Intangible Asset Impairment under Statement 142 - Goodwill and Other Intangible Assets
Gary R. Johnstone, CFA CPA/ABV Managing Director October 15, 2001
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Historical Perspective
Prior
GAAP guidance was APB 17 (Intangible Assets) issued in 1970 and FAS 121 (Impairment of Long-Lived Assets) issued in 1995.
Under
APB 17, intangible assets, including goodwill, were valued at fair value and then amortized over their remaining useful lives. The maximum life for goodwill was 40 years.
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Historical Perspective (cont.)
Under FAS 121, long-lived assets, including intangible assets such as goodwill, were tested for impairment whenever “events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable”.
Based on our experience, not all reporting companies complied with APB 16 (i.e., purchase price allocations) - consequently, there were not as many intangibles (other than goodwill) arising from acquisitions. Impairment tests for goodwill were performed only after the capital markets had penalized companies for poor earnings performance or other bad news.
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Reasons for Statement 142 (New GAAP)
According to FASB, the main reasons for Statement 142 are:
Analysts and other users of financial statements, including company management, noted that intangible assets are becoming increasingly important economic resources and an increasing percentage of the assets acquired in any given transaction.
The new GAAP should improve financial reporting because the users of financial statement will be better able to understand the investments made in intangible assets and the subsequent performance of those investments. FASB concluded that the nonamortization of goodwill coupled with impairment testing is consistent with the concepts of FASB Concepts No. 2, Qualitative Characteristics of Accounting Information.
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Key Differences between Statement 142 and Prior GAAP Guidance
Goodwill
will no longer be amortized. This may lead to volatility in reported income because goodwill impairment losses may occur irregularly and in varying amounts. Goodwill is no longer presumed to be a “wasting asset”. intangible assets (i.e., Statement 141 assets), including goodwill will need to be ascribed to a particular “reporting unit”. Intangible assets are no longer to be associated with just the corporate entity. valuation information will need to be presented on a “reporting unit” basis. A reporting unit is an operating segment or one level below the operating segment.
Identifiable
Relevant
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New GAAP (cont.)
An
annual impairment test for goodwill is required on the first day of the fiscal year (or the same date each year) and at each reporting period, the remaining useful lives of intangible assets with definite lives will need to be reexamined and adjusted according should a change in life be indicated. annual impairment test will be performed at the “reporting unit” level using a two-step process. The first step requires an estimation of the fair value of the reporting unit and whether an impairment of the goodwill is indicated. second step requires an examination of the fair value of the reporting unit’s assets if there is a goodwill impairment indicated at the reporting unit level.
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The
The
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New GAAP (cont.)
Statement
142 provides specific guidance on the impairment testing of identified intangible assets that are not amortizable and thus removes those intangible assets from the scope of other impairment guidance. Disclosures - Statement 142 requires disclosure about goodwill and other intangible assets in the years subsequent to their acquisition.
Additional
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Additional Guidance Provided by Statement 142
The proper Standard of Value is still Fair Value, not Investment Value.
Internally generated intangible assets are still expensed.
Clarification about remaining useful life and the identification and valuation of an intangible assets:
If an intangible asset has a finite useful life, but the precise length of that life is not known, that intangible asset shall be amortized over the best estimate of its useful life. The method of amortization shall reflect the pattern in which the economic benefits of the intangible asset are consumed or otherwise used up. An intangible asset has an indefinite life (indefinite does not mean infinite), if no legal, regulatory, contractual, competitive, economic, or other factors exist limit the useful life of the intangible asset to the reporting entity.
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ValuationVC’s Conclusions/Expectations
1.
Reporting companies will need to define their “reporting units” and substantiate their criteria to their auditors. We expect that most companies will adopt their operating segments as their reporting units. There is conflicting information about what may be the best strategy regarding the optimal number of reporting units that a reporting company should have (e.g., fewer vs. more). Companies should look to the guidance provided by Statement 142 regarding the definition of a reporting units and the aggregation of reporting units when there is a commonality of economic characteristics. An identifiable intangible asset will now need to be assigned to a particular reporting unit as opposed to an asset existing at the corporate level.
2.
3.
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V/VC Conclusions/Expectations (cont.)
4.
5.
6.
Companies will seek to mitigate the risk of an unexpected goodwill charge. Strategies include: (1) the acquisition of IPRD assets (immediate write-off of goodwill) and (2) taking the impairment charge after the company has already publicized any negative news. Reporting companies will have to prepare for the annual impairment test – you should understand the fair value of each reporting unit. Reporting companies will need to spend time each reporting period to track the utilization of their identified intangible assets; this will be a new responsibility similar to tracking fixed assets.
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V/VC Conclusions/Expectations (cont.)
7. 8.
More information about identifiable intangible assets and goodwill will need to be disclosed to the public. It will be more difficult (read:expensive) to perform the Statement 142 analysis for private companies (it may require a reconciliation between the Income and Market Approach) than public companies because publicly traded companies will only require a Market Approach valuation. Fortunately, auditors are not likely to require Statement 142 compliance for non-reporting companies.
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