Peeling away financial reporting issues one layer at a time

The Asset Impairment Song and Dance (Part 2 of 2)

My latest post was about general problems with asset “impairment” accounting —  its absurdity, high cost and dubious information value.  And I haven’t even begun to hone in on the wurst part: goodwill impairment.

It is somewhat more challenging to think about recognition and measurement of goodwill impairment when initial recognition of goodwill is itself an absurdity.  To be as generous as possible, “goodwill” refers to a collection of assets that defy description; and at wurst, and by far most often, it is a homemade sausage of errors and omissions. “Goodwill” doesn’t begin to describe hardly any of it; and I will go so far as to claim that the term term itself is at the bottom of the accounting nomenclature barrel.

Now, back to impairment. From 2001 (See SFAS 142) until very recently (and more on this later) the core of the goodwill impairment exercise boiled down to an elaborate fill-in-the-blanks protocol:

  • Step 0 — Optional, and not relevant here.
  • Step 1 — Compare the fair value of a “reporting unit” to its carrying amount. (All of the other assets in the reporting unit would have already been assessed for impairment.)
  • Step 2 — Pretend that the company purchased the “reporting unit” on the balance sheet date at its fair value. Fill in the blanks for the “implied fair value” of goodwill.  For example, assuming a fair value of $300 million for the reporting unit, individual fair values for the recognized assets and liabilities of $250 million, the implied fair value of goodwill is $50 million.  Goodwill would be written down if its carrying amount were greater than $50 million.

Accounting Sudoku.  Yet, as we have seen before, asset impairment is important to executives.  It is so important, the Financial Executive Institute in collaboration with Duff and Phelps publishes detailed surveys of goodwill impairment trends, attitudes and whatnot. But behind the impressive detail and production values, I see little information about business trends that would actually matter to investors.

This makes it important to note that FASB seems to be finally coming to terms with all of the waste it has produced by goodwill impairment testing.  ASU 2017-04 has simplified the solution to the goodwill impairment puzzle by eliminating the contrived and costly Step 2.   Henceforth, goodwill for purposes of measuring impairment will be derived from Step 1.  So, in the above example if the fair value of the reporting unit minus the carrying amounts of its non-goodwill net assets is less $50 million, goodwill would be written down.

FEI Tries to Crash the Party

Trust me, when the two-step impairment test was first put into US GAAP in  2001 accountants embraced it for all of the busy work it gave them; but it was not well-received by the folks who would be responding to those FEI surveys.  Yet, in its comment letter to the 2016 simplification proposals, the FEI expressed a reluctance for Step 2 go away completely.  It would be better, they wrote, to make Step 2 an accounting policy election.  In other words, Step 2 is only a waste of time and money if it can’t help executives manage earnings.

Same old story.  Accounting judgments should be left to the people who manage the company.  Right.  And students should be allowed to grade their own papers.

* * * * * * *

I didn’t write this post simply to add to my previous criticisms of goodwill accounting, but these are some:

My larger purpose was to add one more piece of evidence to show that investor protection becomes more imperiled the more executives become involved in the production of financial statements. The reality that policy makers must come to terms with is this:

  • The estimates that management makes that go into financial statements are biased, and that auditor’s are largely powerless to stop them.
  • The FASB’s “due process” is rigged to give management an outsized say in accounting standard setting.

Here is a case where the FEI should be applauding the FASB for acting to make goodwill accounting slightly less insane and for reducing wasted compliance costs.  Instead, it sees an opportunity to acquire more levers for executives to pull at will.

The FEI didn’t win this one, but they’ll be back.

No Comments

Leave a Comment