Impairment Bucket List

No, it’s not a list of cool impairments that an accountant might calculate in his lifetime, if he or she had the time and luck.

Accounting standard-setters are working on a new method of categorizing impaired financial instruments.

The recent credit crisis has advanced a need for revision of the current model as large financial institutions did not agree with existing standards. Large banks, for example, claim that the existing standards result in a “pro-cyclical” result. That means that when times were good, they accounting rules made things look better, faster. And when times were bad, things looked bas faster. Or went to hell faster, as we saw in 2009/03. The rules also impact other sectors.

Credit Crisis Effects
In 2008, banks were following a system of incurred loss reporting, meaning assets were marked down, or impaired, only once their value had demonstrably fallen. Critics said this caused catastrophic shortcomings in financial early warning systems, meaning banks were unable to build up reserves for expected losses and were woefully unprepared when asset values suddenly went into freefall.

The IASB has developed a more forward-looking set of rules for calculating impairment.

“Three-Bucket Solution”

One approach, and the major one being advocated now, is called the three-bucket approach.

One pre-IFRS problem was earnings management, when banks would set aside provisions with little justification, only to release them in lean years to plump up earnings. Critics said this made it hard for investors to get a handle on banks' true financial positions; from these concerns was born incurred loss reporting.

After the credit crisis, the accounting problem was how to permit the judgment essential for expected loss provisioning without paving the way for a potential return to earnings management.

The three-bucket approach aims to break down assets according to impairments, keeping a tighter rein on provisioning and giving analysts a clearer picture of financial health.

Into bucket one goes 'healthy' assets, those for which banks expect a reasonable return and need only make minimal provisions. Bucket two is reserved for assets with some level of impairment, but which are not completely useless, while bucket three is for assets that are undeniably 'bad'.

Throughout its life, the asset can move between buckets according to macro- and micro-economic triggers, hopefully allowing banks to make exactly the right provision at exactly the right time.

An example might be a bundle of mortgages. The bank grants the mortgages, and works out on the basis of historical data that it is likely to take an 80% return on them. It therefore makes provision for the 20% loss and the mortgage bundle sits in bucket one until a trigger makes re-evaluation necessary.

This trigger could be a macro-economic event such as falling oil prices, a contracting economy or rising unemployment. From this, the bank might deduce that a greater proportion of mortgage holders will struggle to pay and shift the asset bundle into bucket two, requiring higher provisions to be made.

For the mortgages to jump to bucket three, they must be demonstrably impaired, for example when the inhabitants of a town hit by unemployment begin defaulting on their mortgages. This is essentially an incurred loss model and would result in very high or 100% provisioning for the de-valued assets.

Unfinished business
Like all theoretical models, there is much uncertainty to be hammered out. What constitutes a bucket-moving trigger? When an asset is impaired, who decides whether the impairment is expected – therefore already provided for – or unexpected, meaning more cash should be set aside? How will auditors examine such a complicated model and will it really prevent earnings management if banks are determined to do it?

A number of question exist, and will need to be ironed out prior to implementation.

New Thoughts on Goodwill Impairment Testing

New thoughts on goodwill impairment testing by Marie Leone of CFO.com

Over two-thirds (68%) of U.S. public companies in the United States wrote down goodwill by taking impairment charges in 2008. Total charges were $260 billion according to a report issued by financial advisory firm Duff & Phelps and the Financial Executives Research Foundation. The report examined 2008 financial statements of nearly 6,000 publicly held companies.

As 2009 results are being filed it appears that goodwill write-downs have declined., says Greg Franceschi, who heads up the global financial reporting practice for Duff & Phelps. Since the worst of the financial crisis ended, company market values have increased and accordingly there are fewer goodwill write-offs.

However a new accounting wrinkle has surfaced related to goodwill impairments. At issue is whether companies should determine the fair value of a reporting unit — and thereby the value of the related goodwill — based on either the unit's equity value or its enterprise value. (In general, enterprise value is the sum of the fair value of debt and equity.)

The question was sparked by a December speech given by Evan Sussholz, an accounting fellow in the Office of the Chief Accountant at the Securities and Exchange Commission. In his speech, Sussholz suggested that in certain situations, using an enterprise-value measurement may provide a more economically accurate picture of the reporting unit. His suggestion left preparers and auditors clamoring for a clarification, as companies have historically applied the equity-value approach to impairment testing, says PricewaterhouseCoopers partner Larry Dodyk.

In response, the Financial Accounting Standards Board and the American Institute of Certified Public Accountants have launched efforts to figure out whether additional guidance on the subject is needed. FASB's emerging issues task force is slated to start discussing potential guidance during the second half of the year, while the AICPA is currently working on completing a practice aid, which is a sort of unofficial manual that discusses best practices and concepts that auditors and preparers may want to apply.

Under U.S. GAAP, companies must perform a goodwill impairment test at least once a year to determine if the current value of an acquired reporting unit is worth more or less than its original price. The test is a two-step process in which the company must first compare the fair value of a reporting unit with its original price — the amount the company carries on its books. If the book value exceeds the fair value, then the asset is impaired and a second step is required to measure the amount of the impairment. If the book value is lower than the unit's fair value, then the asset passes the test and nothing more is required.

The confusion over whether to use equity value or enterprise value stems from the seemingly straightforward first step of the test, because the accounting rule is unclear. Sussholz said that originally, the SEC didn't believe the selection of one approach over the other would affect the test outcome. However, since taking a closer look at the practical implications, SEC staffers have acknowledged one unanticipated situation that is a potential problem: when the book value of a reporting unit measured at the equity level is negative.

Intuitively, it might seem that a negative book value would mean a reporting unit is on the verge of bankruptcy, but that may not be the case. Dodyk explains that a single reporting-unit company, for example, may have negative shareholders' equity as a result of unrecognized assets (such as intangibles) that have significant value but don't figure into the equity equation. Heavy borrowing for a leveraged buyout could also send shareholders' equity into negative territory.

Consider what happens in an equity-value impairment test when a reporting unit's book value is negative. By definition, the fair value of common equity cannot be less than zero, because the equity is essentially a call on the company's operations. That means the fair value of a reporting unit measured at the equity level would always be greater than a negative book value, and therefore always pass step one of the impairment test. That would be the case even if significant goodwill exists and the underlying operations of the reporting unit "may be deteriorating," asserted Sussholz.

On the other hand, says Franceschi, testing for impairment at the enterprise level would include the reporting unit's debt burden, providing what Sussholz claimed was a more accurate picture of the company's financial health. To be sure, his speech opened up the possibility that another testing approach may be permitted or required.

Franceschi doesn't believe the additional guidance will cause a significant increase or decrease in goodwill write-offs. But it may require companies to rethink valuation models and approaches, especially if the guidance recommends that companies use more judgment when determining a reporting unit's fair value. "For valuation issues, you can never have something that says, 'This is the way to do it, and the only way to do it,'" he says. "There may be multiple approaches one needs to consider."

Another concern with tinkering with Topic 350 is that it may spark other changes. "Once you open the rules to the goodwill impairment test, you never know where it is going to go," says Dodyk.

SEC Comment Letters--In Your Mailbox Soon?

The accounting firm Crowe Horwath has published an article Recent Trends in SEC Comment Letters--Reproduced in its entirety below.

In December 2008, the Securities and Exchange Commission (SEC) staff indicated at the American Institute of Certified Public Accountants’ (AICPA) National Conference on Current SEC and PCAOB Developments that they would be conducting targeted reviews of fair value, other-than-temporary impairment (OTTI) of securities, and other asset impairments. As a result, several recent examples of SEC staff comment letters on periodic filings (Form 10-Qs and 10-Ks) have a clear focus on these issues.

Following are some general themes present in comment letters from the SEC staff on recent filings that might be helpful for registrants to consider as they prepare periodic filings. Management should carefully review their company's accounting policies as well as related financial statement and management’s discussion and analysis (MD&A) disclosures related to these issues.

Accounting
OTTI of Securities
The SEC has:

• Asked registrants to justify why securities with fair values significantly below cost are not considered to be OTTI.
• For securities with ratings of "default" or "speculative," the SEC has asked how management determined that an adverse change in cash flows had not occurred.
• Challenged registrants on whether the losses for sales of securities after a period end should have been recognized in the prior period.
• Asked registrants to provide specific information about securities with significant unrealized losses.
• Requested information includes the specific issuer and name of each security; type of underlying collateral, credit rating, severity, and duration of the unrealized loss; and how the financial condition and near-term prospects of the issuer were considered when determining that no OTTI was present.

Securities/Other
The SEC has asked registrants to:

• Provide implied discount rates used in determining fair value of securities when using Level 3 inputs (in accordance with the guidance in Financial Accounting Standards Board Staff Position 157-3 (FSP FAS 157-3), “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” and FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly”).
• Reconcile the cash flows used to determine fair value with the cash flows used to assess OTTI.
  Indicate the systems and controls used to validate prices received from third parties when valuing securities.

Goodwill and Other Intangible Assets
The SEC has commented on:

• Implied control premiums used to determine fair value of reporting units for purposes of step one of goodwill impairment tests. Assumptions used to determine fair value must be supportable and should not contradict observable data about recent transactions.
• The lack of support for a reasonable period in the context of determining market capitalization of a reporting unit.
• The lack of support for assumptions used when determining the fair value of an intangible asset – for example, when a multiperiod earnings approach has been used.

Presentation and Disclosure

Loans and the Allowance for Loan Losses
The SEC has:

• Asked registrants to consider more disaggregated disclosure about loan portfolios – for example, providing disclosures by exposure to subprime, alt A-paper, or other relatively high-risk loans.
• Commented on disclosing reasons for changes (or lack thereof) in general loan reserves considering changes in credit risk.
• Commented on presenting the basis for each risk category and the method for determining the loss factor applied to each category. It has asked companies to specifically identify how historical loss trends were adjusted based on current factors.
• Asked registrants to explain reasons for directional inconsistencies in loan-loss allowances – for example, when impaired loans increased but specifically identified reserves decreased.

Securities
The SEC has requested:

• More disclosure of reasons for transfers into and out of the Level 3 category and more robust discussion of how fair value was determined when classified as Level 3.
• Support for securities being presented as Level 2 that appear to require Level 3 classification based on other disclosures.

www.crowehorwath.com

SEC Comment Letters: Goodwill Impairment

In a webcast last week, the Controllers’ Leadership Roundtable discussed SEC Comment letter activity surrounding goodwill impairment charges. Below is their summary of recent activity in this area.
SEC is hitting on three main areas.

• Clear Identification of Impairment Recoverability Risks: If they are not doing so already, companies are going to need to ensure that they quantitatively disclose information about potential risks to revenue, operating results, and asset recoverability, so that investors have the ‘raw material’ required to judge the likelihood of future impairments. This includes explicitly addressing the economy, and the range of assumptions they used in evaluating its potential impact (and what changes in those assumptions would do to potential impairments).
  


• Requiring Detailed Sensitivity Analysis: Along with identifying the range of assumptions used in their calculations, companies need to also disclose the sensitivity analyses used, so that investors and users can get a better sense of how impairment might change if certain conditions (e.g. 1% decline in revenue, 50 basis point increase in the interest rate) came to pass. This provides a check both on the validity of the impairment charges, and on the validity of management’s thought processes.
  


• Managerial Judgment Process: In general, the SEC is also requiring companies to detail their impairment ‘thought process,’ including what inputs they used, and how they came to those input values. One comment letter called on firms to:
  
  In the interest of providing readers with a better insight into management’s judgments in accounting for goodwill and intangible assets, please consider disclosing the following:


• The reporting unit level at which you test goodwill for impairment and your basis for that determination;


• Sufficient information to enable a reader to understand how you apply the discounted cash flow valuation model in estimating the fair value of your reporting units and why management selected this method as being the most meaningful in preparing your goodwill impairment analyses;


• How you determine the appropriate discount rates and attrition rates to apply in your intangible asset impairment and analysis;


• A qualitative and quantitative description of the material assumptions used and a sensitivity analysis of those assumptions based upon reasonably likely changes; and


• If applicable, how the assumptions and methodologies used for valuing goodwill and intangible assets in the current year have changed since the prior year, highlighting the impact of any changes.

Worst Year Ever for Goodwill Impairments: KPMG Study

Goodwill impairments soared in 2008, doubling over 2007 levels for a surveyed group of companies.

KPMG completed the survey of approximately 1,600 public companies from January 2005 to December 2008.

Goodwill impairment charges at the companies were $340 billion in 2008, $143 billion in 2007 and $87 billion in 2006.

This result is not surprising given the current economic downturn and general financial market turmoil.

The study found that in 2008 the hardest-hit industries were banks, which accounted for about 23 percent of the total goodwill impairment charges. Materials, energy, media, and technology hardware and equipment companies were next. Other segments of the economy including pharmaceuticals and food and beverages took significant goodwill write-downs in 2008.

The largest two median goodwill impairment charge by industry were:
Banks--$411 million in 2008, from $49 million in 2007
Materials $394 million from $30 million in 2007.

Percentages of companies taking impairments by industry were:

• Semiconductor and semiconductor equipment (31 percent)


• Technology hardware and equipment (31 percent)


• Media (30 percent)


• Consumer durables and apparel (27 percent)


• Diversified financials (25 percent)

Watering Down Fair Value Accounting is "Crazy"

Moves by Wall Street lobbyists slammed

Excellent article from the Financial Post

Bank lobbyists and politicians are damaging the credibility of corporate reporting and hurting the interests of investors around the world by pulling back on mark-to-market accounting, one of the world's top international accountants warned.

The comments from Tom Jones, vice-chair of the International Accounting Standards Board (IASB), come after U.S. standard-setters unilaterally decided to dilute the controversial accounting rule earlier this month.

In an interview with the Financial Post, Mr. Jones warned of "a loss of credibility" and said the rationale for watering down so-called fair value accounting is "crazy." He also cited concerns about political interference that could undermine the independence of accounting rule setters.

These fears were echoed by other senior accountants, who urged Canadian authorities to resist pressure from big banks to follow the American lead.

In early April, the U.S. Financial Accounting Standards Board pledged to backtrack on fair value accounting under intense pressure from Wall Street and demands from Congress. U.S. lawmakers had even threatened to take the matter into their own hands rather than leave it to the accountants. The resulting FASB rule changes allow banks to use judgment rather than market prices, to value financial instruments.

Despite the urgings of Bay Street, the oversight council of Canada's standards board opted not to move to align with the U.S. when it met earlier this month, though the organization will weigh the matter again after the international accounting board meets this week.

The Canadian stance has received significant backing from the accountancy profession. Chris Clark, chief executive of PricewaterhouseCoopers Canada, said his firm does not support rushing to imitate the Americans and urged authorities to "balance" the demands of banks with "the needs of the investor".

Nouriel Roubini, the New York University economist nicknamed "Dr. Doom" for his prescient forecast of the global economic downturn, yesterday called the U.S. rule changes "a big mistake" that has allowed Wall Street banks to "fudge" their latest set of quarterly accounts.

The changes circumvent capital rules set by bank regulators and would, if adopted, weaken Canada's banking system, said Wayne Landsman, a professor from the University of North Carolina who will speak on the topic at the Rotman School of Management in Toronto on Thursday.

Proponents of fair value, or mark-to-market, accounting say it is the most accurate and independent way to price assets. But bankers say fair value accounting has exacerbated the current financial crisis by unfairly forcing them to take huge writedowns. They say illiquid markets for certain securities have led to fire sale prices that do not represent appropriate valuations, and they have lobbied to be allowed to value certain troubled securities based on their own estimates.

The idea that banks have been forced to write down assets beyond any rational level is "actually crazy," said IASB's Mr. Jones. The market price for troubled financial instruments has probably not even hit the bottom yet, he added.

Mr. Jones insisted there are better answers to the current problems in the banking sector than tinkering with fair value rules. One possibility would be to change the amount of capital that banks are required to set aside by bank regulators, he said.

Politicians and lobbyists in the U.S. seeking to further weaken fair value are having the effect of pressuring global standard setters to follow FASB's lead, Mr. Jones said. European finance ministers, for instance, have already called standard setters outside the U.S. to "level the playing field" on fair value accounting.

The IASB has reacted by urgently cutting short a consultation period on changes to its rules on financial instruments.

The London-based IASB uses a different rule book to the FASB. In recent years, most countries outside the U.S. have adopted or pledged to adopt the IASB rules. At a meeting in the U.K. this month, G20 leaders called for significant progress towards a single set of global accounting standards. Some observers say a single set of rules would make it easier for investors around the world to make informed decisions.

Mr. Jones said the integration plans have not been derailed by the U.S.'s decision to back away from fair value accounting. Full adoption of IASB standards by the U.S. seems unlikely, but some form of convergence is expected in the long term.

"We are going to try to ensure the difference isn't as great as it seems," he added. Mr. Jones noted that IASB rules on fair value also allow companies to exercise judgment in some cases, like the amended U.S. rules.

Separately, members of a joint committee formed by the two accounting organizations to deal with the financial crisis also complained about political interference in their work.

At a London meeting of the Financial Crisis Advisory Group, that was broadcast on the Internet, senior industry experts expressed concern about the politicization of the process of revising accounting standards.

Harvey Goldschmid, the group's joint chair who is a former commissioner of the Securities and Exchange Commission, and IASB chair Sir David Tweedie, were among those who warned of the dangers of political pressure that could weaken the independence of accounting standard setters.
By Duncan Mavin and Eoin Callan
Financial Post

Got Goodwill? Part 21

A few more large goodwill impairments:

HONG KONG -- Ping An Insurance (Group) Co. of China Ltd. an impairment charge of 22.79 billion yuan (US$3.33 billion) on the company's stake in Fortis NV.

First Data Corp. reported goodwill impairment charge of $3.2 billion which resulted from the decline in economic conditions which drove a change in First Data's management projections and an increase in discount rates reflected in First Data's fair value estimates.

MGM MIRAGE reported goodwill and indefinite-lived intangible asset impairment charges of $1.2 billion as a result of global economic conditions and market trends--and that these trends have continued into the first quarter of 2009.

Rite Aid goodwill impairment, store impairment and deferred tax asset write-down that totaled $2.2 billion. The goodwill impairment charge is related to the July 2007 Brooks Eckerd acquisition.

Oshkosh Corporation anticipates recording non-cash impairment charges of $1.2 - $1.5 billion for the write-down of goodwill and other indefinite-lived intangible assets in the second quarter of driven by the short-term economic environment.

Macy's Impairs $5 Billion

Macy's Inc,, the U.S. based department store chain has recorded a goodwill impairment charge of $5.4 billion in the fourth quarter. The impairment charge follows a sharp decline in the company's market capitalization.

Macy's market cap today is about $4 billion, down from about $20 billion at its peak in 2007.

Macy’s had previosuly warned of the impairment charge and said the estimate is subject to further adjustment when it completes its calculations in the first quarter of 2009.

The non-cash write-down should not affect Macy’s financing covenants and accordingly will not cause defaults in bank credit agreements or bond indentures.

Macy’s reported operating income of $1 billion but the impairment charge brings their fiscal 2008 loss to $4.4 billion.

The goodwill arose on Macys' 2005 acquisition of May Co., the economic downturn and the decline in market capitalization.

Investors vs. Bankers--Who will Win?

Recently the IASB and the FASB issued for comment changes to accounting rules that would allow looser mark to market accounting. This has sparked opposition to the changes from consumer and investor groups that who are advancing their previously expressed arguments that the rules give management (banks?) too too much freedom in valuing assets in distressed or illiquid markets.

Opposition comes from such places as the Consumer Federation of America, the CFA Institute and the FASB's Investors Technical Advisory Committee. The opposition may also have an impact on proposed changes to financial institutions' regulatory capital levels, which the banks claim are needed to ease the existing credit crunch and to avoid future credit messes like we have had in the past year.

Banks have claimed for years that mark-to-market rules force them to place unrealistically low values on illiquid or otherwise difficult to trade assets (known in mark-to-market accounting terms as "Level 3 Financial Instruments".)

The FASB/IASB proposals require "significant judgment" on the part of management in determining when a market isn't active. Once determined inactive, it would effectively allow management to ignore trading prices when coming up with a value for a security.

Those who have recently voiced opposition to the proposed rules say that they make it too easy for companies to reduce write-offs on impaired assets and make it easier for banks to keep their regulatory capital at unrealistic levels, allowing unstable financial institutions to make bad credit choices.

Mark-to-market accounting is under increasingly fierce attack by bankers who are lobbying hard for U.S. Congress to suspend or repeal mark to market rules. Bankers blame the rules for the current financial crisis.

Those who oppose the rules are against the banking industry's ability to make the statutory and regulatory regime work in their favour. They claim that the banks want accounting rules to change to fix irresponsible banking activity. While they agree that mark to market rules are not perfect, they do provide transparency in valuing assets and that such transparency helps investors.

Got Goodwill? Part 19: The Horror

Impairments are continuing to carve up balance sheets as 2008 earnings are reported.

It’s always interesting (at least to us financial reporting geeks?) how companies talk about huge impairment charges. Usually the talk is around “non-cash charges”, implying that an impairment charge is meaningless, so let’s drive on.

However the CFO of Energy Future Holdings recently was a bit more talkative oon the subject , saying he was “horrified" to make a large impairment charge.

Paul Keglevic, EFH's new chief financial officer said the above about writing off $9-billion in goodwill. Other charges include $500 million related to the company's trade name.

Keglevic also said:

• The number $9 billion "doesn't roll off my lips."
• When private equity investors bought the company, they calculated it was worth $48 billion, including $23 billion for goodwill and intangibles.
• The goodwill value has declined because the value of other electricity companies has dropped as the stock markets fell and because the value of EFH debt is down.
• The decline is on paper; EFH isn't in financial trouble
• The value of the company is only interesting if EFH owners want to sell, sort of like the value of a home.
• The good news is we aren't trying to sell the company today.
• He is not worried about EFH's cash flow. They will have enough cash flow to pay off the $40 billion in debt taken on to buy the company.
• They expect the recession and decline in the stock market to prompt other companies to take similar goodwill charges
• "This will be the biggest year of goodwill impairment this country has ever seen,"

Other recent big impairment charges:

Novelis $1.5 billion
Gerdau Ameristeel $1.2 billion
Sprint Nextel $1 billion
Kinross Gold $994 million
Barrick Gold $773 million
Chemtura $665 million
Ingram Micro $659 million
Nalco $544 million
Chiquita Brands $374 million

Reasons for impairment cited include:

• Increased market cost of capital, due primarily to the significant deterioration in the capital markets during the third fiscal quarter, when market cost of debt required in impairment calculations is significantly higher than the interest rates on existing debt
• Decline in market capitalization for the issuer and other industry participants
• Impact of the global recession on near-term operating forecasts.
• Closure of underperforming units
  
  

Got Goodwill? Part 20: Impairment and Share Price

Royal Bank of Scotland just announced around 20 billion pounds in goodwill writedowns. Interesting to watch their share price--when they made the final announcement their share price actually rose about 30%. That's not the whole story though. They first warned the markets about large impending losses a few weeks ago and their share price dropped about 90%. When companies announce impairments, sometimes the impairment is already priced into their share price, other times it is is not.

Fifth Third Bancorp shares dropped 29% after announcing close to a billion in impairment. However the shares were partially pushed lower by their CEO's comments about the rest of the year.

Regions Financial shares fell 24% after a $6 billion in goodwill writedowns. Hartford Financial shares were down 16% after a $2 billion goodwill hit. Companies usually argue that goodwill impairment has no impact and it is almost always described as a non-cash charge. Stock markets usually anticipate the write-down. However companies need to watch their lending covenants. Some companies may be downgraded after announcing impairments since impairments reduce assets, potentially causing problems with lenders and rating agencies. Moody's put Weyerhaueser under review after a goodwill impairment charge of close to $1 billion, stating that goodwill impairment charges "may reduce covenant headroom" under their credit facilities. This means that Moodys thinks that Weyerhauser is less credit-worthy because it has fewer assets on its balance sheet to make it worthy of receiving more lending.

Got Goodwill? Part 17: SEC Views on Impairment

SEC Speech Shares Views on Impairment

At the December AICPA/SEC/PCAOB Conference, SEC staff talked a lot about goodwill in a number of speeches.

Key points:

Thorough disclosures about critical accounting estimates related to goodwill impairment testing are required.

Disclose:

• How goodwill reporting units are determined, including any aggregation of reporting units,
• Methodology used to determine the fair value of reporting units (including the weighting of each approach in cases in which multiple approaches are used)
• Date or range of dates used to determine market capitalization
• Evidence used to assess the reasonableness of an implied control premium (difference between the fair value of the reporting units and the enterprise’s market capitalization)
• Key assumptions and sensitivity analysis related to those key assumptions.
• Early warning disclosures in MD&A if it is reasonable to expect a material impairment in a future period.

Beware

SEC speakers said staff will ask questions about the adequacy of disclosures if there are indicators of impairment but no impairment charge.

SEC staff warned that assumptions underlying impairment analyses should be consistent with other accounting measurements and non financial disclosures in their SEC filings.

Goodwill Impairment Calculations

Reconciliation to market capitalization—a key element of the analysis is to reconcile the aggregate fair values of goodwill reporting units to market capitalization.

SEC staff does not expect a registrant to determine its market capitalization using a point in time market price as of the date of its goodwill impairment assessment.

Instead, consider recent trends in its stock price over a reasonable period.

Given recent stock price volatility, SEC staff would likely not expect enterprise market capitalization to be calculated solely based on stock price fluctuations on or around the goodwill impairment assessment date.

They warned not to ignore a recent drop in market capitalization.

The SEC does not apply a bright-line test to analyzing control premiums. They say that application of judgment can result in a range of reasonably possible control premiums.

Evidence should support the judgments that the implied control premium is reasonable, and support should be in the form of contemporaneous documentation, including any identified transactions.

It is not acceptable to use a “rule of thumb” to support the implied control premium.

The amount of documentation supporting the implied control premium to increase as the control premium increases.

A different speech revealed:

Indicators of Impairment According to the SEC

• Recent operating losses at the reporting unit level
• Downward revisions to forecasts
• Decline in enterprise market capitalization below book value
• Restructuring actions or plans
• Industry trends.

Malcolm McKay

Got Goodwill? Part 16: Billions Gone from Vacation, Car Rental, Communication, Insurance Balance Sheets

Wyndham Worldwide one of the world's largest hospitality companies recorded non-cash goodwill impairment charge of $1.3 billion vacation time share business related to adverse financial markets.

Lloyds Banking Group announced £7bn for 2008 impairments in the HBOS corporate banking business. They said it was only £1.6bn higher than it had expected when it issued its shareholder circular on the takeover at the HBOS business last year. It said that the "acceleration in the deterioration in the economy" and a "more conservative provisioning methodology consistent with that used by Lloyds" caused the higher impairment.

Avis Budget announced an impairment charge of $1.3 billion given “the significant decline in the company’s equity market value over the last several months, as well as soft economic conditions and financial market disruptions that have increased the cost of capital for many corporations.”

Charter Communications announced that it expects to record an impairment charge of $1.5 billion. Unlike other “good news” announcements emphasizing investor value, they said that they will restructure debt under bankruptcy protection, completely wiping out shareholders.

Malcolm McKay

Got Goodwill? Part 15: It’s All in the Timing

CBS announced a goodwill impairment, then got sued.

CBS issued a press release on October 10, 2008 announcing that it would to incur an impairment charge of approximately $14 Billion in the third quarter of 2008.

After the announcement, CBS common shares declined from $10.14 to $8.10. CBS closed this week at $5.81.

A more recent press release talks about an investigation of the timing of the CBS announcement and how alleged damages might have resulted to shareholders of various CBS plans.

The complaint alleges that CBS violated securities regulations by making materially false and misleading statements about its financial condition and operating results.

The complaint is a class action on behalf of former or current employee or members of CBS investment plans or profit sharing retirement plans or individuals who purchased CBS stock in one of those plans during the periods February 26, 2008 to October 10, 2008.

The complaint alleges that:

• CBS failed to disclose that ‘adverse market conditions had materially impaired CBS's operations, expected cash flows and the value of its intangible assets, including goodwill'
• CBS's goodwill and intangible assets were materially overstated'
• CBS' positive statements that it 'clearly has the right broad range of assets to produce outstanding free cash flow quarter after quarter, year after year,' were materially false and misleading and without reasonable basis.

You can have a look at a graph of CBS share price in 2008 here.

Read the complaint here.

Malcolm McKay