Recession, Market Meltdown Put Focus on Goodwill Impairment
The sharp decline in stock market indices through the first eleven months of 2008 has shaved over $5.0 trillion off the equity market capitalization of companies in the S&P 500. The falling market valuations reflect both a reduced appetite for risk and an expectation that corporate cash flows will be pressured as the global economy enters a recession of unknown depth and duration.
For auditors and financial statement preparers, the bear market suggests that the goodwill reported on many corporate balance sheets may be impaired. The accounting for goodwill, the amount paid in excess of net identifiable assets in previous acquisitions, is set forth in SFAS 142, Goodwill and Intangible Assets. SFAS 142 provides for an annual impairment test for goodwill, rather than systematic amortization as under prior guidance. The two-step impairment test starts with a comparison of the reporting unit's fair value to carrying value. Impairment is indicated if the fair value of the reporting unit is less than carrying value. Step 2 of the impairment test involves quantifying the amount of impairment by determining the implied fair value of the reporting unit's goodwill.
A broad look at the S&P 500 provides some clues regarding the magnitude of potential impairment for companies throughout the economy. In the following table, we compare the market capitalization of companies in the index to their respective book values. While the actual analysis for an individual company depends on reporting unit structure and a host of other unique facts and circumstances, consideration of the price/book multiple is often viewed as a reasonable proxy for assessing where goodwill impairment is likely to exist.