The 2016 U.S. Goodwill Impairment Study by Duff & Phelps and the Financial Executives Research Foundation (FERF) examines general and industry goodwill impairment trends of 8,500+ U.S. publicly-traded companies, as well as an annual survey of FEI members that tracks the use of optional qualitative goodwill impairment test (a.k.a. “Step 0”) by its members.
FEI Daily spoke with Marianna Todorova, a Duff & Phelps Managing Director, about the Goodwill Impairment study and recent changes to impairment reporting proposed by the Financial Accounting Standards Board (FASB).
FEI Daily: In general terms, can you describe the survey findings?
Marianna Todorova: Two key findings rise to the top in the 2016 Survey. First, Step 0 continues to gain a solid foothold among companies. The Survey demonstrates record use of the Step 0 test since the option first became available. Fifty-nine percent of public company respondents report that they use Step 0 when performing goodwill impairment analyses, which is up from 54 percent in the 2015 survey, and compares to 29 percent in 2013.
A similar trend was noted with private companies — 50 percent of private company respondents currently apply Step 0, compared to 40 percent in 2015 and 22 percent in 2013.
FASB’s proposal to simplify goodwill impairment testing is very well-received. Over 80 percent of respondents to the 2016 Survey prefer the elimination of Step 2 of the current goodwill impairment test.
FEI Daily: Can you summarize FASB’s proposed changes to goodwill impairment?
Todorova: FASB had proposed and recently voted to remove Step 2 of the current goodwill impairment test, and has also disallowed an option to apply Step 2. Under the new model, a goodwill impairment is calculated as the difference between the carrying amount of the reporting unit and its fair value, but not to exceed the carrying amount of goodwill.
Previously (under the current model), if the carrying amount of a reporting unit exceeded its fair value in Step 1, one would proceed to Step 2 to calculate the amount of goodwill impairment. This was achieved by performing a hypothetical purchase price allocation for the reporting unit, whereby the resulting implied goodwill was compared to the carrying amount of goodwill; any excess of the carrying amount of goodwill over the implied value of goodwill would be recognized as an impairment.
The optional qualitative assessment (Step 0) is still retained in the new model, which enables an entity to bypass the quantitative test for goodwill impairment (Step 1) whenever the circumstances permit it.
A final ASU setting out the new provisions is expected to be issued in the first quarter of 2017.
FEI Daily: How are those likely to affect companies?
Todorova: The objective of the new one-step model is to simplify goodwill impairment testing and reduce costs for preparers, while preserving relevant information for investors. Further, on a high level, the one-step test appears similar to the IAS 36 one-step goodwill impairment test conducted on a cash generating unit (CGU) level.
At the same time, the amount of any impairment under the new model may differ from the amount that might be recognized under the two-step test. Depending on the mix and type of assets of the entity, compared to the one-step test, the two-step test may have resulted in:
No impairment or a lower impairment amount (e.g., when the fair value of long-lived assets is below their carrying amount, resulting in a goodwill cushion in Step 2); or,
A higher impairment (e.g., when there are significant unrecognized intangible assets, compressing the implied value of goodwill in Step 2).
FEI Daily: Are there other notable differences between previous surveys?
Todorova: Apart from the steady rise in the use of Step 0, and the wider acknowledgment of its costs-saving benefits, there has been an increased consideration of best practices in the goodwill impairment testing process, as evidenced by the trends in the use of the AICPA’s Accounting and Valuation Guide Testing Goodwill for Impairment, published in 2013.
In the 2014 Survey, less than 20 percent of respondents overall had indicated they were incorporating this guidance into their goodwill impairment testing process, whereas in the 2015 survey, 35 percent of respondents overall had stated that they had already updated their process to reflect these best practices. In the 2016 survey, this trend further increased to include 44 percent of respondents overall.
FEI Daily: Are we seeing notable trends around goodwill impairment?
Todorova: Overall, goodwill impaired by U.S. companies in 2015 more than doubled compared to the prior year, rising to $57 billion in 2015 from $26 billion in 2014. This comes against the background of 2015 being an extremely robust year for M&A activity, with a massive $458 billion of goodwill added to balance sheets, a record high since 2008, as first reported in the 2013 U.S. Goodwill Impairment Study.
Energy was the hardest-hit industry for two consecutive years. The amount of GWI almost tripled from 2014 to 2015 (increasing from $5.8 billion to $18.2 billion), while the number of impairment events doubled from 32 to 65. Five of the top ten largest impairment events were in Energy. For perspective, by the end of 2015, Brent crude oil prices had sunk 67 percent relative to their height in mid-2014, helping explain the hardship felt by Energy companies.
Information Technology also was particularly affected in 2015, with aggregate GWI more than tripling from 2014 (up to $12.9 billion from $3.6 billion). Industrials and Consumer Discretionary goodwill impairments also doubled in 2015 ($7.7 billion and $7.6 billion, respectively), compared to the 2014 levels ($3.5 billion and $2.8 billion, respectively).
FEI Daily: What’s driving increased use of Step 0?
Todorova: The increased use of Step 0 is likely driven primarily by companies getting more comfortable with the qualitative assessment and the related documentation requirements, and sustaining the conclusions reached with their auditors. Additionally, more published guidance is available on the application of Step 0.
Furthermore, as the 2016 Survey found, two-thirds of respondents believe Step 0 meets the stated objective of reducing costs, holding steady from 2015, and up from 50 percent in 2014.
Apart from these factors, circumstances conducive to the use of Step 0, and which may generally explain increased application, include favorable economic and industry environment; consistent operating performance; robust market-to-book ratios; a comfortable cushion (excess of fair value over the carrying amount) at the reporting unit level; or a recent quantitative fair value measurement that provides a backdrop for the qualitative judgments.
Overall, the increased use of Step 0 may reflect a combination of broader economic, company-specific, practice and behavioral factors.
FEI Daily: Are there differences in Step 0 use between public and private companies?
Todorova: From the time the use of Step 0 started being tracked in the FEI member survey in 2013 through 2016, the rate of uptake of Step 0 among public companies has been slightly higher than that among private companies by an average of about 11 percentage points.
In interpreting this picture, however, it should be noted that private companies were given the option to amortize goodwill as early as 2014 with the issuance of ASU 2014-02, Intangibles – Goodwill and Other (Topic 350), Accounting for Goodwill – a Consensus of the Private Company Council. Under this ASU, goodwill is tested for impairment only when there is a triggering event, although the qualitative option for assessing goodwill impairment remains available.
However, not all private companies have elected the accounting alternative pursuant to ASU 2014-02 for various reasons, including expectations of becoming a public business entity. Overall, even with these opposing forces at work there has been an overall increase in the use of Step 0 by private companies over time.