1. Goodwill Impairment Goodwill is not amortized. Generally, goodwill will be carried at its acquisition-date assigned value. At some future point in time, goodwill may become either partially or completely impaired. Goodwill is not amortized. Generally, goodwill will be carried at its acquisition-date assigned value. At some future point in time, goodwill may become either partially or completely impaired. SFAS 142 calls for an annual test of possible Goodwill impairment. 3-1

2. Goodwill Impairment Examples Exh. 3-15 3-2

3. Goodwill Impairment Test Step 1  Compare fair value of REPORTING UNIT to carrying value of the REPORTING UNIT Step 2  Compare fair value of GOODWILL to carrying value of GOODWILL Step 1  Compare fair value of REPORTING UNIT to carrying value of the REPORTING UNIT Step 2  Compare fair value of GOODWILL to carrying value of GOODWILL 3-3

4. Goodwill Impairment Test - Step 1 Is the Fair Value of a Reporting Unit Less Than Carrying Value? Compare the Reporting Unit’s Fair Value to its Carrying Value. If Fair Value of the Reporting Unit is < Carrying Value, GO TO STEP 2. Recompute Fair Value if the previous Fair Value cannot be used Compare the Reporting Unit’s Fair Value to its Carrying Value. If Fair Value of the Reporting Unit is < Carrying Value, GO TO STEP 2. Recompute Fair Value if the previous Fair Value cannot be used 3-4

5. Goodwill Impairment Test - Step 1 Is the Fair Value of a Reporting Unit Less Than Carrying Value? Use the most recent Fair Value if: The net assets of the reporting unit have not changed significantly since the most recent fair value determination. AND The most recent fair value determination > the carrying amount of the reporting unit by a substantial margin. AND It is remote that computing a new fair value would result in an amount < the current carrying amount of the reporting unit. 3-5

6. Goodwill Impairment Test - Step 2 If the fair value of a reporting unit < its carrying value, then Step 2 is performed. If goodwill’s fair value falls below its carrying value, then impairment has occurred, and an impairment loss (ordinary income) is recorded. If the fair value of a reporting unit < its carrying value, then Step 2 is performed. If goodwill’s fair value falls below its carrying value, then impairment has occurred, and an impairment loss (ordinary income) is recorded. Three Complexities Arise  The assignment of acquisition value to reporting units  The periodic determination of the fair values of reporting units  The determination of the implied fair value of goodwill ? 3-6

7. A Reporting Unit can be: A component of an operating segment A segment of an enterprise The entire enterprise A Reporting Unit can be: A component of an operating segment A segment of an enterprise The entire enterprise Assignment of Acquisition Value to Reporting Units To better assess potential declines in value for goodwill, the goodwill must be assigned to its related REPORTING UNIT. 3-7

8. Basis for determining fair value: Market price, if the reporting unit is publicly traded. Market price of comparable businesses. Business valuation techniques using PV. Basis for determining fair value: Market price, if the reporting unit is publicly traded. Market price of comparable businesses. Business valuation techniques using PV. Periodic Determination of the Fair Value of a Reporting Unit 3-8

9. Use the fair value of the reporting unit as the “purchase price”. Allocate the “purchase price” to all identifiable assets and liabilities of the reporting unit. Compare the resulting “implied goodwill” to the goodwill on the books. If “implied goodwill” < recorded goodwill, impairment has occurred. Use the fair value of the reporting unit as the “purchase price”. Allocate the “purchase price” to all identifiable assets and liabilities of the reporting unit. Compare the resulting “implied goodwill” to the goodwill on the books. If “implied goodwill” < recorded goodwill, impairment has occurred. Determination of the Implied Fair Value of Goodwill implied The “implied” fair value of Goodwill is calculated in a similar manner as the determination of goodwill in a business combination. 3-9

10. Closing Observations Related to the Testing of Goodwill for Impairment Determining the “fair value” of the reporting segment adds a new, potentially costly, periodic task of consolidated financial reporting. The fair values of the assets and liabilities of the reporting unit used in the test for impairment do not impact the amounts reported on the consolidated financial statements. A decline in the value of the reporting unit does NOT necessarily signal an impairment of goodwill under SFAS No. 142. 3-10

11. Goodwill Impairment Test Example 3-11

12. Goodwill Impairment Test Example 3-12

13. Goodwill Impairment Test Example 3-13

14. Acquisition Method – Accounting for Contingent Consideration Under SFAS 141R, the acquiring firm must estimate the fair value of any contingent performance obligation. How? Any or all of the following:  An estimate of the future cash flow(s)  Expectations about possible variations in the amount or timing of future cash flows  The time value of money, represented by the risk-free rate of interest  The price for bearing the uncertainty inherent in the asset or liability  Other factors, including illiquidity and market imperfections (These are described in FASB Concepts Statement No. 7) 3-14

15. Push Down Accounting Direct recording of acquisition-date fair value allocations and subsequent amortizations by a subsidiary Currently, there is little official guidance (Focus is on parent’s records and required consolidation procedures) Generally limited for external reporting, but increasingly popular internally 3-15

16. Summary The passage of time and the method applied by the parent in accounting for the subsidiary affect the consolidation procedures Alternative methods include initial value, partial equity and equity methods. Key worksheet entries include income recognition, allocation of values, amortization and elimination of reciprocal balances. Changes may occur in the accounting for contingent consideration involved in business combinations 3-16

17. Possible Criticisms Some critics contend that the purchase of an entity effectively creates a new entity and, therefore, valuation changes should be “pushed down” to the subsidiary’s records Goodwill impairment is controversial as some argue that it is difficult to objectively measure and can lead to financial statement manipulation WHAT DO YOU THINK ????? 3-17