FASB Revisits Goodwill Accounting-Again
Community Bankers everywhere continue to wait breathlessly for the Financial Accounting Standards Board (FASB) to issue the guidance on the Current Expected Credit Loss (CECL) model, but for now will have to settle for the latest round of proposed changes in accounting for goodwill after initial recognition.
Before diving into the proposed change, it will be instructive to see where we have been on this topic, and where we are now.
Long ago, before the age of FASB (established in 1973), accounting for goodwill was governed by Accounting Principles Board Opinion No. 17 Intangible Assets. This old guidance (issued August 1970) presumed that goodwill had a finite life and thus should be amortized over that life in determining net income. It also established a maximum amortization period of 40 years.
In June 2001, FASB issued Statement No. 142 Goodwill and Other Intangible Assets. This guidance concluded that goodwill has an indefinite life and should not be amortized. Instead, goodwill is required to be tested at least annually for impairment using a two step process:
Step 1-Compare the fair value of a reporting unit (think “the Bank”) with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and the test is finished. If the carrying amount of the reporting unit exceeds its fair value, go to Step 2 to measure the amount of impairment, if any.
Step 2-Determine the current implied fair value of goodwill in the same manner used in a business combination. This means the reporting entity allocates the fair value of the reporting entity to all of the assets and liabilities of that entity (including any unrecognized intangible assets) as if the reporting entity had been acquired in a business combination. The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. If the implied fair value of the goodwill is less than the recorded amount of goodwill, an impairment loss must be recorded. Note that that amount of loss cannot exceed the carrying amount of goodwill. Also, goodwill cannot be recovered or adjusted upward if subsequent impairment tests show a recovery or increase in fair value.
Amid numerous complaints that Step 1 in this process was both costly and complex, FASB issued Accounting Standards Update (ASU) No. 2011-08 Intangibles-Goodwill and Other in September 2011. This new guidance gave reporting entities the option to first assess qualitative factors to determine if current facts and circumstances led to the conclusion that it was more likely than not that the current fair value of the reporting entity was greater than its carrying amount, including goodwill. If such a conclusion were indicated, then performing the two-step impairment test is not required. However, if such a conclusion could not be reached, then Step 1 of the impairment test must be performed, then Step 2 if necessary.
Despite this change, private company stakeholders continued to voice their concerns over the costly and complex goodwill accounting rules that resulted in providing limited decision-useful information. Accordingly, FASB issued ASU No. 2014-02Intangibles-Goodwill and Other (Topic 350) in January 2014.
This pronouncement essentially allows non-public business entities to elect an accounting alternative for goodwill. The electing entities would:
- Amortize goodwill on a straight-line basis over 10 years (or shorter period if appropriate).
- Test for goodwill impairment after a “triggering event” that would indicate that the fair value of the entity may be below its carrying amount (as opposed to annually).
- The quantitative portion of the goodwill impairment test would only include Step 1 described above. If the fair value of the reporting entity is less than the carrying amount, including goodwill, an impairment loss is recorded for the difference, not to exceed the carrying amount of the goodwill.
As a practical matter, we have not observed any community banks that have elected this alternative, as the goodwill amortization expense adversely impacts earnings which is an important component in a bank’s CAMELS rating.
Which now brings us to FASB’s most recent proposal Intangibles-Goodwill and Other (Topic 350) Simplifying the Accounting for Goodwill Impairment that was issued May 12, 2016. Once again citing the cost and complexity of the current goodwill impairment testing, FASB is proposing to do away with Step 2 of the impairment test for all entities. Within the proposal, FASB informs us that this proposal represents Phase 1 of the project. The next phase will consider whether to make additional changes to accounting for goodwill, including consideration of permitting or requiring amortization of goodwill and/or further changes to impairment testing methodology.
It seems we will have gone full circle by the time the project is completed.