Goodwill Impairment Under ASC 350: Simplified Testing for the CPA Exam
Understand the current goodwill impairment test under ASC 350 for the CPA FAR exam. Covers the one-step quantitative test, qualitative assessment option, and practical calculation examples.
Goodwill Impairment Testing Overview
Goodwill arising from business combinations is not amortized under U.S. GAAP. Instead, it is tested for impairment at least annually at the reporting-unit level, or more frequently when events or changes in circumstances indicate that impairment may exist. ASU 2017-04 simplified the goodwill impairment test by eliminating the former Step 2, which required a hypothetical purchase price allocation. The current model uses a single quantitative step, making the test more straightforward but no less important for CPA candidates.
Reporting Units
A reporting unit is an operating segment or one level below an operating segment (a component). Two or more components may be aggregated and treated as a single reporting unit if they have similar economic characteristics. Goodwill must be assigned to reporting units at the time of the business combination, and all goodwill must reside in a reporting unit for testing purposes.
When a business is reorganized and reporting units change, goodwill must be reassigned using a relative fair value approach. For example, if a reporting unit with $500,000 of goodwill is split into two new units, and their fair values are $3 million and $2 million respectively, goodwill is allocated $300,000 and $200,000 based on the 60/40 relative fair value split.
Qualitative Assessment (Step 0)
Before performing the quantitative test, an entity may first perform a qualitative assessment to determine whether it is more likely than not (greater than 50% probability) that the fair value of a reporting unit is less than its carrying amount. Factors to consider include macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, entity-specific events such as changes in management or litigation, and whether there has been a sustained decrease in the entity's share price.
If the qualitative assessment concludes that it is not more likely than not that the reporting unit's fair value is below its carrying amount, no further testing is required. If the opposite conclusion is reached, the entity proceeds to the quantitative test.
Quantitative Test (One-Step Model)
The quantitative test compares the fair value of the reporting unit to its carrying amount, including goodwill. If the carrying amount exceeds the fair value, goodwill impairment is recognized in an amount equal to the excess, limited to the total amount of goodwill allocated to that reporting unit.
Example 1: Impairment Recognized
Reporting Unit A has the following balances:
- Net identifiable assets (excluding goodwill): $4,000,000
- Goodwill: $1,500,000
- Total carrying amount: $5,500,000
- Fair value of the reporting unit: $4,800,000
The carrying amount ($5,500,000) exceeds the fair value ($4,800,000) by $700,000. Because this excess ($700,000) is less than the total goodwill ($1,500,000), the impairment loss is $700,000. Goodwill is reduced to $800,000.
Example 2: Impairment Exceeds Goodwill
Reporting Unit B has:
- Net identifiable assets: $3,000,000
- Goodwill: $400,000
- Total carrying amount: $3,400,000
- Fair value: $2,800,000
The excess of carrying amount over fair value is $600,000, but goodwill is only $400,000. The impairment loss is limited to $400,000 (the total goodwill balance). Goodwill is written down to zero. The remaining $200,000 difference suggests potential impairment of identifiable long-lived assets, which would be evaluated separately under ASC 360.
Income Tax Considerations
When goodwill has a tax-deductible component, the impairment of book goodwill can change deferred tax balances. If book goodwill of $700,000 is impaired but tax goodwill continues to be amortized, the temporary difference between book and tax goodwill changes. The deferred tax impact must be considered when computing the goodwill impairment loss. In some cases, the tax effect of the impairment can itself cause additional impairment, requiring an iterative calculation.
Private Company Alternative
Private companies may elect to amortize goodwill on a straight-line basis over 10 years (or a shorter period if the entity demonstrates a more appropriate useful life) under ASC 350-20-35. Companies making this election also test goodwill for impairment only when a triggering event occurs, rather than annually. This alternative simplifies accounting but is only available to entities that are not public business entities.
Key Exam Tips
- The goodwill impairment test is now a single step: compare reporting-unit fair value to carrying amount.
- Impairment loss is the excess of carrying amount over fair value, capped at total goodwill for that reporting unit.
- The qualitative assessment is optional and can eliminate the need for quantitative testing.
- Goodwill impairment is never reversed under U.S. GAAP (unlike IFRS, which also prohibits reversal for goodwill).
- Know the private company alternative for goodwill amortization, as it is a testable topic.
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