2013 MACPA BV FLS CONFERENCEMAY 10, 2013

“Fair Value Testing Goodwill ( and Other Identified Assets) for Impairment”

Mark L. Zyla, CPA/ABV, ASA, CFA

Objectives2

Provide Background on Impairment Testing Discuss the Two-Step Goodwill Impairment Test Discuss the FASB’s Accounting Standard Update

2011-08 allowing qualitative assessments. Discuss the AICPA’s Goodwill Impairment Working

Draft Guide Describe Best Practices and Issues Regarding

Impairment

Background Prior to FASB 142, guidance was APB Opinion No 17, Intangible Assets which

required that goodwill and other intangible assets be amortized over a period not to exceed 40 years.

In 1996, FASB decided to consider the method of accounting for goodwill because: Two methods of accounting for business combination transactions: pooling and purchase Methods of accounting affected competition in M&A markets Increased M&A activity

In connection with determining the best method to account for transactions, FASB also considered accounting for goodwill

In 1999, based on comments received from constituents, the Board decided that goodwill should no longer be amortized and should be tested for impairment.

FASB issued FAS 142, Goodwill and Other Intangible Assets in June 2001, effective for fiscal years beginning after December 15, 2001

Now FASB ASC 350, Intangibles - Goodwill and Other

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Impairment Testing4

“Impairment is the condition that exists when the carrying amount of a long lived asset (asset group)

exceeds its fair value.” FASB

FASB ASC 350, Intangibles - Goodwill and Other Describes the tests for impairment of goodwill and

indefinite lived assets.

FASB ASC 360, Property, Plant and Equipment Describes the test for impairment of definite lived assets.

FASB continues to update: Issuance of ASU 2010-28 Issuance of ASU 2011-08

Goodwill Impairment Studies

KPMG published a study that analyzes goodwill impairment for public companies from January 2005 through December 2010.

As shown below, the number of companies that recorded goodwill impairment losses have declined over the past three years.

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0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

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100

150

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300

350

2005 2006 2007 2008 2009 2010

Annual Goodwill Impairment Trend

Total number impaired Percentage impaired

Source: KPMG’s “Evaluating Impairment Risk: Goodwill impairment continues its downward trend in 2010” Study

Goodwill Impairment Studies Duff & Phelps and the Financial Executives Research Foundation published the

“2010 Goodwill Impairment Study” which provides an analysis of the companies examined over the 12-month period before and after the goodwill impairment. Purpose of the study

To report and examine the general and industry trends of goodwill and goodwill impairment of U.S. companies. To analyze the relative performance of companies that record goodwill impairment vs. the performance of the

market as a whole. To report the 2010 results of the annual goodwill impairment survey of Financial Executives International

members (FEI)

Highlights of the Study Compared to 2008, the total amount of goodwill impaired in 2009 declined by over 80 percent. Financial service firms had the greatest proportion of total impairments in 2009. Over 70 percent of total

impairments were recognized in the financial services, industrials and information technology sectors. Most of the underperformance of companies that recorded goodwill impairment occurs prior to the actual

impairment charge, indicating that in general, investors are aware of the issues that may lead to a subsequent impairment long before the actual impairment is taken.

FEI members were asked whether they performed an interim goodwill impairment test in either 2009 or 2010. Fifty percent of the respondents indicated they had, with nearly 30 percent citing economic declines as the triggering event.

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Source: Duff & Phelps and the Financial Executives Research Foundation’s “2010 Goodwill Impairment Study”

Acuitas, Inc. Study of Audit Deficiencies7

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40

60

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2008 2009 2010

Num

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of D

efic

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Deficiency Trends

FVM Deficiencies

Impairment Deficiencies

Other Deficiencies

Goodwill Impairment (Topic 350)

Goodwill is not amortized, but tested for impairment at the reporting unit level (the operating segment or one level below).

The fair value of goodwill can be measured only as a residual of all other assets.

If condition exists that it is “more likely than not,” that fair value of reporting unit is less than its carrying value, then the FASB requires a two-step impairment test to identify potential goodwill impairment and measure the amount of loss to be recognized (if any).

Topic 350 has been updated for ASU 2010-28 ASU 2011-08

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Goodwill Impairment (Topic 350) “Step Zero”

Previously, Goodwill was tested annually for impairment, or more frequently if certain events occur and circumstances change.

Entities have the option to first access qualitative factors to determine if test is necessary.

“more likely than not” fair value < carrying value then perform step one test. If not, then no need to test.

Unconditional option to skip qualitative assessments and perform step one test.

With the issuance of ASU 2011-08, the timing of the test may change.

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Step One: Goodwill Impairment Test

Identify the reporting unit Determine the fair value of the reporting unit Compare the fair value of the reporting unit to the

carrying value If the carrying value exceeds the fair value, an

impairment is indicated Perform step two of the goodwill impairment test

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Step Two: Recognition and Measurement of an Impairment Loss

Calculate the implied value of goodwill Subtract the fair value of net tangible assets and identifiable intangible

assets from the fair value of the reporting unit as of the test date. Include intangible assets not previously given recognition in the financial statements.

The difference is the implied value of goodwill

Determine whether goodwill is impaired If the implied value of goodwill exceeds the carrying value of

goodwill, there is no impairment.

If goodwill’s carrying value exceeds the implied value, a goodwill impairment exists and the difference must be written off.

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ASU 2010-28, When to Perform Step 2 of the Goodwill Impairment Test, for Reporting Units with Zero or Negative Carrying Amounts

History: Address questions about entities with reporting units with zero or negative carrying

amounts because some entities concluded that Step 1 of the test is passed in those circumstances because the fair value of their reporting unit will generally be greater than zero. As a result of that conclusion, some constituents raised concerns that Step 2 of the test is not performed despite factors indicating that goodwill may be impaired.

At the September 16, 2010 EITF meeting, the Task Force reached a consensus-for-exposure on EITF Issue No. 10-A, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.”

A proposed Accounting Standards Update was issued on October 6, 2010, with a comment period that ended on November 5, 2010.

Became affective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted.

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ASU 2010-28, When to Perform Step 2 of the Goodwill Impairment Test, for Reporting Units with Zero or Negative Carrying Amounts

Carrying value concerns: Enterprise value premise – debt is excluded from the liabilities assigned to a reporting

unit and consequently from the fair value of the reporting unit

Equity value premise - debt, like any other liability, is available for assignment to a reporting unit

FASB now requires entities with zero or negative carrying amounts to perform a qualitative assessment to determine whether an impairment exists

If an impairment is indicated using the qualitative assessment, Step 2 is performed

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FASB’s ASU 2011-08 Testing Goodwill for Impairment Objective is to simplify thus reducing the cost and complexity of performing Step 1

of the two-step goodwill impairment test

Adds an optional qualitative approach to determine whether it is more likely than not (having a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount; if so, then Step 1 is required

Applies to public and nonpublic entities

New qualitative factors replace existing triggering factors for interim goodwill impairment testing

Does not change the current guidance for testing indefinite-lived intangible assets for impairment

Published in September 2011 and effective for annual and goodwill impairment tests performed for fiscal years beginning after December 15, 2011 (early adoption permitted)

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FASB’s ASU 2011-08 Testing Goodwill for Impairment – New Qualitative Factors

General macroeconomic conditions Deterioration in general economic conditions Limitations accessing capital Fluctuations in foreign exchange rates Other developments in equity and credit markets

Industry and market considerations Deterioration in the operating environment Increased competition A decline in market-dependent multiples A change in the market for the entity’s products or services A regulatory or political development

Cost factors that have a negative effect on earnings Increases in raw materials, labor or other costs

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FASB’s ASU 2011-08 Testing Goodwill for Impairment – New Qualitative Factors

Decline in overall financial performance Negative or declining cash flows A decline in actual or planned revenues or earnings

Entity-specific events Changes in management or key personnel Changes in strategy or customers Bankruptcy or litigation

Events affecting a reporting unit A change in the carrying amount of net assets (write offs) Plans to sell or dispose of a portion or all of a reporting unit Testing for recoverability of a significant asset group within a reporting unit Recognition of goodwill impairment in a component of the reporting unit

A sustained decrease in share price, both absolute and relative to peers

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Issues to Consider Under the New ASU

How does one audit qualitative factors? Accounting firms are just recently developed internal guidance.

In some respect, there will have to be “quantitative” analysis to support “qualitative” factors.

Focus on impairments may shift from valuation analysis to perception of audit risk.

Gap between public and private entities in certain circumstances as to audit requirements.

Still a potential opportunity for valuation specialists. Step Zero Testing less likely as time passes from previous quantitative

measurements.

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ASC Topic 360 Property, Plant & Equipment

Guidance of Testing Long Lived Assets subject to depreciation or amortization for impairment.

Compares sum of undiscounted cash flows to carrying value.

Typically measures asset groups.

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IFRS Impairments Long lived assets

Impairment test is a one step test based on whether impairment indicators exist.

Impairment loss is excess of carrying value over recoverable amount, which is higher of fair value less cost to sell, or value in use

Goodwill One step impairment test comparing cash generating unit’s carrying

amount to its recoverable amount Impairment loss is carrying value less recoverable amount Loss is allocated to reduce goodwill to zero and other assets are

reduced based on their prorate carrying amounts

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IFRS Impairments

Indefinite lived intangible assetsLoss is equal to the amount by which carrying

value exceeds recoverable amounts Reversal of losses

Prohibited for goodwillOther long term assets must be reviewed

annually for reversal indicatorsReversal can not exceed initial carrying

amount adjusted for depreciation or amortization

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THE WORKING DRAFT OF AICPA GUIDE –TESTING GOODWILL FOR IMPAIRMENT

http://www.aicpa.org/interestareas/frc/accountingfinancialreporting/pages/workingdraftofaicpaguidetestinggoodwillforimpairment.aspx

Applying ASC 820 Framework to Reporting Units Step 1: Determine the unit of account Step 2: Determine the valuation premise Step 3: Identify the potential markets Step 4: Determine market access Step 5: Determine the fair value

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Assigning Assets and Liabilities to a Reporting Unit – Additional Considerations

Debt recognized at the corporate level Deferred taxes related to assets and liabilities

of a reporting unit Cumulative translation adjustment Contingent consideration arrangements Non-controlling interests

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24 Issues Regarding Impairment and Best Practices

Issues and Best Practices of Measuring Fair Value of a Reporting Unit Highest and best use: Issue - current use of a specific reporting unit may be different

from how a market participant may intend to hold the same net assets.

Best practice – consider the interrelationships or synergies among the reporting units to determine the fair value of each.

Discounted cash flow method: Issue – are market participant assumptions reflected? Best practice – incorporate market participant assumptions in the

prospective financial information (PFI) (i.e. cash flows and weighted average cost of capital).

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Issues and Best Practices of Measuring Fair Value of a Reporting Unit

Consideration of Market Participant assumptions in management’s PFI. Issue -Planned acquisition activity In general assumptions should not include planned acquisition

activity.

Issue - Working Capital Adjustments may be necessary if not at normal levels.

Issue - Deferred Revenue PFI should be modified to reflect cash flows.

Issue - Non-operating assets and liabilities PFI should be analyzed to see if adjustments should be made.

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Issues and Best Practices of Measuring Fair Value of a Reporting Unit Legal form of reporting unit: Issue – legal forms where the reporting units is not subject to the

payment of income taxes however a market participant would subject to income taxes.

Best practice – in most cases the discounted cash flows should be calculated on an after-tax basis to ensure consistency with market participant assumptions.

Depreciation and amortization amounts: Issue – depreciation and capital expenditures are usually equal in

the terminal period. Best practice – consider, in some cases, capital expenditures may

exceed depreciation for companies involved in capital intense industries.

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Issues and Best Practices of Measuring Fair Value of a Reporting Unit Share-based compensation: Issue – management’s PFI may include an upward

adjustment for share-based compensation. Best practice – noncash expenses related to share-based

payments should not be included as an adjustment as they are already captured in PFI as other accruals.

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Challenges – Use of Market Approach

Recent securities markets volatility has led to less comparability If the subject company is distressed, then comparative companies would also be distressed Appraisals based on comparable data will face more scrutiny by courts, regulators and lenders Some advocate using average multiples over a longer period rather than valuation date multiples Others believe Price to Projected Earnings Multiples are more relevant

Comparables come and go – affected by M&A activity FASB Guidance in FSP FAS 157-4 In bankruptcy, additional adjustments to the subject company may be

needed Special financing terms Restrictions imposed by the bankruptcy court

Other methods may be preferable in turbulent times Compare the FVM to external value indications

Market capitalization of entire entity.

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Questions?

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Mark L. Zyla is a Managing Director of Acuitas, Inc. an Atlanta, Georgia based valuation and litigation consultancy firm. Mark has provided valuation consulting for various types of entities for a wide variety of purposes.

Mark received a BBA degree in Finance from the University of Texas at Austin and an MBA degree with a concentration in Finance from Georgia State University. Mark also completed the Mergers and Acquisitions Program at the Aresty Institute of The Wharton School of the University of Pennsylvania and the Valuation Program at the Graduate School of Business at Harvard University. He is a Certified Public Accountant, Accredited in Business Valuation (“CPA/ABV”), Certified in Financial Forensics (“CFF”) by the AICPA, a Chartered Financial Analyst (“CFA”), and an Accredited Senior Appraiser with the American Society of Appraisers certified in Business Valuation (“ASA”).

Mark is a member of the American Society of Appraisers (“ASA”), the American Institute of Certified Public Accountants (“AICPA”), and the CFA Institute. He was a member of The Appraisal Foundation’s Business Valuation Best Practices Working Group on Contributory Asset Charges and the AICPA’s Fair Value Resource Panel. He is currently working on the AICPA’s Goodwill Impairment Guide Task Force. He is also the Chairman of the AICPA’s Fair Value Measurement Conference Committee. Mark is a former member of the Business Valuations Committee of the AICPA, and a former Chairman of the ABV Examination Committee of the AICPA. He is also a member of the Business Valuation Standards Subcommittee of the ASA.

Mark is a frequent presenter and author on valuation issues. Mark is the co-author of the courses, “Fair Value Accounting: A Critical New Skill for All CPAs” and “Accounting for Goodwill and Intangible Assets” published by the AICPA. He is the author of Fair Value Measurement: Practical Guidance and Implementation, 2nd ed. Recently published by John Wiley & Sons.

mzyla@acuitasinc.com

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Mark L. Zyla, CPA/ABV, CFA, ASA