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Important trends in goodwil impairment.

Approximately $21 billion of goodwill impairments were recorded by U.S. public companies in calendar year 2013, representing a 59 percent decrease from the $51 billion reported in the prior year, according to the Duff & Phelps 2014 U.S. Goodwill Impairment Study. The 2013 aggregate impairment is at the lowest level since the height of the financial crisis in 2008, which is also consistent with U.S. macroeconomic and stock market trends.

Of particular interest in this year's survey of Financial Executives International (FEI) members is the continued uptick in the use of Step 0, with public companies increasing their usage rate from 29 percent to 43 percent, and private companies following a similar trend, rising from 22 percent to 29 percent. Further, a significant number of public company respondents (42 percent) preferred to use the traditional quantitative test. Among respondents that did not have such preference, almost 75 percent indicated Step 0 was being used for some or all reporting units, marking a significant increase over last year's 53 percent.

Recognizing that the population of respondents to the surveys varies from year to year, and that the survey results are based on a relatively small number of respondents, Duff & Phelps undertook an additional independent analysis of public company disclosures to further examine the trend of Step 0 use for public companies. This Step 0 Study indicated an overall increase in the application of the qualitative goodwill assessment by public companies from 33 percent to 41 percent, consistent with the FEI survey findings.

History of the Studies

Duff & Phelps and the Financial Executives Research Foundation (FERF) first published the results of their Goodwill Impairment Study in 2009. This inaugural study examined U.S. publicly traded companies' recognition of goodwill impairment at the height of the financial crisis (the end of 2008 and the beginning of 2009), as well as the findings of a survey of FEI members. The 2010 Goodwill Impairment Study expanded the time horizon over which goodwill impairments were studied to five years, and modified the dataset to enable a more in-depth assessment of goodwill impairment trends over time. Industry Spotlights were introduced in 2012, along with cross-tabulation analyses.

The 2013 study added two new comparison tables that bridged industry trends along with other summary data; these tables have been updated and continue to be included this year.

Goodwill Landscape

Now in its sixth year of publication, the 2014 study continues to examine general and industry goodwill impairment trends observed through December 2013, and reports the 2014 results of the annual goodwill impairment survey of FEI members.

Figure 1 captures the evolution of goodwill in the study from 2009 through 2013 to aid in assessing goodwill balances and goodwill impairment trends over time. Mergers and acquisitions (M&A) activity summarizes the transactions (both number of deals and value) by U.S. publicly-traded companies to acquire a 50 percent or more controlling interest (as only a change of control would trigger the recording of goodwill).

2014 Highlights and Trends

* U.S. companies in the study recorded $21 billion of goodwill impairment in 2013, a 59 percent decrease from $51 billion in 2012. This marks the lowest aggregate impairment amount since the level reported in 2008, at the height of the financial crisis.

* The concentration of goodwill impairments attributable to the three largest impairment events declined from 47 percent to 22 percent.

* Industry concentration also declined, with 52 percent of the 2013 aggregate amount of goodwill impairments attributable to three industries: materials, health care and industrials (versus 67 percent for the top three industries in 2012).

* Overall deal volume and value declined for transactions involving a greater than 50 percent interest acquired by U.S. publiclytraded acquirers (see Figure 1). There was a 47 percent decrease in deal value, leading to a drop in additional goodwill recorded on balance sheets from $211 billion in 2012 to $147 billion in 2013. Interestingly, this is in stark contrast to the trend seen for the overall U.S. M&A market during 2013. Most 2013 reviews of U.S. M&A deal activity in the financial press tend to use different parameters to compile data. Specifically, they typically looked at 2013 announced deals (rather than closed), and included transactions for any ownership interest (both controlling and minority) by both public and private company acquirers. If one were to use such parameters, the deal value in the U.S. M&A market would have increased for 2013 (in contrast to the trend seen in Figure 1), while the number of deals would have still suffered a small decline.

* About 43 percent of all U.S. companies carried some amount of goodwill on their balance sheet; unchanged from the prior year.

* Of the companies carrying goodwill, 8.6 percent recognized a goodwill impairment in 2013, a decrease from 10.5 percent in 2012. This contrasts with the findings of the 2014 survey where 30 percent of public company respondents reported a goodwill impairment (down from 37 percent in the prior year's survey).

* The average impairment amount was $108 million. This represents a 50 percent decline from the prior year (although, it is noted that 2012 was characterized by the occurrence of three very large events, skewing the data upwards) and is now approaching the low of $86 million in 2009.

Industry Insights

* Materials jumped from fifth place in 2012 to first place in 2013 as the industry with the highest amount of goodwill impairment ($4.5 billion), replacing information technology (IT). While IT had reported $22 billion of goodwill impairments in 2012, the top two events accounted for 90 percent of the total (or $19.9 billion); excluding those two events would have resulted in a goodwill impairment amount of $2.1 billion, which is more in line with the $1.4 billion recorded in 2013.

* Industrials had the largest percentage of companies with impaired goodwill (7 percent), followed by IT and consumer discretionary (both at 6 percent).

* Over the 2009-2013 period, industrials had the highest percent of companies with goodwill on the books in any given year (62 percent on average), while financials had the lowest proportion (29 percent on average).

* In aggregate, the proportion of companies carrying goodwill that recorded goodwill impairment ranged from 7 percent to 13 percent during the five-year period. Energy is the only industry to have exhibited an upward trend in impairment during the entire period.

* Goodwill intensity (goodwill as percentage of total assets) for the study in total held fairly stable over the years at approximately 6 percent. Industrials is the only sector to have shown a consistent upward trend over the 2009-2013 period, with goodwill intensity increasing from 12 percent in 2009 to 16 percent in 2013.

2014 FEI Member Survey Highlights

FEI and Duff & Phelps surveyed FEI members in the summer of 2014, focusing on recent goodwill impairment trends and valuation methodologies utilized. Insights gained from these annual surveys provide a helpful benchmark for companies as they undergo their respective impairment analyses. Following are some highlights from this year's survey.

* QUALITATIVE IMPAIRMENT TESTS. The Financial Accounting Standards Board (FASB) finalized guid anee on optional qualitative impairment testing for goodwill in late 2011 (codified by ASU 2011-08) and for indefinite-lived intangibles in mid-2012 (codified by ASU 2012-02). ASU 2011OS gives public and private companies the option to first assess qualitative factors to determine whether the fair value of a reporting unit is not "more likely than not" (greater than a 50 percent likelihood) less than its carrying amount. This is now commonly referred to as "Step 0". Notably, public companies demonstrated a higher usage rate of Step 0 (43 percent) than private companies (29 percent).

A large proportion of both public (42 percent) and private (31 percent) companies stated they prefer to bypass Step 0 and proceed directly to applying the quantitative Step 1 test. This may be an indication they have grown accustomed to the quantitative testing process and in some cases may also see some incremental benefits beyond a compliance exercise.

Even more interesting, if the respondents who prefer to proceed directly to the quantitative test were excluded, 75 percent of the remaining public company respondents elected to apply Step 0 to some or all of their reporting units. This is a stark increase from 53 percent in the prior year's survey.

* GOODWILL IMPAIRMENT TRENDS. Consistent with improvements seen in the general U.S. macroeconomic environment, the proportion of public company respondents recognizing goodwill impairment in 2013 (30 percent) is less than in last year's survey (37 percent). Impairment rates for private company respondents continued their decline from 23 percent to 15 percent in 2013.

* COST REDUCTION OBJECTIVE. Overall, half of the respondents believed Step 0 met its stated objective. Notably, of those companies that actually applied Step 0, 78 percent were satisfied that the cost reduction objective had been achieved.

* SMALL PRIVATE VS. LARGE PUBLIC COMPANIES. Several cross-tab analyses were performed to draw some insights into specific subsets of the respondents to the 2014 survey. For instance, responses for small private companies (with revenue less than $100 million) were contrasted to those of large public companies (with revenue greater than $1 billion).

Almost half of both groups believed Step 0 meets the objective of reducing costs (43 percent private and 47 percent public companies), and the two groups also aligned regarding their expected use of Step 0 in the future, if they had not used it in the past (41 percent and 43 percent, respectively). Small private companies are far more likely to perform the analysis in-house than large public companies (71 percent vs. 43 percent), yet they continued to be less aware of the AICPA Goodwill Impairment guide (48 percent vs. 26 percent, small private vs. large public companies, respectively).

* PREFER QUANTITATIVE TEST VS. APPLICATION OF STEP 0. An additional series of cross-tab analyses were performed to assess whether there were differing views between all respondents that preferred using the quantitative Step 1 test and those that applied Step 0. Companies that preferred the quantitative test were more likely to be aware of the AICPA Goodwill Impairment Guide (67 percent) relative to those electing to apply Step 0 (58 percent). At the same time, companies applying Step 0 were twice as likely to believe Step 0 meets the objective of reducing costs, compared to those that preferred the quantitative test (78 percent vs. 41 percent).

Step 0 Study

ASU 2011-08 aims to simplify how public and private entities test goodwill for impairment. Its objective is to reduce the cost and complexity of performing the first step of the two-step goodwill impairment test under Topic 350, Intangibles--Goodwill and Other. Under this ASU, a company is not required to calculate the fair value of a reporting unit, if the company determines its fair value is not "more likely than not" (greater than 50 percent likelihood) less than its carrying amount. The heightened recent interest in the topic of goodwill impairment by a variety of constituents, and the recent FASB discussions on the most appropriate model for goodwill accounting, prompted Duff & Phelps to perform a more expansive assessment of the use of Step 0, beyond the public company responses to the annual FEI member surveys. This more rigorous, statistically significant analysis provides a better gauge as to the extent to which companies have embraced the qualitative assessment option.

The Step 0 Study expands on the FEI member surveys by evaluating the disclosures of a random selection of 355 U.S. public companies reporting under U.S. GAAP that carry goodwill on their balance sheets. The evaluation of disclosures required significant judgment at times. In some cases, companies made a positiue assertion as required by ASU 2011-08 (Basis for Conclusions, paragraph 24), which unambiguously indicated they are Step 0 users ("Definite Users"); other companies had disclosures that varied greatly in the nature of the discussion and information provided. Companies that described Step 0 as an integral part of their impairment testing process--but stopped short of making an explicit positive assertion --were considered to be likely Step 0 users ("Probable Users").

Overall, Step 0 users (comprising Definite Users and Probable Users) increased from 33 percent (2012) to 41 percent (2013) (see Figure 2). It is noteworthy that while this study was more expansive than the FEI Surveys and has statistical significance, the indications about public companies' use of Step 0 in both are quite comparable.

It is also possible the Step 0 results observed fall on the conservative side. Not all companies may be aware of FASB's intent to make a positive assertion about the use of Step 0. This guidance is included in the Basis for Conclusions of ASU 2011-08 and is not incorporated in FASB's Accounting Standards Codification. Further, it is also possible there were some Step 0 users among the other companies where the disclosures were not as clear.

Beyond simply analyzing the prevalence of Step 0 use, the study also evaluated various attributes to assess whether they were indicators or predictors of Step 0 usage. Demographic attributes including market capitalization; primary industry sector; carrying amount of goodwill; goodwill-to-total assets; and company auditors were all crossreferenced with the broad population to determine if any of these indicated a greater likelihood of using Step 0. However, none of these attributes provided such specific insight.

On the other hand, the market-to-book ratio did provide some insight into the use of Step 0. This is not surprising, as this ratio is an indication of the "cushion" that a company has in place. The "cushion" represents the excess of fair value of the company's capitalization over its book value (or the excess of a reporting unit's fair value over its carrying value). Since the first step of the ASC 350 test compares the fair value of a reporting unit with its book value, the market-to-book ratio has always been a meaningful indicator, albeit on an overall entity level.

Similarly, when considering the use of Step 0, a higher market-to-book ratio for the reporting unit or overall entity, as appropriate, would enter into the analysis as a factor, having a positive impact on the qualitative assessment, all else equal. Companies with a market-to-book ratio of 2 or greater were almost twice as likely to be a Step 0 user.

With more experience in the application of the qualitative assessment, both among preparers and auditors, and an improved economic outlook, Step 0 use may continue to expand. Further, the recent publication of application guidance on the qualitative assessment--discussed below--may also contribute to a continued uptick in Step 0 usage. In summary, the observed adoption rate of Step 0 is significant and has been increasing; and overall, FASB's objective to provide relief in goodwill impairment testing seems to have been achieved.

Implementation Guidance on Goodwill Impairment

The AICPA Accounting and Valuation Guide--Testing Goodwill for Impairment ("AICPA GWI Guide") released in November 2013, addresses the needs of preparers, auditors and valuation specialists by providing implementation guidance on goodwill impairment analyses, with Chapter 3 focused exclusively on Step 0. Though the guide is non-authoritative, it continues a tradition set by prior AICPA guides on a range of topics including IPR&D (In-Process Research & Development) and cheap stock, which have gained wide use and acceptance in practice.

This very helpful guide has suffered from a lack of awareness. In the 2013 survey, nearly 39 percent of public company and 65 percent of private company respondents were unaware of the draft version of the AICPA GWI Guide. Since then, the guide has been issued in final form and familiarity with it has increased to a degree; however, 31 percent of public companies and 49 percent of private companies continue to report that they are unaware of the guide in this year's survey.

Practical Considerations

As companies undertake future goodwill impairment tests, it is important to review relevant guidance, including the AICPA GWI Guide and the Appraisal Practices Board's Valuation Advisory Discussion Draft The Measurement and Application of Market Participant Acquisition Premiums. Specific areas that have received scrutiny, and are addressed in these guides, include the following:

* MARKET PARTICIPANT ASSUMPTIONS: One should consider the manner in which market participants would operate a reporting unit as well as the impact of any market participant synergies, such that the exit value is maximized.

* PROPERLY REFLECTING THE USE OF SHARED ASSETS: It is a common occurrence for a company to have assets and liabilities used in the operation of multiple reporting units, and there are several ways to address the issue of common use. Failing to do so would result in a misallocation of assets or cash flows and may affect the outcome of the impairment test.

* COMPARISON TO MARKET CAPITALIZATION: It is considered best practice for public companies to compare the sum of the fair values of their reporting units to their market capitalization and explain any differences. It is not best practice to default to a generic "control premium" as the reconciling item.

What is Next for Goodwill Impairment?

Goodwill impairments have declined and companies have notably increased their use of Step 0, taking advantage of the optional qualitative screen introduced by FASB in 2011. Additional changes may be in the winds, as FASB is considering the results of the IASB's post-implementation review of IFRS 3 Business Combinations, before revisiting the accounting for goodwill by public companies.

GARY ROLAND, managing director, CARLA NUNES, director; and MARIANNA TODOROVA, director are members of Duff & Phelps' office of professional practice. To obtain a copy of the 2014 Goodwill Impairment Study visit or To obtain a copy of Duff & Phelps' Step 0 Study, visit

Step 0 Users (Definite and Probable Users) increased from 33% to
41% based on our assessment of Form 10-K filings for the two most
recent fiscal years of a sample group of companies filing under

          Step 0 Users   Definite Users

2012           33%            22%
2013           41%            32%

Note: Table made from pie chart.
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Title Annotation:ACCOUNTING
Author:Roland, Gary; Nunes, Carla; Todorova, Marianna
Publication:Financial Executive
Date:Sep 22, 2014
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