ACCT 313 Case Assignment

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Feb 20, 2024

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MEMORANDUM TO: DR. AMANDA GONZALES FROM: ABBY FLAUGH AND RUBY LENZEN SUBJECT: IMPAIRMENT OF GOODWILL DATE: DECEMBER 1, 2023 ______________________________________________________________________________ Goodwill is a valuable, infinite-life intangible asset of the company gained during acquisition. It is unable to be captured numerically and can not be independently or separately identified apart from the business. Examples include customer loyalty, brand awareness, employee reputability, and managerial ability. However, all assets are impacted by internal and external events, including goodwill. Some events that could potentially lead to the impairment of goodwill include economic downturn, poorly acquired assets, management changes, and decrease in competitive advantage (alternatively, increase in competition). Investors and creditors pay close attention to goodwill to gain insight into more complex business operations such as the success of company decisions and strategies. For instance, repeated goodwill impairments may indicate poor acquisition or management decisions. This in turn may impact the company’s net income and financial stability in its balance sheets, ultimately influencing the share price for the investors and creditors. Goodwill is a unique intangible asset with an infinite life, and it must be treated as such. It can not be amortized, and its value is “attached” to a larger segment of the company. Previous to the FASB’s Statement No. 142 in 2001, goodwill was treated as though it had a definite life and was amortized over a specific period under US GAAP. Often, this period was 40 years and did not faithfully capture the value of goodwill over its entire life, seeing as goodwill has an indefinite life. In 2001, however, FASB instated impairment testing rather than amortization to more accurately capture the unique nature and value of goodwill. This resulted in a two-step approach to determine the implied fair value of goodwill. This implied fair value would then be compared to the carrying value, the amount that the carrying amount of goodwill exceeded that implied fair value was counted as an impairment loss.

With the high costs and longer timelines associated with this two step approach, investors and creditors were not receiving the goodwill impairment information in a timely manner. Therefore, FASB saw little need to predict its implied fair value when just the fair value comparison would suffice as faithful and accurate information, which was communicated in its Accounting Standards Update No. 2017-4. This meant the two-step process was now condensed into one. Now, currently under US GAAP, the impairment of goodwill occurs when the fair market value at a reporting unit level is less than its current carrying amount (FASB 350-20-35-1,2). A company is expected to evaluate its goodwill asset for any impairments at least once a year if it reports under this standard. Under IFRS, more specifically IAS 36, the impairment of goodwill occurs when the recoverable amount at a cash-generating unit level is less than its current carrying amount (IAS 36-90). Again, a company with this reporting method must test for goodwill impairment each year. Both US GAAP and IFRS evaluate how much goodwill should be reported, as well as how much impairment loss should be reported, on an annual basis.Furthermore, the impairment of goodwill in both standards is irreversible, meaning that once goodwill is decreased with the impairment loss, it can not be recovered again. Additionally, both GAAP and IFRS record goodwill impairment by debiting impairment loss and crediting goodwill, as seen in a sample journal entry below. Impairment Loss………………………………………………………………..XX Goodwill………………………………………………………………………..XX The impairment of goodwill impacts the income statement and the balance sheet in similar ways between the two standards. Impairment loss, as shown in the above entry, impacts the income statement by decreasing net income, and goodwill, again shown above, impacts the balance sheet by lessening the value of intangible assets. Some key differences between GAAP and IFRS include the comparison value to carrying value and the basis of goodwill application. First, the value to which the carrying value is compared to is the fair value for US GAAP and the recoverable amount for IFRS. The fair value is primarily based on market price or the present value of the net future cash flows, whereas the recoverable amount is the higher of the following: a) Present value of cash flows expected from future use (known as value-in-use) b) Fair value less costs to sell It is also important to note that under US GAAP, the company does not have to go through with calculating and recording the impairment of loss if it believes there is less than a 50% chance

that it has a loss (IFRS 350-20-35-3A). This assessment of qualitative factors is not able to be done under IFRS. Below is a summary of how the impairment loss is calculated under GAAP and IFRS, assuming that under US GAAP, the company’s qualitative factor assessment resulted in a loss likelihood of more than 50% : Impairment Loss = Carrying Amount - Fair Value/Recoverable Value *Also assumes that the difference will be positive. If the difference is negative, that means that there is no impairment loss since the carrying amount does not exceed the fair value or recoverable value. Secondly, the way goodwill is allocated, and therefore the way the impairment loss impacts the balance sheet, differs. According to US GAAP, goodwill is allocated based on reporting units, which is generally a lot larger of a group than cash-generating units, as required as the allocation method for IFRS. A reporting unit is oftentimes a whole operating segment, whereas a cash- generating unit is a smaller, more identifiable asset group. When capturing the impairment of goodwill, as with recording any other impact on the financial statements, it is essential to keep the FASB Framework in mind. Information that impacts the financial statements materially, and therefore impacts the decisions of investors and creditors, must not be left out (Relevance). Furthermore, that information must be faithfully reported as unbiased and accurate in a timely manner. With this in mind, It seems as though the IFRS standards do a better job of maintaining relevance and faithful representation. This is because under US GAAP, as mentioned above, there is more room for human interference, such as under-predicting an impairment loss (and therefore, not reporting it) and an over-allocation of goodwill to reporting units that may not be directly tied to goodwill. Impairment of goodwill is compared to the recoverable amount in comparison to just the fair value, encompassing two different mechanisms to find the true valuation of goodwill, giving a more well-rounded view of the current state of the company’s financial standing. Also, since IFRS ties goodwill impairment to a more precise cash-generating activity, investors know it is relevant to a particular part of the company, leading to more informed decisions by the investors. Investors and creditors looking to support the company (or looking to support a different company) need to have access to information that is not skewed or outdated, but rather information that is consistent, faithful, and accurate. This will help them make decisions in not

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only providing resources and investing in the company, but also in analyzing the company’s current financial state and predicting future financial states. Specifically in terms of goodwill, investors and creditors want to not only see the potential future benefits that the company will reap due to its assets that are not concretely identifiable or separable.They also would likely look at how fast Goodwill is being impaired to see how wise the company is in its acquisitions and if it is being efficient is using the goodwill to maximize their processes. IFRS provides a more well-rounded computation of how much goodwill is impaired and which cash-generating operation will likely be affected by its impairment, informing investors and creditors about more specific parts of the company’s financial health. Nestle is a good example of a successful company with heavily involved investors and creditors that reports using IFRS rather than US GAAP. In the last fiscal year, 2022, Nestle reported an impairment loss of 71 million on page 107 of their consolidated financial statement notes due to an unresponsive market in terms of their newest product Palforzia. According to their note on page 109, their peanut allergy treatment is not being adopted by healthcare professionals as they had expected, leading to decreased value of the brand and intellectual property rights. This impairment loss decreased net income on the income statement and goodwill was reduced on the balance sheet, ultimately reducing the value of intangible assets. This information communicates to investors and creditors what method was used to calculate the impairment loss and why the loss is occurring. This helps them in their decision-making to either withdraw funding, if they were full supporters of this new product, or to continue to support the company, if they see potential in a new product endeavor. However, the company did not mention how much of their resources they still plan to contribute towards their Palforzia product. Investors and creditors may want to know if this product, seeing as though the target market is not adopting it, will still be funded or if the company will stop its production. An additional disclosure regarding this matter may be useful. Investors and creditors may also want to know how the company judged its relative fair value, future cash flows, and the growth rates they used. Since determining impairment can sometimes be subject to human decisions and estimations, shareholders may want to know if they are being fully transparent with the amount of impairment loss or if they are slowly planning to impair this cash generating unit of goodwill over time. The future implications of the underlying event of this impairment may affect the future financial statements of the company in several ways. First, if the product Palforzia is not expected to be accepted by healthcare professionals and Nestle is simply delaying recognizing the entire

impairment loss at once, there likely will be increased impairment losses to goodwill in the future. As mentioned previously, this will decrease net income and also decrease the value of intangible assets. Secondly, since this product may not be successful in the market, Nestle may choose to pursue other products similar to Palforzia. This may lead to an increase in research and development costs, more operating costs in their health science department, and more costs to advertise its new ideas. As much as this would decrease net income, it could eventually benefit the balance sheet if they attain materially valuable intangible assets such as patents or trademarks, or if their new product is more successful. Overall, the impairment of goodwill under IFRS is more specific, pointing investors and creditors to a more precise cash-generating unit that clearly impacts a relevant part of the business. As shown by Nestle, this standard is not without its limitations, but it provides a far more comprehensive knowledge base behind why the impairment occurred, how much was impaired, and how it will impact future statements.