FASB Retreats on Goodwill Reform

Well, good riddance to the proposed reform of goodwill accounting. The Financial Accounting Standards Board has shelved a plan that would’ve had companies amortize their goodwill assets over a fixed period, and instead will maintain the longstanding rule that companies must test goodwill at least once a year and then write down the value if necessary.

FASB made that decision Wednesday, voting 7-0 to end its goodwill accounting project despite tinkering with the amortization idea for several years. In the final analysis, board members said, the details of implementing amortization simply wouldn’t generate enough benefit for investors and corporations to be worth the effort. 

That’s not to say the current rule for annual testing and impairment is much better. It often depends on subjective judgment, and investors have long complained that they don’t have enough insight into how or why a company decides to declare an impairment; they just pick up the pieces after the company detonates an impairment bomb in the middle of an earnings release. 

Still, amortization of goodwill was one of those ideas that sounded much better than it ever would’ve been in practice. So FASB finally came to its senses and decided to stick with the devil we already know.

“Are we trading one set of challenges with a different set of challenges?” FASB vice chair James Kroeker asked during Wednesday’s meeting. “I need to try and avoid what I would call standard-setting hubris of thinking my answer is better than all of the answers we’ve tried in the past.”

Phrase it any way you want, FASB. The financial reporting community can just breathe easier that this star-crossed idea of amortization has been put out of its misery.

Why Goodwill Matters

First, let’s remember what goodwill is. When one company buys another, goodwill is that portion of the purchase price above the fair value of all the target’s other assets and liabilities once you net those items out. It’s an intangible asset that represents, say, customer loyalty to the company you’re acquiring, or the perceived excellence of the company’s products.   

Goodwill matters because for many companies it can be an enormous part of the balance sheet, especially among tech companies or highly acquisitive firms. At semiconductor company Broadcom, for example, goodwill was 57 percent of total assets for 2021. At Salesforce.com, it’s 50 percent. I’ve seen some firms where goodwill is more than 90 percent of total assets. 

So should companies amortize those assets over time, and watch that value slowly evaporate? Or should they keep that value until an impairment is necessary, and suddenly shareholders see their equity shot in the gut? Which method is a better way to reflect the true value of an acquisition, and the judgment of the management team that agreed to pay that price? 

Accountants have bickered over those questions for decades, with no clear answer. Nobody really loves the impairment method, which has been around for 20 years now; but its supporters say impairment provides at least some information to investors. Namely, when a company discloses an impairment, it’s essentially admitting that the acquisition hasn’t lived up to expectations. Investors can then use that insight to, say, tar and feather the CEO for bungling the deal. 

Amortization would take that information away. Hence we saw groups such as the CFA Institute come out forcefully against amortization, and even SEC chief accountant Paul Munter fired off a statement early this year warning FASB to think long and hard before pulling the amortization trigger

So we’re sticking with the impairment method… and all the internal control issues that come along with it.

Internal Control Issues Remain

Goodwill accounting is slippery under the best of circumstances. Companies must test the value of their goodwill assets at least annually, plus amid any other significant change in circumstance. That could be anything from a sharp, sustained fall in share price, to a sudden global pandemic, to a war in Ukraine, to the return of inflation; even a big internal reorganization could warrant an impairment test. 

The challenges for internal control and accounting teams are several.

  • You need to define the trigger events that would lead to an impairment test. 
  • You need (or should have, at least) clearly defined procedures to conduct the test.
  • You need sufficiently strong internal controls to assure that your impairment test follows that procedure.

One cautionary tale comes from Sequential Brands. The SEC charged Sequential in 2020 with poor internal controls that allowed management to stall on declaring a goodwill impairment for nearly a year, during which time the impairment charge ballooned from $96 million to $304 million.

In its complaint, the SEC flagged several flaws in Sequential’s internal controls:

  • No process to identify events that would trigger a test of goodwill impairment. Instead, Sequential only required a test “as triggering events occur,” but let management decide for itself when and what those events might be. 
  • No requirement to document management’s conclusion that no triggers were identified.
  • No documentation to show that any Sequential employee was monitoring indicators of impairment — like, say, a prolonged and sharp decline in share price, which the accounting standard for goodwill specifically mentions as a triggering event (and which Sequential experienced in 2016). 

Put simply, Sequential’s internal controls to govern goodwill testing were all subjective judgment, no objective fact. That’s way too loosey goosey for a line item that might account for the majority of your company’s total assets. 

Effective internal control over goodwill assessment depends as much as possible on objective, data-driven evidence. Sure, the CFO and other financial executives still make the final decision on whether an impairment is necessary, but your internal control should be designed to force their hand — that is, the review and testing generate so much evidence that it’s nearly impossible for management to put the results aside and rely on their own subjective judgment.

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