5. Goodwill impairment: a primer on SFAS 142

Explaining SFAS 142: Goodwill and Other Intangible Assets

If you've been through an M&A transaction in the past few years, you've experienced the need for a purchase price allocation to stay in compliance with Generally Accepted Accounting Principles (GAAP) according to SFAS 141. As you proceed along the often bumpy path of managing such acquisitions, you may have the unlucky experience of requiring further analysis for goodwill impairment required by SFAS 142. Read on.

As you may know, SFAS 141 is that new-ish accounting rule (circa 2001) associated with Fair Value measurements pertaining to M&A transactions. This is the one that did away with the old pooling-of-interests accounting method. Briefly, SFAS 141 requires companies to allocate long-lived intangible assets, formerly bundled into the single “goodwill” line item, into various different buckets including things such as customer relationships, trademarks, technology, and others including good old goodwill. As it turns out, this is quite an exercise, and it warrants the help of valuation boutiques such as Arcstone to do the work properly. In the words of Lynn Turner, former Chief Accountant of the SEC,

“…in almost every instance, companies will be required to obtain the assistance of a competent and knowledgeable professional to assist in the valuation of these intangible assets.”

Now, as if allocating goodwill across several new asset classes weren't enough, here comes more. SFAS 142 requires that companies perform an at-least annual valuation test for possible impairment of intangible assets (aka goodwill). If your acquired entities aren't performing to expectations, you may be facing impairment. Goodwill impairment is defined as the point at which today's Fair Value of goodwill (in all its various buckets) is worth less than what appears on your books.

Sometimes impairment is easy to see and measure; sometimes it’s a close call. Either way, if the test suggests possible impairment, your company will require a new, full analysis of goodwill, called a Step II analysis. It's called Step II because Step I is discovering your goodwill may be impaired, and Step II is figuring out what the value of the goodwill should be (again, in all its various forms). The Step II analysis is the equivalent of a purchase price allocation. Quite an exercise. Only this time it's slightly less fun, since you will likely be marking down your assets to their current (lower) Fair Value, and taking a charge on your income statement.

Said differently, in order to determine the implied Fair Value of the goodwill, all assets must be valued and adjusted downward, where appropriate, to their current Fair Value. If the carrying amount of goodwill exceeds the implied Fair Value of that goodwill, then an impairment loss must be recognized for an amount equal to the deficiency.

In times of financial upheaval, asset re-valuations are common. If you think you might need some help in this department, give us a ring. We'll do our best to make the process as painless as possible.