Accounting for acquired goodwill

Goodwill is an acquired intangible asset that can affect earnings if it declines in value. The Financial Accounting Standards Board (FASB) is soliciting feedback on this topic as it considers whether to change the subsequent accounting of goodwill and other acquired intangible assets for public companies. The International Accounting Standards Board (IASB) also is considering improving the disclosures for goodwill, but it wants to keep the same reporting rules. Here are the details.

The basics

Goodwill is typically associated with the premium the buyer of a business or asset pays over its fair value. It’s an intangible asset that may be linked to things like a target company’s customer loyalty or business reputation.

The value of goodwill is determined by deducting, from the cost to buy a business, the fair value of tangible assets, identifiable intangible assets and liabilities obtained in the purchase. Investors are interested in goodwill because it enables them to see how an acquisition fared in the long run.

Under U.S. Generally Accepted Accounting Principles (GAAP), public companies that report goodwill on their balance sheet can’t amortize it. Instead, they must test goodwill at least annually for impairment. When impairment occurs, the company must write down the reported value of goodwill.

Testing should also happen whenever a “triggering event” occurs that could lower the value of goodwill. Examples of triggering events include the loss of a key customer, unanticipated competition or negative cash flows from operations. Impairment may also occur if, after an acquisition has been completed, there’s a stock market or economic downturn that causes the parent company or the acquired business to lose value.

Impairment write-downs reduce the carrying value of goodwill on the balance sheet. They also lower profits reported on the income statement.

However, goodwill and impairment are accounting constructs that don’t necessarily translate well with investors. There are significant differences between how investors view the topic vs. how accountants view it.

Simplified alternative for private companies

Accounting Standards Update (ASU) No. 2014-02, Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill (a Consensus of the Private Company Council), made it easier for private companies merging with or buying other companies to account for the goodwill recorded with the deals. It gave private companies the option to amortize acquired goodwill over a useful life of up to 10 years.

The test private businesses have to perform to determine whether the goodwill has lost value was also simplified in 2014. Instead of automatically testing for impairment every year, private companies are required to test only when there’s a triggering event, meaning the company has evidence that the fair value of the acquired business is less than the carrying amount on the balance sheet.

Next steps

The FASB is now seeking insights about whether and how it should further revise the accounting for goodwill, particularly for public companies. It wants to determine whether the benefits of revising the accounting rules would be worth the costs companies would incur to apply the changes.

“Some have questioned whether the cost of an annual impairment test warrants the process every year,” FASB member Marsha Hunt said in a podcast. “And some have actually been disappointed that, when there have been impairments, the disclosures haven’t been as timely or as useful as they would like.”

Specifically, companies are asked to answer the following questions:

  • Should the subsequent accounting for goodwill be changed, and, if so, how could the FASB do so cost effectively?
  • Should the FASB modify the recognition of intangible assets in a business combination so that items such as noncompete agreements or certain customer-related intangible assets are subsumed into goodwill?
  • Should disclosures about goodwill and other intangible assets be added, changed or deleted?
  • To what extent does lack of comparability between public, private and not-for-profit entities in the reporting of goodwill and certain recognized intangible assets reduce the usefulness of financial reporting information?

In the United States, the focus is on return on the investment. By comparison, investors outside of the United States tend to look at stewardship ― that is, whether they can trust management with their capital and whether management is good at identifying targets, paying the right price and integrating the acquisition. They’re also looking back at the original objective of the business combination and whether those objectives are being achieved.

So, rather than revise the accounting rules for goodwill, the IASB plans to zero in on disclosures that would reveal how an acquisition fared in the long run. The IASB plans to issue a discussion paper later this year that, among other things, will look for feedback on how an entity’s management monitors and measures its own internal reports, including whether the key objectives of business combinations are being considered.

“The way to think about this is that it’s a business combination, not just goodwill or intangible assets,” IASB member Nick Anderson explained. “The things we are thinking of proposing include a quantitative assessment of the synergies rather than just a qualitative description, and data that’s often missing in our world,” he said.

Comments welcome

The FASB is seeking comments by October 7 on invitation-to-comment (ITC) No. 2019-720, Identifiable Intangible Assets and Subsequent Accounting for Goodwill. In addition, it plans to hold a roundtable in the coming months for stakeholders to discuss possible changes to the accounting for goodwill and impairment.