One of the challenges faced by companies in the goodwill impairment testing process involves estimating the carrying value of a reporting unit when the corporate structure of the business has been reorganized. At Mercer Capital, we have assisted companies with this potential problem on numerous occasions.
ASC 350-20-35-39 provides guidance on assigning acquired assets and assumed liabilities to a reporting unit for goodwill impairment testing. In the ideal scenario, this process takes place during the initial purchase price allocation for an acquisition or merger. Tangible and intangible assets as well as the associated liabilities are measured at fair value and allocated to relevant reporting units.
Businesses are dynamic though, and as a company changes its products, services, and geographic markets, the need for new reporting units may emerge. Often times, resources are shared between reporting units. How should a firm go about determining which of these existing balance sheet items are allocated to the new reporting units? According to ASC 350, assigned balance sheet items should (1) relate to the operations of the reporting unit, and (2) be considered in the determination of the fair value of the reporting unit.
ASC 350-20-35-40 states:
“The methodology used to determine the amount of those assets or liabilities to assign to a reporting unit shall be reasonable and supportable and shall be applied in a consistent manner.”
The general nature of this guidance results in a number of possible methods that may be used to allocate balance sheet items between reporting units. Items may be allocated of the basis of relative sales, the number of employees, or on the basis of underlying business economics and capital needs. Certain items may require additional analysis in determining what value is appropriate to assign to each reporting unit. The equity allocated to each reporting unit may be tested for reasonableness by performing a valuation of each reporting unit. Likewise, items such as goodwill and intangible assets may require further analysis to determine the appropriate reporting unit assignment.
As businesses evolve, so do their financial reporting needs. Proper assignment of balance sheet items to reporting units can help ensure a smoother goodwill impairment testing process going forward. An independent valuation expert can assist in the assignment of various assets and liabilities as part of the overall impairment testing process.
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