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Purchase Price Allocation & Goodwill Impairment

Purchase Price Allocation (ASC 805)

ASC 805  applies to current accounting of business combinations. ASC 805 replaces FAS 141 which applied to business combinations prior to December 15, 2008.

Asset Allocation is the process of assigning fair values to all major assets and liabilities of an enterprise, either following a merger or acquisition (for the restated or opening balance sheet) or in the process of “impairment” testing. Included in these assets can be tangible (machinery and equipment, real property) and intangible assets (customers, technology, trade names, intellectual property, goodwill, other intangibles).

In December 2007, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations, (SFAS 141R), now codified in FASB ASC 805, which changes accounting and reporting requirement for business acquisitions. As part of the Board’s desire to align U.S. accounting practices with international financial reporting standards, FASB ASC 805 requires companies to measure certain contingent liabilities in a merger and acquisition transaction at fair value.

Under ASC 805, acquired goodwill must be stated at its fair value and is to be identified separately from other identifiable intangible assets, the fair value of which is recognized and stated separately. Other identifiable intangible assets include assets of a contractual nature or assets that can be separated from the goodwill of a business, such as marketing-related, customer-related, or technology-based intangible assets.

Goodwill and Intangible Asset Impairment Testing (ASC 350)

In accordance with ASC 350, goodwill and other indefinite lived intangible assets must be tested for impairment at least annually. The standard of value is fair value. Fair value must comply with the definition and standards prescribed by ASC 820. Goodwill and other intangible assets may be tested between annual test dates if there is:

  • A significant adverse change in legal factors or in the business climate
  • An adverse action or assessment by a regulator
  • Unanticipated competition
  • A loss of key personnel
  • A more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of
  • The testing for recoverability under Statement 121 of a significant asset group within a reporting unit
  • Recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit.

The annual goodwill impairment testing requires a two-step process:

  1. The company calculates the fair value of the reporting unit and compares that amount with the carrying amount of the unit, including goodwill. If the carrying amount exceeds the fair value, the company must perform the second step.
  2. The company measures the amount of the goodwill impairment, if any, by comparing the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill.

The company must then recognize any impairment as a loss on its income statement.