Key takeaways
- Under U.S. GAAP (ASC 350-20), goodwill must be tested for impairment. Public companies test at least annually; many private companies can elect simpler rules.
- The private company alternative lets eligible private companies amortize goodwill over up to 10 years and test for impairment only when a triggering event occurs, at the entity level or reporting-unit level.
- Under ASU 2021-03, private companies and not-for-profits can elect to evaluate triggering events only at the end of each reporting period, rather than continuously.
- Impairment is measured as the amount by which the carrying amount of the entity or reporting unit exceeds its fair value, limited to the goodwill balance. Impairment losses cannot be reversed.
- Fair value for impairment testing follows ASC 820: a market participant, exit-price concept that is different from fair market value for tax purposes.
When a company acquires another business, the purchase price often exceeds the fair value of the identifiable assets acquired and liabilities assumed. That excess is recorded as goodwill. Goodwill reflects the expected benefits of the acquisition, such as an assembled workforce, synergies, market position and future customers.
But expectations don’t always pan out. Revenue falls short, a key customer leaves, the industry shifts. When that happens, accounting rules require the company to consider whether the goodwill on its balance sheet is still supported, and to write it down if it is not.
For private companies, the rules are simpler than for public companies, but they still require judgment, documentation and, often, a valuation. This article explains how goodwill impairment testing works for private companies.
Where goodwill comes from
Under ASC 805, Business Combinations, an acquirer records the identifiable assets acquired and liabilities assumed at fair value. Goodwill is the residual:
Goodwill = Consideration transferred (including the fair value of any contingent consideration) − Fair value of identifiable net assets acquired
Contingent consideration such as earnouts is part of consideration transferred; see our article on earnouts in a business sale. Identifiable intangible assets, such as customer relationships, trade names and technology, are generally recognized separately from goodwill. Our article on valuing intangible assets explains how those are measured.
The general model under ASC 350
For entities that do not elect the private company alternative:
- Goodwill is not amortized.
- It is tested for impairment at the reporting unit level at least annually, and between annual tests if a triggering event makes it more likely than not that fair value is below carrying amount.
- An entity may first perform a qualitative assessment (often called “Step 0”). If it concludes that it is not more likely than not that the reporting unit’s fair value is less than its carrying amount, no quantitative test is needed.
- Otherwise, it performs a quantitative test comparing the reporting unit’s fair value with its carrying amount (including goodwill). Since ASU 2017-04, the impairment loss is simply the excess of carrying amount over fair value, limited to the goodwill allocated to that unit. The former “Step 2” hypothetical purchase price allocation was eliminated.
The private company alternative
Recognizing the cost and complexity of annual testing for private companies, the FASB issued ASU 2014-02 (based on recommendations from the Private Company Council). Private companies, and later not-for-profit entities under ASU 2019-06, can elect an accounting alternative:
1. Amortize goodwill
Goodwill is amortized on a straight-line basis over 10 years, or a shorter period if the entity demonstrates that a shorter useful life is more appropriate.
2. Test only upon a triggering event
Instead of annual testing, goodwill is tested only when a triggering event occurs that indicates the fair value of the entity (or reporting unit) may be below its carrying amount.
3. Choose the level of testing
The entity makes a policy election to test goodwill at the entity level or the reporting unit level. Many private companies choose the entity level for simplicity.
4. Simplified measurement
When a test is required, the entity may first assess qualitative factors. If a quantitative test is needed, impairment is the amount by which the carrying amount of the entity (or reporting unit) exceeds its fair value, not to exceed the carrying amount of goodwill.
Related alternative: fewer separately recognized intangibles
Under ASU 2014-18, private companies may also elect not to recognize certain customer-related intangible assets (unless capable of being sold or licensed independently) and non-compete agreements separately from goodwill in a business combination. An entity that elects this alternative must also adopt the goodwill amortization alternative.
ASU 2021-03: triggering event evaluation at period end
Under ASU 2021-03, private companies and not-for-profit entities may elect to evaluate goodwill impairment triggering events only as of the end of each reporting period, whether interim or annual, rather than monitoring continuously throughout the period. This was particularly helpful during periods of rapid economic change, when conditions could shift multiple times between reporting dates.
What counts as a triggering event?
ASC 350 provides examples of events and circumstances to consider, including:
- Macroeconomic conditions, such as a deterioration in general economic conditions, limits on access to capital, or fluctuations in interest rates and exchange rates;
- Industry and market considerations, such as increased competition, declining market multiples, changes in the market for the entity’s products, or regulatory or political developments;
- Cost factors, such as increases in raw materials, labor or other costs that negatively affect earnings;
- Overall financial performance, such as negative or declining cash flows or a decline in actual or planned revenue or earnings;
- Entity-specific events, such as loss of key personnel or customers, changes in strategy, litigation, or contemplation of bankruptcy;
- Events affecting a reporting unit, such as a change in the composition of its net assets or an expectation of selling or disposing of all or part of it; and
- for public companies, a sustained decrease in share price.
Lenders, auditors and boards often ask about triggering events when a company misses its budget materially, loses a major customer, breaches a covenant, or receives a lowball acquisition offer.
A worked example
A private company elected the private company alternative and tests at the entity level.
- Carrying amount of the entity’s net assets, including goodwill: $12,000,000
- Carrying amount of goodwill (after amortization to date): $3,000,000
During the year, the company lost its largest customer, which represented 25% of revenue. Management concludes this is a triggering event.
An independent valuation estimates the fair value of the entity at $10,500,000.
| Amount | |
|---|---|
| Carrying amount | $12,000,000 |
| Fair value | $10,500,000 |
| Excess of carrying amount over fair value | $1,500,000 |
| Goodwill balance (limit) | $3,000,000 |
| Impairment loss | $1,500,000 |
The company records a 1.5million * * impairmentloss.Goodwillisreducedto * *1.5 million and continues to be amortized over its remaining useful life. The impairment cannot be reversed if conditions later improve.
How fair value is measured
Fair value for goodwill impairment testing follows ASC 820, Fair Value Measurement: the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date.
That is different from: – fair market value used for tax and many other purposes; and – fair value used in state shareholder dissent and oppression statutes.
See our article on standards of value for the distinctions.
Common methods include: – Income approach: discounted cash flow analysis using market-participant assumptions and a discount rate reflecting the entity’s risk (see our article on cost of capital for private companies). – Market approach: guideline public company multiples or comparable transactions. – Reconciliation of approaches, with consideration of control and marketability as appropriate to the unit of account.
See the three approaches to business valuation.
Practical implications for private companies
- Covenant compliance. An impairment reduces equity and earnings, which can affect loan covenants based on net worth or leverage. Talk to lenders early.
- Tax differences. For tax purposes, acquired goodwill is generally amortized over 15 years under Section 197. Book impairments are not deductible for tax and create book-tax differences.
- Audit readiness. Auditors will want documentation of the triggering event assessment and support for fair value conclusions.
- Policy elections. Elections to adopt private company alternatives should be evaluated carefully, especially if an IPO or sale to a public company is possible, because public business entities cannot use them and may require restatement.
Documentation checklist
Frequently asked questions
Not if they elect the private company alternative. They test only when a triggering event occurs.
Changing an accounting policy election requires a preferability assessment and has implications, especially if the company later becomes a public business entity.
Not necessarily. It indicates that current expectations no longer support the recorded amount, which can result from market conditions beyond management’s control.
Management is responsible for the estimate, but many companies engage independent valuation specialists to support it, particularly when results are material.
The bottom line
The private company alternative makes goodwill accounting simpler, but it doesn’t eliminate judgment. Companies need a disciplined process for identifying triggering events and a defensible fair value analysis when they occur.
Foxboro Consulting Group, Inc. performs business enterprise valuations for financial reporting, including goodwill impairment testing, purchase price allocations and intangible asset valuations. Contact us to discuss your reporting needs.
This article is for general informational purposes and does not constitute accounting, auditing or valuation advice. Consult your auditors and accounting advisors regarding the application of GAAP to your facts.
