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Comment Letters Support Proposed Changes to Goodwill Impairment Test

A FASB proposal to simplify the measurement of goodwill impairment calls for eliminating Step 2 in the two-step measurement process. The comment letters tended to support the board’s plan, but some asked that the second step be made optional and not eliminated.

Most of the businesses, auditors, and professional groups weighing in on the FASB’s proposal to simplify the measurement of goodwill impairment agree with its overall goal, although several express concerns about its details.

Released on May 12, 2016, Proposed Accounting Standards Update (ASU) No. 2016-230, Intangibles — Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment, calls for eliminating the second step in the two-step process to calculate how much the value of acquired goodwill drops. Comments were due on July 11.

The first step in the test requires a business to determine whether there is an impairment and then calculate the amount. Most analysts and investors are interested in the existence of an impairment as opposed to its numerical value, FASB research has shown. Businesses long have complained that the two-part exercise requires costly valuation estimates and that the number ultimately is not useful to shareholders.

Businesses that buy other businesses typically recognize the part of the purchase cost that is above the seller’s book value as goodwill. Goodwill is considered an intangible asset and includes things such as the value of the acquired company’s reputation or brand name. When the carrying amount of goodwill exceeds its fair value — that is, the value of the goodwill drops — the acquiring business must book an impairment charge.

U.S. GAAP for public companies does not allow the amortization of goodwill, but companies must test goodwill at least once a year for a decline in value.

The American Bankers Association, in its comment letter to the FASB, described the test as “an arduous process that often provides little value” to investors and regulatory examiners, as the value is excluded from a bank’s regulatory capital. The bank group said it supported the FASB’s proposal as written.

Several other parties said they supported the standard-setter’s plan in full.

The Corporate Reporting Users’ Forum (CRUF), one of the few groups of analysts and investors to weigh in on the proposal, said it supported the FASB’s move.

“It shall reduce the complexities involved in performing the impairment test for goodwill and help corporates report more cohesive numbers, i.e. whether the goodwill is actually impaired can help users determine the actual valuation for the business,” the Users’ Forum wrote.

Credit Suisse Group said the proposed change also would bring U.S. GAAP closer to IFRS.

But other parties called on the FASB to make the second step in the test optional, saying it sometimes was useful for some businesses.

Step two of the goodwill analysis provides a “more clear measurement” of the fair value of goodwill than the first step, banking company Comerica Inc. wrote.

“Although removing Step 2 in theory may decrease the complexity or cost of the goodwill analysis, it could also result in greater scrutiny to Step 1 of the analysis. In this sense, the burden will simply be shifted from one methodology to the next,” Comerica wrote.

Lincoln National Corp.’s Lincoln Financial Group said it disagreed with the plan because there are “inherent” differences between Step 1 and Step 2 calculations, and “one is not a replacement for the other.”

“We view Step 1 as a valuation of the reporting unit’s overall balance sheet and Step 2 as a specific test of the franchise value of the particular reporting unit,” the insurer and asset manager wrote. “To replace the more precise Step 2 test with the initial Step 1 screen would not result in an improvement to accounting and financial reporting.”

Financial Executives International, which represents large businesses, said eliminating Step 2 in the model would be helpful in some situations, but not all. In some cases, businesses would want to continue to perform the second step, such as trying to determine a more accurate measure of impairment, FEI wrote.

“Therefore, we believe the board should retain the current two-step model for impairment testing, but specifically allow a ‘practical expedient’ under which a company could forego Step 2 and record goodwill impairment based on Step 1,” FEI wrote.

Pfizer Inc. expressed similar views, calling for the FASB to make it optional for businesses to perform the two-step test.

On the other hand, all four Big Four accounting firms — Deloitte & Touche LLP, KPMG LLP, PricewaterhouseCoopers LLP, and Ernst & Young LLP — expressed reservations about the idea of making Step 2 an option. All four supported the FASB’s plan as written.

“We believe that retaining an option would create complexity and result in a lack of comparability,” wrote Deloitte & Touche.

The FASB’s work to simplify the accounting for goodwill impairments stems from the board’s separate efforts to make some accounting processes easier for private companies. In 2014, the FASB published ASU No. 2014-02, Intangibles—Goodwill and Other (Topic 350), Accounting for Goodwill, a Consensus of the Private Company Council, which lets private companies amortize goodwill for up to 10 years.

After it completes its discussions about Proposed ASU No. 2016-230, the FASB said it plans to consider additional changes to the subsequent accounting for goodwill, including whether to permit or require amortization of goodwill.