Big changes in store for goodwill testing, report says

Big changes in tax and accounting rules should produce big changes in goodwill impairment testing this year, according to a new report from Mercer.

The Tax Cuts and Jobs Act, for example, has produced a number of changes for companies to consider in both their qualitative and quantitative assessments of any goodwill sitting on their balance sheets. Companies are required under Accounting Standards Codification Topic 350 to test goodwill, which is an intangible asset that results from mergers or acquisitions, to determine if its value is holding up or should be marked down.

The standard tells companies to consider things like macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, other entity-specific events, asset impairments, major dispositions, or sustained declines in share price when making the first-step qualitative assessment of whether goodwill might be holding up. Many of those same factors have seen significant change as a result of tax reform under the 2017 year-end tax legislation, some of which might support goodwill values and some not, Mercer points out.

Quantitative assessments of goodwill might also look different for companies as a result of tax reform, the firm points out. A reduction in the tax rate might contribute to higher fair values for reporting units, and bonus depreciation provisions could accelerate the timing of tax benefits in a way that might provide some marginal effects on values, the report says. Limitations on the deductibility of interest is likely to have an adverse effect on “only a small minority of companies,” Mercer predicts.

An increase in the after-tax cost of debt is likely to also be a factor, the report says. “On balance, we expect the negative effect from higher costs of capital to be smaller than the positive cash flow effect from lower tax rates,” Mercer says.

New accounting rules on measuring and reporting financial instruments could also affect impairment testing, Mercer says. Accounting Standards Update No. 2016-01, codified under ASC 825, took effect at the beginning of 2018 to require a new method for reporting equity investments, among other holdings. If companies elected an alternative that permits an investment to be reported at cost, the standard still calls for impairment testing, the report says.

The Financial Accounting Standards Board has taken a number of steps to simplify impairment testing in recent years, most notably permitting companies to perform a qualitative assessment as a starting point and doing away with the most onerous step of measuring an impairment if testing indicates goodwill should be written down.