The one-step method may also lead to an understatement of goodwill impairment if the fair value of liabilities is less than their carrying amount, for example due to a deterioration in their solvency. In this scenario, the entity may not be obligated and has no incentive to recognise impairment losses on its goodwill. Whatever the taxpayer`s motivation to retain control of the business name, the maintenance of the law would result in the loss resulting from the sale of the intangible assets associated with product B business that would not be taken into account. Under paragraph 197(f)(1)(A), the loss would not be tax deductible at this time and the undepreciated tax base would continue to be recovered through increased capital cost allowances related to the retained business name asset. First, the company compares the fair value of the reporting unit with its book value (step 1). If the fair value is less, the entity shall calculate any impairment of goodwill by comparing the implied fair value of the goodwill to its carrying amount (step 2). Goodwill can only be written down if the constructed implied fair value of the goodwill is less than its carrying amount. A depreciation reduces the recognized goodwill and is irreversible. M&A transactions can be structured as a share sale or asset sale/ 338(h)(10) choices. Structure determines the tax impact of goodwill: The FASB issued the ASU in 2017-04 in response to component comments in 2014 when it published an accounting alternative that allowed private corporations to amortize goodwill and use a simpler one-step impairment test (ASU 2014-02, Intangible Assets – Goodwill and Others (Theme 350): Recognition of goodwill or goodwill Goodwill). ASU 2017-04 has set staggered validity dates for its implementation: Technically, bad debts on receivables constitute an impairment. In many cases, this is only a provision used in GAAP accounts, which are based on historical values as a means of transparency and prudence. In these cases, it is – as a depreciation – not tax deductible.
Under ASU 2017-04, entities recognise impairment to the extent that the carrying amount of a reporting unit exceeds its fair value (not exceeding the carrying amount of goodwill). To determine the fair value of the unit, corporations determine whether the hypothetical sale took place in a taxable or non-taxable business, as described above. This finding could affect the fair value of the unit and therefore any impairment loss on goodwill. Impairment losses on goodwill under the new guidelines may differ from current forecasts because the difference per unit (carrying amount of the unit minus the fair value of the unit) always takes precedence over the difference in goodwill (goodwill minus fair value). Therefore, if the unit difference under the new guidance is greater than or less than the goodwill difference margin, it replaces the goodwill difference, which may result in a more or less significant impairment of goodwill. While some companies may not write down under the current guidance if they do not comply with Step 1, under the new guidance there will still be some impairment of goodwill if the carrying amount of the reporting unit exceeds its fair value. Figure 1 shows the alternatives to goodwill impairment in different scenarios. These guidelines require entities to calculate the implied fair value of goodwill in Step 2 by calculating the fair value of all assets (including unrecognized intangible assets) and liabilities of the reporting unit and subtracting them from the fair value of the reporting unit previously calculated in Step 1.
This process makes any goodwill impairment analysis costly and complex. However, private companies may choose to amortize the goodwill they have acquired in business combinations on a straight-line basis over a period of 10 years or less if the entity demonstrates that another useful life is more appropriate and may opt for a one-step goodwill impairment test (ASC 350-20-35-63). As a result, the new guidelines may not apply to private corporations. (For more information, see Lange, Fornaro, and Buttermilk, “A New Era for Private Company Accounting Standards, Changes in Long-standing Practices for Goodwill,” The CPA Journal, January 2015.) Figure 2 shows that the direct application of a goodwill impairment loss of $1,000 results in a book value of $12,600, which would always exceed the fair value of $12,000. Figure 4 shows what happens when Company A simultaneously calculates its goodwill depreciation and deferred taxes. In this scenario, the book value of $12,000 is equal to the fair value of the unit for $12,000. The journal entry for goodwill impairment is as follows: ASU 2017-04 addressed this issue and requires an entity to simultaneously calculate the impairment and deferred tax effect (in the same way that an entity calculates goodwill and related CDIs in a business combination). For example, if Company A has impairment losses on goodwill of $1,000 (the excess of the fair carrying amount of the carrying amount of the reporting unit) and the effective tax rate is 40%, the impact of the impairment on the carrying amount of the goodwill is $600 [$1000 to $1000 ($1000 × 40%)]. However, if Company A uses simultaneous equations (based on the new forecasts), the goodwill impairment is $666 [40% divided by (1 to 40%)] × $1,000, ASC 350-20-55-23C&D).
Companies must conduct impairment testing each year or whenever a triggering event causes the fair value of goodwill to fall below the carrying amount. Some triggering events that can lead to impairment are adverse changes in the general state of the economyCFI`s economic articles are designed as a self-learning guide to economics at your own pace. Browse hundreds of articles on the economy and key concepts such as the business cycle, GDP formula, consumer surplus, economies of scale, economic value creation, supply and demand, balance and more, the increased competitive environment, legal implications, changes in key personnel, declining cash flow, and a situation where working capital exhibits a pattern of declining market value. Asset impairments are normal changes in a company`s balance sheet. This is how accountants carefully reassess the value of assets based on the market. One of the challenges of accounting for goodwill is that it is treated in a different way in tax accounting and in a different way in GAAP (“Bookbook”) accounting. In the following, we describe the fundamental differences: In some jurisdictions, goodwill depreciation is tax deductible. If a reporting entity operates in these jurisdictions, impairment losses on goodwill may reduce its deferred tax liability (DTL) or increase its deferred tax asset (DTA). A decrease in DTL or an increase in DTA will result in an immediate increase in the carrying amount of the reporting unit, which would require additional impairment charges (ASC 350-20-35-20 & 21 and ASC 850-740-25). The new guidance could result in impairment losses on goodwill that would not have been recognized under previous GAAP. When companies recognise impairment losses on goodwill, the circumstances may be such that they must measure impairments of other assets that are subject to triggering events. BB Company acquires CC Company`s assets for $15 million, values its assets at $10 million and has $5 million in goodwill on its balance sheet.
After one year, BB tests the depreciation of its assets and finds that CC`s turnover has decreased significantly. As a result, the present value of CC`s assets increased from $10 million to $7 million, representing an impairment of assets of $3 million. This reduces the value of goodwill assets from $5 million to $2 million. Early adoption is eligible for interim or annual goodwill impairment testing conducted on test dates after January 1, 2017. Many companies may consider adopting the new guidelines earlier due to the complexity of the current guidelines. AsU 2017-04 requires businesses to recognise impairment losses on goodwill when the carrying amount of a reporting unit exceeds its fair value. The impairment loss is based on this difference and is limited to the amount of goodwill allocated to that unit; Thus, the new guidance eliminates the analysis of Step 2 of the current goodwill impairment test. Companies also have the opportunity to make a qualitative assessment of the impairment of goodwill; However, if a company makes a qualitative assessment of its goodwill and fails, it must conduct a quantitative impairment test (ASC 350-20-35-3A). If companies simultaneously test goodwill and long-lived assets (held and used) as a result of a triggering event, they must follow a certain sequence in their impairment test.
Before looking at goodwill impairment, companies should first test other assets (e.g., trade receivables, inventories) and intangible assets with unlimited lifespan, then long-lived assets (including intangible assets with indefinite life) and finally goodwill.