1. The assets employed in a reporting unit's operations and the liabilities relating to those operations. These assets and liabilities may include items from past operations, like environmental liabilities relating to a facility within the reporting unit.
2. Any other asset or liability that the entity will consider in determining the reporting unit's fair value. For example, it may assign a portion of an asset or liability that relates to the operations of multiple reporting units. The allocation of such an asset or liability must be based on reasonable, supportable methods that the entity applies on a consistent basis. The Codification gives an example of assigning such an asset or liability based on the benefit received from each reporting unit or based on the relative fair values of the reporting units. The entity must document its methodology and allocation.¹⁰⁶

General corporate assets of an acquired company typically are not allocated to reporting units.

Subsequent to the business combination that created the reporting units, the entity likely will create or acquire additional assets and incur additional liabilities that may need to be added to the reporting unit.

c. Assigning Goodwill to a Reporting Unit

An entity must assign its goodwill among the identified reporting units. This allocation is done at the time the goodwill is acquired through a business combination. The allocation methodology is based on the expected benefit each reporting unit will receive from the synergies of the business combination. The exact method of assigning goodwill must be reasonable and supportable, and it must be applied on a consistent basis year to year.¹⁰⁸ Moreover, the amount of goodwill assigned to any particular reporting unit need not necessarily be consistent with the amount of goodwill assigned to operating segments for segment reporting purposes under ASC 280.¹⁰⁹

The method for assigning goodwill to reporting units is similar to the method in ASC 805 for determining the amount of goodwill to recognize in a business combination. First, an entity must determine the fair value of the portion of the acquired business to be included in a reporting unit. Second, it must determine the fair value of the acquired assets and liabilities assigned to the reporting unit. Any excess of the first amount over the second amount is the goodwill assigned to that reporting unit.¹¹⁰ If the reporting unit benefits from the synergies of the acquisition but does not receive an allocation of any acquired assets or liabilities, then the value of the goodwill assigned to the reporting unit is the difference between the reporting unit's fair value before the acquisition and its fair value after the acquisition (known as a “with-and-without computation”).¹¹¹

d. Reorganization of Reporting Units

If the composition of reporting units changes, the entity must reassign assets and liabilities to the newly configured reporting units using the allocation rules described above for assigning assets and liabilities to reporting units. However, it does not use the above allocation rules for assigning goodwill to the newly configured reporting units. Rather, it must reassign goodwill based on the relative fair value allocation method.¹¹² This allocation method is best explained by example.

a. Whether to Conduct a Qualitative Assessment

The qualitative assessment allows an entity to forgo the time and expense of calculating the fair value of a reporting unit (which is required in Step 1 of the quantitative analysis) if the assessment indicates it is more likely than not that the reporting unit's carrying amount is less than the unit's fair value. However, if an entity has not determined a reporting unit's fair value for several prior periods, a question arises as to the effectiveness of the qualitative assessment. In the Basis for Conclusions to ASU 2011-08, which introduced the qualitative assessment, the FASB indicated that it considered a provision that would have required entities to periodically calculate a reporting unit's fair value. However, it rejected this proposed requirement because it believed the process for conducting a qualitative assessment mitigates any risk of not timely identifying an impairment loss. Thus, an entity could conduct the qualitative test indefinitely and not update a reporting unit's fair value calculation for years. On the other hand, if the perceived gap between a reporting unit's fair value and the unit's carrying amount gradually narrows, the entity may want to forgo the qualitative assessment in one period and measure the reporting unit's fair value under Step 1 of the quantitative assessment.

b. How to Conduct a Qualitative Assessment

The objective of a qualitative assessment is to determine if it is more likely than not that the fair value of a reporting unit is less than the unit's carrying amount, including goodwill.¹¹⁶ The more-likely-than-not standard means there is a greater than 50 percent likelihood. Therefore, the evidence suggesting that the unit's fair value is less than the unit's carrying amount must at least slightly outweigh the evidence suggesting that the fair value exceeds the carrying amount.

To make this determination, an entity must assess relevant events and circumstances that affect the fair value or carrying amount of a reporting unit.¹¹⁷ The relevant events and circumstances are not limited to company-specific items (such as a decrease in a reporting unit's sales), but also to industry-specific factors and macroeconomic factors. The FASB lists the following examples of events and circumstances, but this list is not intended to be all inclusive and the existence of any single item on this list does not require a particular conclusion:¹¹⁸

• Macroeconomic conditions (e.g., deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets)
• Industry and market considerations (e.g., deterioration in the environment in which any entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics 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)
• Cost factors (e.g., increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows)
• Overall financial performance (e.g., 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)
• Other relevant entity-specific events (e.g., changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; litigation)
• Events affecting a reporting unit (e.g., 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 the unit; the testing for recoverability of a significant asset group within the unit; recognition of a goodwill impairment loss by a subsidiary that is a component of the unit)
• A sustained decrease in share price in both absolute terms and relative to peers

It is important to note that each of the above examples has a flipside that, if present, could mitigate the effects of other events or circumstances. For example, if there is a substantial increase in costs (a factor suggesting impairment) but the reporting unit has significantly increased its volume of sales due to a new marketing campaign, the increased sales volume would be a factor that mitigates the effect of cost increases.¹¹⁹

In 2006, the SEC Staff indicated that it believes the following factors are important indicators of impairment:

• Recent operating losses at the reporting unit level
• Downward revisions to forecasts
• Decline in enterprise market capitalization below book value
• Restructuring actions or plans
• Industry trends

The Codification states that if an entity has recently calculated fair value for a reporting unit, it should consider in its qualitative assessment the difference between this fair value and the carrying amount.¹²⁰ In fact, the size of this difference should be the first evidence the entity considers. Based on the size of the difference, the entity essentially can determine how negative various events and circumstances must be to endanger this cushion between the unit's fair value and carrying amount.

Based on a qualitative assessment, if the entity determines that it is more likely than not that the fair value of the reporting unit is less than the carrying value, then the entity must perform Step 1 of the goodwill impairment test.¹²¹ If the entity determines that events and circumstances indicate that the reporting unit's fair value is not less than the carrying amount using a more-likely-than-not criterion, then no further testing is required.¹²²

a. Step 1

Step 1 of the goodwill impairment test compares the fair value of the reporting unit to its carrying value if the carrying amount is a positive number.¹²³ If the carrying amount is zero or negative, the required analysis is different.

b. Step 2

If Step 1 indicates that goodwill may be impaired, a second step is required to be performed to measure the amount of impairment. Under the second step, the fair value of the reporting unit's identifiable assets and liabilities is subtracted from the fair value of the reporting unit, similar to the acquisition method of accounting for business combinations under ASC 805, and the resulting amount is the fair value of the implied goodwill. The fair value of the implied goodwill is compared to the carrying value of goodwill. Any excess carrying value of goodwill over the implied fair value is the amount of the goodwill impairment. However, unlike the accounting for a business combination under ASC 805, the fair values of individual assets and liabilities as of the impairment test date are not recorded on the entity's financial statements. The fair values of the individual assets and liabilities are determined only for the Step 2 test under ASC 350.

Worksheet 2 contains an example of how to apply the quantitative impairment test.

If any impairment loss remains after these allocations, the entity must recognize a liability for such amount if required by another IFRS standard.¹³⁰

There are some caveats to the above allocation rules. First, the carrying amount of any particular non-goodwill asset cannot be reduced below the highest of: (1) the asset's fair value less costs of disposal, (2) the asset's value in use; and (3) zero. Any impairment loss that would have been allocated to a particular asset but for this limitation should be allocated to the other assets in the unit on the pro rata basis described earlier.¹³¹ Second, IAS 36 contains a practical expedient in that it requires an arbitrary allocation of impairment loss between the non-goodwill assets of a unit if it is not practicable to estimate the recoverable amount of each individual asset.¹³²

The resulting reductions in the carrying amounts of these other assets are treated as impairment losses on the individual assets, which means the loss is recognized immediately in profit or loss unless the asset is carried at a revalued amount under a standard other than IAS 36 (such as property, plant, and equipment carried at a revalued amount under IAS 16). Losses allocated to assets carried at such revalued amounts are treated as revaluation decreases in accordance with the applicable standard (such as IAS 16).¹³³

a. Determining the Estimated Future Net Cash Flows

Determining the estimated future net cash flows attributable to an intangible asset requires estimating the future cash inflows from the intangible asset and subtracting from them the estimated future cash outflows made to support the intangible asset. This calculation is done every year.

In some rare instances, the entity might be able to easily estimate future net cash flows. It is more likely, however, that the entity cannot easily estimate the future cash inflows or the outflows, or both. In these instances, the entity needs some method of making these estimates.

A frequently used method of estimating future outflows or inflows is regression analysis. Regression analysis is a relatively straightforward means of developing a formula for a straight line running through the data used to calculate the straight line. The formula for a straight line is Y = a + bx. Assuming that the future is like the past, the formula for a straight line can be used to predict future values. The mathematics of regression can be rather difficult; fortunately, there are easy ways around the math calculations. One such way is contained in Excel®¹³⁴ spreadsheets.¹³⁵

Assume that Acquirer Company is considering purchasing a smaller company, Target Company, which has a favorable storage and loading contract at a local warehouse. The warehouse contract allows Target Company to store “X” volume at the warehouse and ship “Y” volume through the loading and shipping dock of the warehouse. The contract is a flat fee for Y volume. Any volume above Y does not cost the Target Company extra. Target Company has been shipping in excess of Y volume for no extra charge because they developed an improved loading process. The contract for the local warehouse is for 12 years and there are 6 years left. Exhibit 4.2 shows the amount Target Company saved by this contract for each of the past 6 years.¹³⁶

The first step, if necessary, is for Acquirer Company to adjust Target Company's data to suit its own use. (In this instance, Acquirer Company did not need to adjust the data.) The information in cells B2–B7 is from Target Company's records and is the amount it would have paid (i.e., its cost savings) if the contract were not a flat fee for using the storage area and loading dock. As the purchasing company, Acquirer Company would like to predict the cost savings for the next six years, assuming that the past six years is representative of the next six years. Acquirer Company expects to include some amount for this contract in its purchase offer for Target Company.

The second step is for Acquirer Company to determine if a straight line can be representative of the last six years of cost savings. If a straight line is representative of the past six years' data, the line can be used to predict the next six years' cost savings. The way to do this is with a formula (called function in Excel®) that uses the past six years' cost savings. The formula in Excel® is:

The “=” sign is required at the beginning of a formula in Excel®. The “=” sign tells Excel® that a formula follows. LINEST is the function used in Excel® to determine a straight line. The first set of cells, B2:B7, is the data for which Acquirer Company wishes to determine a straight line. The second set of cells, A2:A7, is the period for which Acquirer Company wishes to determine the straight line. The second set of numbers is followed by “True.” This “True” ensures that Acquirer Company will have a constant calculated for its straight-line formula. The second “True” ensures that the proper descriptive and diagnostic statistics will appear. These statistics will tell Acquirer Company if its straight line is useful. To determine the straight line, use the following steps:¹³⁷

1. Type the formula into cell C2,¹³⁸ =LINEST(B2:B7,A2:A7,True,True).
2. Highlight (select) cells C2:D6,¹³⁹ using either your mouse or keyboard.
3. With the area above highlighted, Press F2.¹⁴⁰
4. Press Ctrl+Shift+Enter simultaneously. (The result should look like Exhibit 4.3.)

The formula is in cells C2 and D2. The formula is:

To use the formula, substitute an x and calculate a Y. For example, to calculate the sixth year, Y = $132,840 + 1055.714(6) = $139,174, which is very close to the actual value of $139,100 shown in Exhibit 4.3.

Cells C3 to D6 contain the other descriptive and diagnostic statistics. (See Worksheet 2.) Cell C4 contains the R² for the straight-line formula. It is read as 99.4 percent, which is considered extraordinarily high for accounting data.¹⁴¹ In accounting, Acquirer Company will use the following guidelines for R²:

Now Acquirer Company is ready to begin the process of determining the value of the warehouse contract, which Acquirer Company will carry as an intangible asset.¹⁴² To do this, Acquirer Company needs to predict the cost savings it will have for the next six years. Acquirer Company can use another function in Excel® that will use the past six years' cost savings of Target Company, adjusted for Acquirer Company's use, to determine the next six years' cost savings. The formula, which is not shown in Exhibit 4.4, is in cell B9. The formula is:

TREND is the function Excel® uses to estimate the future cash flows. Instead of entering the formula itself, enter the function. Behind the function is a predetermined formula built into Excel® for use.¹⁴³ The first set of numbers, B2:B7, is the cost savings for the previous six years. The second set of numbers, A2:A7, is the years in which each cost savings occurred. The third set of numbers, A9:A14, is the years for which Acquirer Company wishes to predict the cost savings.

To predict the next six years, use the following steps:¹⁴⁴

1. Type the formula into cell B9,¹⁴⁵ =TREND(B2:B7,A2:A7,A9:A14).
2. Enter the numbers 7-12 in Cells A9-A14 as is shown in Exhibit 4.4.
3. Highlight (select) cells B9-B14, using either your mouse or keyboard.
4. Press F2 (this changes cell B9 from a numerical form to the formula in step 1).
5. Press Ctrl+Shift+Enter simultaneously. (The result should look like Exhibit 4.4.)

What has Acquirer Company accomplished? It has mathematically estimated the future net cost savings for years 7–12 for this contract. Excel® has analyzed the data given it, and using the TREND function, extended the straight line of Y = $132,840 + 1055.714x over years 7–12. (This straight line is the one Acquirer Company calculated earlier.) Excel® then used the straight-line formula to determine the values for cells B9–B14. In addition, notice that the estimated values include the growth of the cost savings. The cost savings in cells A9–A14 continue to grow just as the cost savings in cells A2–A7 did. Exhibit 4.5 shows the first six years' actual cost savings followed by the next six years' estimated cost savings.

Savings (Second Six Data Points) Actual and Estimated Cost Savings

The first six data points are the actual cost savings experienced by Target Company in years 1–6. The second six data points are the estimated cost savings for Acquirer Company. The first six are not exactly a straight line, but they are close to it.¹⁴⁶ Notice that the second six data points fall on a straight line. The TREND formula mathematically calculated these six data points and the TREND formula is always a straight line.

Mathematics gives the feeling of precision. If something is done mathematically, the tendency is to accept it more quickly than a nonmathematical determination. A company cannot be carried away with mathematical solutions. However, if the R² is high, the projections will be good, assuming the past is representative of the future. If the R² is below 70 percent, the data points might not be very good and the entity might need another method to estimate future cash flows. Often, a commonsense look at the data can show that something is wrong.

What if the past cost savings rose and fell in a pattern like that in Exhibit 4.6, Column B. In this example, the highest cost savings is in the middle of the period (year 3). The cost savings fall after that. If Acquirer Company tries to fit a straight line through data that is obviously not increasing (or decreasing) in a straight-line fashion, what will it get?

The equation for the line, taken from Cells C2 and D2, is:

The negative sign in front of the 227.14x means that the straight line goes downward. The R² is 9.98 percent the F statistic in Cell C5 is below one, and the T statistic, calculated C2/C3 = .666, is also below one. In other words, the straight line calculated by the LINEST function is useless.¹⁴⁷

If Acquirer Company uses the equation to estimate the future net cost savings for years 7–12 and plots the results on a graph, it will look like Exhibit 4.7.

If Exhibit 4.7 does not cause Acquirer Company to pause, nothing will. The diamond-shaped points on the graph are the actual cost savings that Acquirer Company got from the records of Target Company. The line is the regression line.¹⁴⁸ The estimated future cost savings goes steadily downward, in a straight line. In this instance, the regression line calculated with Excel's® LINEST function not only did not do Acquirer Company any good, it will mislead the company if it is not careful.¹⁴⁹

This does not mean that the actual cost savings experienced by Target Company are useless. (The actual cost savings are the first six data points in Exhibit 4.7.) Acquirer Company needs to research the reasons why the actual cost savings for Target Company rose for three years and then started to fall. Acquirer Company must determine if the decline Target Company experienced could affect them also or if they can reverse this decline.

After careful research, Acquirer Company determined that the cause of the decline was a disagreement between the owner of Target Company and some of the employees working in the warehouse. Acquirer Company decided that they could reverse the decline Target Company experienced the past three years. Acquirer Company's estimated cost savings for years 7–12 are shown in Exhibit 4.8 along with Target Company's actual cost savings for years 1–6.

Using the best information available to it, Acquirer Company estimated the next six years' cost savings. It expects to pass Target Company's highest cost savings of $136,000 quickly. After that, Acquirer Company expects the cost savings to continue to grow, but not as quickly as the first year.

This method is simply one of many methods to estimate the net cash flows for a future period. Without an observable market for the intangible asset, Acquirer Company must use the tools that are available to it. In addition, Acquirer Company must remember that it is determining the net cash flows for the next six years. It is not possible for it to be perfectly accurate. The best it can hope for is to come close. The only real caveat about the ad-hoc method, shown in Exhibit 4.8, is that Acquirer Company must be careful not to simply guess what the next six years' cost savings will be. In other words, “There must be some method behind their madness.”

The cost savings are an intangible asset. Acquirer Company still does not know the value of the cost savings and, hence, it does not know the value of the intangible asset. It cannot just add up cells A9–A14, because the value of money depends on when it is received. Ten thousand dollars received today does not have the same value to Acquirer Company as $10,000 received five years from now due to the time value of money. Acquirer Company cannot determine the value of the intangible asset without first determining an appropriate discount rate to take into consideration the time value of money.

b. Determining the Discount Rate

Determining the discount rate is the final item needed to calculate present value.

CON 7 lists several factors to take into consideration when determining the discount rate. They are:

1. The time value of money, represented by the risk-free rate of interest
2. The price for bearing the uncertainty inherent in the asset (or liability)
3. Expectations about possible variations in the amount or timing of cash flows
4. Other, sometimes unidentifiable, factors, including illiquidity and market imperfections

These factors represent something of a multistep process. First, determine the risk-free rate of interest. Add to this a premium for the risk inherent in holding an asset (translated into an interest rate). Then add a premium to the interest rate that represents possible timing and amount variations. Finally, add an interest rate representing other, sometimes unidentifiable, factors.

Determining the appropriate discount rate is difficult and contains a great deal of subjectivity. Remember that intangible assets valued using an income approach typically do not have an observable market so there is very little guidance. It is possible that a company has already developed a discount rate for other tangible assets. In this instance, a review of the process used to develop the other discount rate might be useful in determining the discount rate for an intangible asset, either newly acquired or already on the books. At least it can provide a good starting point. In the absence of any other method, the company will have to develop its own discount rate for the intangible asset.

A discount rate must be selected carefully, as the following example shows. Assume an intangible asset should generate $100,000 in revenue each year for the next five years. If a company uses a discount rate of 8 percent, for an annuity of $100,000, for five years, the present value is $399,271.¹⁵⁰ If the same annuity is discounted at 10 percent, the present value is $379,079, a difference of over $20,000 in the present values for a difference of two percentage points in the discount rate. Notice that this difference occurred for a relatively small revenue stream over a short period.

If the same annuity is discounted at 20 percent, the present value is $299,061. (Compare this with $399,271 using 8 percent and $379,079 using 10 percent.) This shows that as the interest rate goes up, the present value goes down. This feature is very important because a company can use a higher interest rate as the discount rate to compensate for risk. This issue will become evident in the discussion ahead.

a. Private Enterprises under U.S. GAAP

The Financial Accounting Standards Board issued ASU 2014-02, Accounting for Goodwill, a Consensus of the Private Company Council, in January 2014. It provides alternative goodwill impairment testing for entities “other than a public business entity, a not-for-profit entity or an employee benefit plan.”¹⁷⁸

Private companies have expressed concerns about the cost and complexity of testing goodwill for impairment under the existing accounting standards. Many users of private company financial information indicated that they did not include any goodwill impairment charges in their financial analysis of the company's operating performance because they focused on other economic performance measures. Moreover, management of private companies believed that the costs associated with goodwill impairment tests often outweigh any benefit. As a result, the Private Company Council (PCC)¹⁷⁹ proposed alternative accounting for the testing of goodwill for impairment by private companies, but only if elected by the company. The PCC proposals were endorsed by the FASB at the end of 2013 and codified as ASU 2014-02.

Under ASU 2014-02, if a private company elects the accounting alternative, it amortizes goodwill over 10 years on a straight-line basis or over a shorter period if it can demonstrate that a shorter useful life is more appropriate.¹⁸⁰ Moreover, under the accounting alternative, annual impairment testing of amortized goodwill is not required. Instead, goodwill must be tested for impairment only when a triggering event suggests that the fair value of the entity (or reporting unit) may be below its carrying amount.¹⁸¹

To conduct the goodwill impairment test under this alternative, a private company must make a policy election to test for impairment at either the entity level or the reporting unit level.¹⁸² If it elects to use the reporting unit level, it must determine the reporting units and allocated assets (including goodwill) and liabilities to the reporting units using the same rules that other companies use.¹⁸³

The simplified impairment test under the accounting alternative involves an elective qualitative assessment and a one-step quantitative test. If an entity decides not to perform the qualitative assessment upon the occurrence of a triggering event, then it must proceed directly to the one-step quantitative test.¹⁸⁴

The qualitative assessment is the same as the qualitative assessment for companies that may not use the accounting alternative. Thus, under the accounting alternative's qualitative assessment, an entity determines if it is more likely than not that the fair value of an entity or reporting unit is less than the entity's or reporting unit's carrying amount.¹⁸⁵ In making this determination, the entity should consider the sample events and circumstances listed in ASC 350-20-35-3C as well as other relevant factors.¹⁸⁶ The manner in which an entity should conduct this assessment is described in the section “Qualitative Assessment.” If the entity determines that it is more likely than not that the fair value of an entity or reporting unit is less than the entity's or reporting unit's carrying amount, then it must perform the one-step quantitative goodwill impairment test to determine if goodwill has been impaired and the amount of any impairment.¹⁸⁷

When performing the one-step quantitative goodwill impairment test, a private company measures the fair value of the entire entity (or reporting unit depending on the policy election made) and compares it to the entity's (or reporting unit's) carrying amount. If the fair value is less than its carrying amount, the difference is the amount of impairment.¹⁸⁸ The fair value of a reporting unit is calculated in the same manner that it is in the traditional goodwill impairment test.¹⁸⁹ See the section “Carrying Amount Is Positive” for guidance on measuring the fair value of the reporting unit under these rules. There is no “Step 2” requiring a hypothetical analysis similar to the acquisition method under ASC 805.

Once an impairment loss is determined, it is allocated to the entity's units of goodwill (or the reporting unit's units of goodwill) on a pro-rata basis using their relative carrying amounts.¹⁹⁰ The allocated portion is deducted from the carrying amounts of each unit of goodwill and subsequent amortization deductions are revised to reflect the lower carrying amount.¹⁹¹

The accounting alternative for private companies, if elected, should be applied to goodwill that exists at the beginning of the period when adopted and to any new goodwill in periods after December 15, 2014. However, early adoption is permitted. Note that on July 21, 2015, the Private Company Council voted to develop a proposal that would allow private companies to make an unconditional one-time election to adopt a PCC alternative without demonstrating the preferability of that alternative.

b. Goodwill Impairment Testing for SMEs under IFRS

All intangible assets, including goodwill, are assumed to have a finite useful life. The useful life is the most reliable estimate. If a reliable estimate cannot be made, then the useful life is presumed to be 10 years.¹⁹²

Unlike U.S. GAAP for Private Enterprises, goodwill is subject to qualitative impairment testing at least annually. If the entity finds no indication of qualitative impairment testing, then no quantitative testing is necessary.¹⁹³

The amount of impairment is measured by calculating the difference between the carrying amount and the highest of (1) its fair value less costs to sell, (2) its value-in-use, and (3) zero.¹⁹⁴

This example is also seen in the illustration here.