SEC and Goodwill Impairment

In the current economic environment, the SEC continues to ask issuers to support their assertions around goodwill impairment. SEC staff comments often arise when a company’s revenues significantly decline or when market capitalization significantly declines below book value, since such declines may indicate impairments in intangible assets and goodwill.

SEC staff also request additional disclosures about goodwill impairments. SEC staff have indicated that in future they will request even more disclosures about how the conditions that caused impairment will affect a company’s business in the future.

Documentation of support for impairment test results is important as SEC staff includes valuation experts who may request and review a company’s goodwill valuation reports.

The staff has also been asking for more robust and comprehensive disclosures about goodwill impairments, including the following:

• Policies for impairment testing
• Organization of reporting units
• Goodwill allocated to the reporting units
• Description of the steps performed to review goodwill for recoverability
• Nature of the valuation techniques used, including descriptions of the significant estimates and assumptions used to determine the fair value of the reporting units
• Results of the most recently completed impairment tests.

Examples of SEC Comments
Goodwill Impairment Testing — We see that goodwill comprises approximately [XX%] of your assets at [year-end]. We also note that revenues and net income continued to decline in the first quarter of 2009 due to decreases in volume, a slowdown in the economy, declining demand from the [XXX] and [YYY] markets and increased competition from imports. Please tell us how you considered these factors in determining whether goodwill was impaired at [year-end]. In addition, tell us whether these items are indicators of potential impairment that would require you to perform a goodwill impairment analysis subsequent to [year-end].

Goodwill Impairment Testing — We note that you recognized a goodwill impairment charge during the year. . . . In the interest of providing investors with a better insight into management’s judgments in accounting for goodwill impairments, please revise future filings to provide the following disclosures as part of your critical accounting policy:

• The reporting unit level at which you test goodwill for impairment and your basis for that determination;
• Sufficient information to enable an investor to understand how you estimate the fair value of your reporting units and why management selected that method as being the most meaningful in preparing your goodwill impairment analyses;
• A . . . description of the material assumptions used;
• If applicable, how the assumptions and methodologies used for valuing goodwill in the current year have changed since the prior year, highlighting the impact of any changes; and
• If or how you consider your market capitalization relative to your net book value in evaluating goodwill for impairment.

Goodwill Impairment Testing — We note there was a significant decline in your market capitalization during the third quarter. . . . It appears this is a triggering event that could require you to reassess your goodwill for impairment. Please tell us what consideration you gave to reassessing the recoverability of your goodwill in the third quarter. If you did not perform impairment tests, please explain why. To the extent that impairment tests were performed tell us how you determined that no impairment existed including in your response what impact the current economic environment had on your cash flow assumptions.

Long-Lived-Asset Impairment Testing — Please revise to describe the impaired long-lived assets or asset groups, the facts and circumstances leading to the impairments and the segment in which impaired long-lived assets or asset groups are reported.

Wayne Carnall, chief accountant in the SEC’s Division of Corporation Finance, recently observed that even though “registrants have provided voluminous disclosures regarding goodwill impairments within the critical accounting policy section of [MD&A], it is not always clear how the information is meaningful to investors.” The disclosures have often focused on the noncash nature of the goodwill impairment but have not addressed the business and economic conditions that gave rise to the charge. We understand that the SEC staff will be asking for more disclosures in MD&A about what the conditions that resulted in impairments mean to the registrant’s business as well as for more forward-looking information about the risk of future impairments, such as:

• Percentage by which the fair value of the reporting unit exceeds its carrying value as of the most recent step 1 test
• Goodwill allocated to the reporting unit
• Assumptions that drive the estimated fair value and a discussion of the uncertainty associated with the key assumptions
• Discussion of any potential events, circumstances, or both, that could have a negative effect on the estimated fair value
• Carnall also stated that the SEC staff “is considering providing . . . guidance in the near-term to provide registrants with a better understanding of its expectations in this area.”

Control Premium and Goodwill Impairment

Robert Fox, a professional accounting fellow in the SEC’s Office of the Chief Accountant, recently raised several points about goodwill impairment. For example, he remarked that the market capitalization of a registrant may not fully reflect the aggregate fair values of all the registrant’s reporting units. Mr. Fox pointed to ASC 350-20-35-22 and 35-23 (formerly paragraph 23 of Statement 142), noting that “an entity might derive ‘substantial value’ from the ability to obtain control.” Accordingly, this control premium may cause the fair value of all the registrant’s reporting units to exceed the registrant’s market capitalization. He also indicated that while it would be “prudent” for an entity to reconcile the aggregate fair value of its reporting units to its market capitalization, the entity should also consider other factors when assessing goodwill for impairment.