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Multidisciplinary Alternative Investment Valuation and Financial Advisory Firm Transparently Serving the Full Range of Asset Managers, CFOs, CPAs, and Attorneys TM

NAV Valuation & Advisory LLC - Alternative Investment Valuation & Financial Advisory Firm

Cutting-Edge Alternative Investment Valuation and Financial Advisory Firm Transparently Serving the Full Range of Asset Managers, Attorneys, CFOs, and CPAsTM

View the 1-minute Firm Overview Introduction

Justin Kuczmarski,
MBA, CPA, CVA, CIRA, ABV
President

Financial Reporting Valuation: Impairment Testing (ASC 350)

 

NAV offers financial reporting services for Accounting Standard Codification 350 (“ASC 350”) compliance.  ASC 350: Intangible–Goodwill and Other, formerly SFAS No. 142, is the U.S. GAAP section outlining the accounting for goodwill and certain identifiable intangible assets. More specifically, CPAs and valuation experts often cite ASC 350-20-35-1 as the most relevant ASC Subtopic within ASC 350.

The issue of goodwill impairment is often complex for technology-driven companies. Technology firms often have tremendous intangible value. Many tech firms, or any firm losing money, nonetheless lack a proven record of either cash flow or profits. A goodwill charge may be the last straw before a line of credit is terminated by a financial sponsor or commercial bank.  

What is At Stake?

 

ASC 350 is often highly controversial. Why? No company wishes to take a write-down impairment of goodwill in their reported financial statements. The charge to goodwill is a non-cash charge similar to depreciation expense. Notwithstanding, a goodwill impairment is an expense that lowers the net income or net loss of a business enterprise for a particular year or quarter.   In addition, financial covenants may be violated as a result of the goodwill impairment triggering a net loss and subsequent reduction in total shareholders’ equity. The stakes in goodwill impairment testing are therefore very serious. Accordingly, the valuation analyst’s expertise and industry experience are often crucial components in a credible goodwill impairment valuation.   

How We Assist Clients and How We Are Transparent 

 

We take a vastly different approach to our goodwill impairment testing. Many valuation and advisory firms tell clients or perspective client that auditors require a full-blown, detailed report for goodwill impairment testing. 

We recommend firms speak with their auditors to decipher and document compliance with ASC 350. After such an endeavor, our valuation team can perform the spreadsheet analysis or a cost-effective summary report or detailed report. We perform all service options. However, we have also found many auditing firms will to accept our independent spreadsheet analysis or summary report due to our reputation and accessibility. At NAV, we don’t deliver our results and walk away. We work tirelessly with auditors in answering questions. The report size and deliverable may vary by client and company performance. The rigorous analysis and valuation procedures supporting our conclusion does not.  

Overview of ASC 350 Steps

 

ASC 350 dictates that companies must initiate goodwill impairment testing at three distinct moments. In testing for goodwill impairment, the valuation analyst must first perform a business valuation of the reporting unit purchased.   The three moments for testing goodwill impairment are as follows:  

  • Transitional Test: when the firm adopted ASC 350 or its predecessor, SFAS No. 142.
  • Trigger Test: when an event indicates likely impairment 
  • Annual Test: companies test goodwill annually for impairment.  

The first instance is the transitional test. The transitional test is likely a distant memory for most companies. The transitional test was required in the first year that SFAS No. 142, the predecessor to ASC 350, was adopted. Considering SFAS No. 142 originated in 2001, virtually all companies in business then have tested for initial goodwill impairment at some point.   The second type of instance mandating a goodwill impairment testing is a triggering event. For publicly-traded companies, a triggering event is often a steep decline in stock price. This loss is market capitalization is a clear indicator of possible goodwill impairment. Other financial indicators that may generate a triggering event test include 1) negative cash flows or negative profits, 2) missed projections, and 3) macroeconomic variables such as industry dangers and risks.  

Many companies assume a triggering event automatically implies a goodwill impairment is likely. This is not necessarily the case. A triggering event is equivalent to a doctor’s appointment initiated by symptoms. In both circumstances, everything may be fine in the end. However, a thorough examination is still necessary to establish certainty. The same logic applies to a triggering event that can be caused by weakness in a company and/or its industry outlook. These events may be temporary or there may signal a new industry or company condition. In these situations, the valuation analyst plays a critical role in independently analyzing both the company and its industry outlook.   Lastly, goodwill is test annually under ASC 350 as part of the audit.    

In testing for goodwill impairment, the valuation analyst must first perform a business valuation of the reporting unit purchased. The goodwill and intangible value of the reporting unit is then allocated to both tangible and intangible components.   After the business enterprise value is established for the reporting unit where goodwill is allocated, goodwill impairment testing is performed in two steps.   Step 1 computes the fair value of the business reporting unit’s equity value to its carrying book value of equity.

Since the business enterprise value of the reporting unit was already established, Step 1 is the allocation of this overall reporting unit fair value of equity to tangible and intangible components. Simply put, if the fair value of the reporting unit’s equity exceeds the book value of equity, then Step 1 is passed and there is no goodwill impairment.   If the business reporting unit fails Step 1, then Step 2 is initiated. Step 2 is similar to a purchase price allocation under ASC 805. Step 2 analyzes and values all the tangible and intangible assets of a business reporting unit. This process under Step 2 quantifies the amount of goodwill impairment testing.