FASB CLARIFIES THE DEFINITION OF A BUSINESS AND SIMPLIFIES THE GOODWILL IMPAIRMENT TEST
In January 2017,the Financial Accounting Standards Board (“FASB”) released Accounting Standards Update(“ASU”) 2017-01 and 2017-04 which impact business valuation. The first, ASU 2017-01: Business Combinations (Topic 805) - Clarifying the Definition of a Business, provides a more robust framework for determining when a set of assets and activities qualify as a business. The second, ASU 2017-04: Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, eliminates Step 2 from the goodwill impairment test in an effort to simplify the accounting.
NEW FASB GUIDANCE: ASU 2017-01 BUSINESS COMBINATIONS
The FASB published ASU 2017-01 on January 5, 2017 to clarify the definition of a business with the objective of adding guidance to assist companies and other reporting organizations with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Currently, the definition of a business affects many areas of accounting, including acquisitions, disposals, goodwill, and consolidation. Many stakeholders believed that the previous definition of a business in Topic 805 was applied too broadly, which resulted in many transactions being incorrectly recorded as a business acquisition, as opposed to an asset acquisition. Also, analyzing these transactions under the previous definition in Topic 805 was considered inefficient, difficult, and costly.
The ASU 2017-01 amendments provide a screen to determine when a set of assets and activities is not a business. The screen requires that when substantially all the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This screen reduces the number of transactions that need to be further evaluated.
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In addition, the ASU 2017-01 amendments specify that if the screen’s threshold is not met, a set cannot be considered a business unless it includes an input and a substantive process that together significantly contribute to the ability to create outputs. The ASU 2017-01 amendments provide a framework to help entities evaluate whether both an input and a substantive process are present, and it removes the evaluation of whether a market participant could replace the missing elements. Also, the ASU 2017-01 amendments narrows the definition of the term “output” to be consistent with the description of outputs in ASC 606.
The ASU 2017-01 amendments affect all reporting organizations that must determine whether they have acquired or sold a business. For public companies, the ASU is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. All other companies and organizations should apply the amendments to annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019.
NEW FASB GUIDANCE: ASU 2017-04 GOODWILL AND OTHER
On January 26, 2017, the FASB issued ASU 2017-04, which removes the requirement to compare the implied fair value of goodwill with its carrying amount. In summary, the ASU 2017-04 amendments removes Step 2 of the goodwill impairment test, which required a hypothetical purchase price allocation. As a result, under the ASU 2017-04 amendments,
“an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount [and] should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit.”
In addition, the ASU 2017-04 amendments:
- Clarifies the requirements for excluding and allocating foreign currency translation adjustments to reporting units in connection with an entity’s testing of reporting units for goodwill impairment;
- Clarifies that “an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable”; and
- Makes minor changes to the overview and background sections of certain ASC subtopics and topics as part of the Board’s initiative to unify and improve those sections throughout the Codification.
ASU 2017-04 is effective prospectively for public business entities that are SEC filers, for fiscal years beginning after December 15, 2019; for public business entities that are not SEC filers, for fiscal years beginning after December 15, 2020; and for all other entities, including not-for-profit entities, for fiscal years beginning after December 15, 2021. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.
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