Newsletter – January 2011
Impairment Testing: How does US GAAP Differ from IFRS
Due to the current economic conditions, more entities will be looking at the value of long-lived assets they are holding and recognizing that possible impairment may be imminent.
This article looks at the differences in impairment testing for long-lived assets with limited life between Generally Accepted Accounting Principles (US GAAP) and International Financial Reporting Standards (IFRS). Little attention has been paid to the differences in impairment testing between GAAP and IFRS.
Significant differences in the testing for potential impairment of long-lived assets with limited life may lead to earlier impairment recognition under IFRS. The key distinction between the impairment testings, is the use of a two-step model under GAAP that begins with undiscounted cash flows, compared with the one-step model used under IFRS, which considers recoverability of the asset value from the application of an entity-specific discounted cash-flow or a fair value measure. This distinction may make a significant difference between an asset being impaired or not.
Long-lived assets include purchase of assets such as brands that are assigned a limited life. Under GAAP, the undiscounted cash flows of the long-lived assets will be considered to see if there is impairment.
Impairment under FASB ASC, 350 is not likely, since the original purchase price was determined using discounted cash flows under FASB ASC, 805.
Impairment of Long-Lived Assets with limited life.
Requires a two step impairment model:
Step 1: The asset carrying amount is first compared with the undiscounted cash flows it is expected to generate. If the carrying amount is lower than the undiscounted cash flows, no impairment loss is recognized and step 2 is not necessary. If the carrying amount is higher than the undiscounted cash flows then step 2 quantifies the impairment loss.
Step 2: An impairment loss is measured as the difference between the carrying amount and fair value.
Requires a one step impairment model
The carrying amount of the asset is compared with the recoverable amount (which is the higher of an asset’s fair value less costs to sell and its value in use.), with any excess of recoverable amount over carrying amount representing the impairment loss. The fair value is the amount obtainable from the sale of an asset in an arm’s length transaction between knowledgeable, willing parties. Value in use of an asset is the discounted present value of the future cash flows expected to arise from the continuing use of an asset, and from the disposal at the end of its useful life.
Long-Lived Assets with limited life: Impairment Testing Compared
Step 1 of the GAAP testing, the comparison of the carrying value of the assets to its undiscounted expected cash flows, inevitably results in a lower level of occurrence of impairment losses for long-lived assets under GAAP than under IFRS.
In December 17, 2010, the FASB issued Accounting Standards Update No. 2010-28, Intangibles-Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (a consensus of the FASB Emerging Issues Task Force).
Under Topic 350 on goodwill and other intangible assets, testing for goodwill impairment is a two-step test. When a goodwill impairment test is performed (either on an annual or interim basis), an entity must assess whether the carrying amount of a reporting unit exceeds its fair value (Step 1). If it does, an entity must perform an additional test to determine whether goodwill has been impaired and to calculate the amount of that impairment (Step 2). The objective of this Update is to address questions about entities with reporting units with zero or negative carrying amounts because some entities concluded that Step 1 of the test is passed in those circumstances because the fair value of their reporting unit will generally be greater than zero. As a result of that conclusion, some constituents raised concerns that Step 2 of the test is not performed despite factors indicating that goodwill may be impaired. The amendments in this Update do not provide guidance on how to determine the carrying amount or measure the fair value of the reporting unit.
How New Pronouncement Differs From Current US GAAP
The amendments in this Update modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that impairment may exist. The qualitative factors are consistent with the existing guidance and examples in paragraph 350-20-35-30, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
The amendments in this Update modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. As a result, current GAAP will be improved by eliminating an entity’s ability to assert that a reporting unit is not required to perform Step 2 because the carrying amount of the reporting unit is zero or negative despite the existence of qualitative factors that indicate the goodwill is more likely than not impaired. As a result, goodwill impairments may be reported sooner than under current practice.
For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted.
For nonpublic entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Nonpublic entities may early adopt the amendments using the effective date for public entities.
On December 21, 2010, the FASB issued Accounting Standards Update No. 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations (a consensus of the FASB Emerging Issues Task Force).
The objective of this Update is to address diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations.
Paragraph 805-10-50-2(h) requires a public entity to disclose pro forma information for business combinations that occurred in the current reporting period. The disclosures include pro forma revenue and earnings of the combined entity for the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma revenue and earnings of the combined entity for the comparable prior reporting period should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. In practice, some preparers have presented the pro forma information in their comparative financial statements as if the business combination that occurred in the current reporting period had occurred as of the beginning of each of the current and prior annual reporting periods. Other preparers have disclosed the pro forma information as if the business combination occurred at the beginning of the prior annual reporting period only, and carried forward the related adjustments, if applicable, through the current reporting period
The amendments in this Update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only.
The amendments in this Update also expand the supplemental pro forma disclosures under Topic 805 to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business Combination included in the reported pro forma revenue and earnings
The amendments in this Update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.