Current market conditions may require companies to revisit previous goodwill impairment calculations or provide more detailed analysis and support for their impairment tests. Under U.S. and Canadian GAAP, the goodwill impairment test has two steps. Step One is essentially a valuation of each business that has goodwill ("reporting unit", using comparative information and/or discounted cash flows. If the value of the business is greater than its carrying value, the testing is done, and Step Two is not necessary.
Step Two is necessary if the value calculated in Step One is less than carrying value. Step Two requires valuation of the individual assets and liabilities of the business of the reporting unit, including intangible assets. This essentially means doing a purchase price allocation ("PPA") as if the business were purchased from a third party. Goodwill is always the residual amount assets have been deducted from the business value calculated in Step One. In Step Two, impairment is measured as the excess of carrying value over the calculated value of goodwill. The following diagram outlines the steps in a PPA ("Steps" are not goodwill impairment calculation steps.)
If you can't see the entire diagram click here.
[Diagram from Grant Thornton]
Once Step One has been completed, companies should make various comparisons to ensure the reasonableness of their goodwill value. One technique is to value all reporting units to arrive at a value for the company as a whole. This helps to demonstrate that value has not been shifted from one reporting unit to another to skew the result.
Another corroborating analysis is to compare the Company's market capitalization (share price times number of shares outstanding) with the total value of the company as a whole, as calculated in the above paragraph. Generally, market cap and value of the business will differ. Reasons for this difference should be explained. Differences may include control premiums, liquidity factors, and non-public information.
More later on this.
