Impairment Testing in the Current Environment

1. Long Live the Asset!Long Live the Asset!
Impairment Testing in the
Current Environment
February 24, 2009

2. Valuation Research Corporation
• Formed in 1975, VRC has eight U.S. offices and eight international
affiliates.
• VRC provides M & A advisory services, fairness and solvency opinions in
support of corporate transactions, and valuations of intellectual property
and tangible assets for financial reporting and tax purposesand tangible assets for financial reporting and tax purposes.
• VRC maintains relationships with corporations, lenders, accountants,
investment banks, private equity firms, and law firms.
• VRC was instrumental in forming the Appraisal Issues Task Force (AITF), a
valuation industry group that meets quarterly to discuss financial reporting
related valuation issues.related valuation issues.
2Valuation Research CorporationValuation Research Corporation

3. P.J. Patel, CFA
• Mr. Patel specializes in the valuation of businesses, assets and
liabilities for financial reporting purposes. In particular, he has
focused on the valuation of intellectual property/intangible assets such
as trademarks, technology, software, customer relationships and
IPR&D. He also values business interests for tax purposes.
• Mr. Patel is an active member of the AITF and is currently a member of
the Appraisal Foundation Working Group preparing a Practice Aid for
the valuation of customer relationships.
• Mr. Patel is a frequent presenter on valuation issues for financial
reporting purposes and has recently presented on valuation issues
relating to SFAS No. 141/141R, SFAS No. 142/144, SFAS No. 157relating to SFAS No. 141/141R, SFAS No. 142/144, SFAS No. 157
and other emerging issues. Mr. Patel recently spoke at the AICPA SEC
conference in Washington D.C.
3Valuation Research CorporationValuation Research Corporation

4. Edward Hamilton
• Mr. Hamilton specializes in the valuation of businesses, assets
and liabilities for financial reporting purposes. In particular, he has
focused on the valuation of intellectual property/intangible assets such as
trademarks, technology, software, customer relationships and IPR&D. He
also values business interests for tax purposes.
• Mr. Hamilton is an active member of the AITF and is currently involved with
the Appraisal Foundation Working Group preparing a Practice Aid for the
valuation of customer relationships.
• Mr. Hamilton is a frequent presenter on valuation issues for financial
reporting purposes and has recently presented on valuation issues relating
to SFAS No. 141/141R, SFAS No. 142/144, SFAS No. 157to SFAS No. 141/141R, SFAS No. 142/144, SFAS No. 157
and other emerging issues.
4Valuation Research CorporationValuation Research Corporation

5. Agenda – Issues in Accounting For Asset Impairment
• Guidance
• SFAS 142: Goodwill and Other Intangible Assets
• Goodwill Testing Consists of Two Stepsg p
• Comparison of the Fair Value of the Reporting Unit to its Carrying Value
• Recognition of an Impairment Amount
• SFAS 144: Accounting for the Impairment of Long-Lived Assets
• Timing/Triggering Events
• Determining Asset Groups
• Determining the Primary Asset
T ti f R bilit• Testing for Recoverability
• Allocating Impairment
• Impairment Testing Order
C l i P tti It All T th• Conclusion: Putting It All Together
5Valuation Research CorporationValuation Research Corporation

6. Sources of Information
Statement/EITF Issue
SFAS 142 The testing and impairment of goodwill and indefinite-
lived intangibles
SFAS 144 The testing and impairment of long-lived tangible and
i t ibl tintangible assets
SFAS 157 Guidance on fair value measurements
EITF 02 7 Unit of accounting for the impairment testing ofEITF 02-7 Unit of accounting for the impairment testing of
indefinite-lived intangible assets
EITF 02-13 Treatment of deferred income taxes in goodwill
impairment testingimpairment testing
2008 SEC
Speeches
Inclusion of a control premium
Market cap reconciliation
Interim impairment testing indicators
6Valuation Research Corporation

7. Summary of Impairment Testing
Accounting
Guidance
SFAS 142 SFAS 144
A t T G d ill I d fi it Li d L Li dAsset Type Goodwill Indefinite-Lived
Intangible Assets
Long-Lived
Tangible &
Intangible Assets
Focus Goodwill carried at
lower of FV or CV
Indefinite-lived
intangible assets
carried at lower of
FV or CV
Test the
recoverability of
long-lived assets
& allocateFV or CV & allocate
impairment
Methodology Two step One step Multiple steps
Frequency Annually/event Annually/event Event basedFrequency Annually/event
based
Annually/event
based
Event based
7Valuation Research CorporationValuation Research Corporation

8. Impairment Testing
• Goodwill under SFAS 142
f S S• Indefinite-Lived Assets under SFAS 142
• Long-Lived Assets under SFAS 144
8Valuation Research Corporation

9. Goodwill Impairment Testing - Issues
• When to Test?
• Testing Methodology• Testing Methodology
• Current Issues
9Valuation Research Corporation

10. When to Test for Goodwill Impairment?
• Paragraph 26 states that goodwill should be tested for impairment annually
or more frequently
• Paragraph 28 notes several events/circumstances causing goodwill to beg p g g
tested between annual test dates:
a) Significant adverse change in legal factors or in the business climate.
b) An adverse action or assessment by a regulatorb) An adverse action or assessment by a regulator
c) Unanticipated competition
d) A loss of key personnel
e) A more-likely-than-not expectation that a reporting unit or a significant portion of) y g g
a reporting unit will be sold or otherwise disposed of
f) The testing for recoverability under Statement 144 a significant asset group
within a reporting unit
g) Recognition of a goodwill impairment loss in the financial statements of ag) Recognition of a goodwill impairment loss in the financial statements of a
subsidiary that is a component of a reporting unit.
10Valuation Research Corporation

11. When to Test for Goodwill Impairment?
Issues:
• Can I carry forward the reporting unit’s fair value per Paragraph 27?
• What if the market capitalization drops below the book value of equity?p p q y
• What if the book value of equity is negative?
11Valuation Research Corporation

12. Step 1: Does Goodwill Impairment Exist?
• Paragraph 19 of SFAS 142 outlines step 1 of goodwill impairment
testing
St 1 i d t id tif t ti l i i t• Step 1, is used to identify potential impairment
• If the fair value is greater than the carrying value, the reporting unit is
not impaired
• If the fair value is less than the carrying value, proceed to step 2 to
determine the level of impairment loss, if any
12Valuation Research Corporation

13. Step 1: Does Goodwill Impairment Exist?
Issues:
• What is the appropriate level to calculate the fair value of the reporting unit?
Enterprise Value, Total Assets, Equity?p , , q y
• Reconciling to the market cap?
• Estimation of a control premium? Mergerstat studies generally point to
control premiums ranging between 20-30%. However, the range of control
premiums is significant.
• SEC – No bright lines. Do a supportable valuation with sufficient analysis
to support position, especially if control premiums are significant.
N ifi d t f d t t d t i t l i• No specific date or range of dates to determine control premium.
• If using an income approach, has the discount rate changed due to increased
risk and/or an increased cost of debt? Increased scrutiny should be applied
when determining the WACC using market participant inputswhen determining the WACC using market participant inputs
13Valuation Research Corporation

14. Step 1: Reconciling to the Market Cap
Your company has two reporting units that get tested annually for goodwill
impairment as of 9/30. Recently, your market capitalization has dropped below your
book value of equity. In light of this and current economic conditions you complete an
interim test for goodwill impairment as of 12/31/08. Reporting Unit 1 (RU1) has ag p p g ( )
carrying value of $350 while Reporting Unit 2 (RU2) has a carrying value of $400.
The market capitalization of the company is $700 and there is no debt. The table
below summarizes the value conclusions.
Reporting Unit Fair Value Carrying Value Conclusion
RU1 $500 $350 No impairment
RU2 $300 $400 Impairment indicatedRU2 $300 $400 Impairment indicated,
proceed to step 2
Total $800 $750
Market Cap $700Market Cap $700
Implied Control Premium 14.3%
14Valuation Research Corporation

15. Step 2: Determine Implied Fair Value of Goodwill
• Paragraphs 20 & 21 of SFAS 142 outline step 2 methodology
• Steps
• SFAS 141 purchase price allocation
• Fair value of reporting unit equivalent to purchase price in a 141
• Allocate to fair value of all assets/liabilities (even if the assets/liabilities are not on
the books of the reporting unit)
• The allocation process is performed only for the purpose of testing goodwill forThe allocation process is performed only for the purpose of testing goodwill for
impairment; an entity should not write up or write down a recognized asset or liability,
nor should it recognize a previously unrecognized intangible asset as a result of that
allocation process.
• The fair value of the goodwill is equal to the residualg q
• The level of goodwill impairment is equal to the difference between the fair value
of goodwill and the book value of goodwill.
• After a goodwill impairment loss is recognized, the adjusted carrying amount
of goodwill shall be its new accounting basis Subsequent reversal of aof goodwill shall be its new accounting basis. Subsequent reversal of a
previously recognized goodwill impairment loss is prohibited once the
measurement of that loss is completed.
15Valuation Research Corporation

16. Step 2: Determining the Level of Goodwill Impairment
• Reporting Unit 2 failed step 1 test
• Fair value = $300
• Carrying value = $400
A f thi l th t b k l f PP&E d i t ibl t• Assume for this example that book value of PP&E and intangible assets are a
reasonable of estimate fair value.
Reporting Unit 2 Book Value Fair Value Impairment
Net Assets $400 $300
Working Capital 70 70
PP&E 50 50
Intangibles 120 130
Goodwill 160 50 110Goodwill 160 50 110
16Valuation Research Corporation

17. Impairment Testing
• Goodwill under SFAS 142
• Indefinite-Lived Assets under SFAS 142
• Long-Lived Assets under SFAS 144
17Valuation Research Corporation

18. Intangible Assets Not Subject to Amortization
• Guidance is in SFAS 142, paragraph 17
• Testing is annual with event based testingTesting is annual with event based testing
• Largely consists of trademarks/brands, certain licenses
• Test compares fair value to carrying value
If f i l i l th th i l th diff i th• If fair value is less than the carrying value, the difference is the
impairment amount
• Subsequent reversal is prohibited
18Valuation Research Corporation

19. When to Test Indefinite-Lived Intangibles
• Indefinite-lived intangibles are tested for impairment annually or due to an
event consistent with paragraph of SFAS 144.
• The following are examples of such events or changes in circumstances:The following are examples of such events or changes in circumstances:
a. A significant decrease in the market price of a long-lived asset (asset group)
b. A significant adverse change in the extent or manner in which a long-lived asset
(asset group) is being used or in its physical condition
c. A significant adverse change in legal factors or in the business climate that could
affect the value of a long-lived asset (asset group), including an adverse action
or assessment by a regulator
d. An accumulation of costs significantly in excess of the amount originally expectedg y g y p
for the acquisition or construction of a long-lived asset (asset group)
e. A current-period operating or cash flow loss combined with a history of operating
or cash flow losses or a projection or forecast that demonstrates continuing
losses associated with the use of a long-lived asset (asset group)losses associated with the use of a long lived asset (asset group)
f. A current expectation that, more likely than not, a long-lived asset (asset group)
will be sold or otherwise disposed of significantly before the end of its previously
estimated useful life.
19Valuation Research Corporation

20. When to Test Indefinite-Lived Intangibles
Issues:
• Can I carry forward the fair value from one year to the next ?
• What if I plan on phasing out the trademark?What if I plan on phasing out the trademark?
20Valuation Research Corporation

21. Indefinite-Lived Intangibles: Impairment Testing
Your company has 2 indefinite-lived trademarks that get tested annually for goodwill
impairment as of 9/30. Recently, your market capitalization has dropped below your
book value of equity. In light of this and current economic conditions you complete an
interim test for impairment as of 12/31/08 Trademark 1 has a carrying value of $35interim test for impairment as of 12/31/08. Trademark 1 has a carrying value of $35
while Trademark 2 has a carrying value of $45. The table below summarizes the
value conclusions.
Fair Value Carrying
Value
Difference Conclusion
Trademark 1 $40 $35 $5 No impairment
Trademark 2 $40 $45 ($5) Impairment,
write down
asset b $5asset by $5
21Valuation Research Corporation

22. Impairment Testing
• Goodwill under SFAS 142
• Indefinite-Lived Assets under SFAS 142
• Long-Lived Assets under SFAS 144
22Valuation Research Corporation

23. When to Test Long-Lived Assets for Impairment
• A long-lived asset (asset group) shall be tested for recoverability whenever events or
changes in circumstances indicate that its carrying amount may not be recoverable.
The following are examples of such events or changes in circumstances:
a. A significant decrease in the market price of a long-lived asset (asset group)
b. A significant adverse change in the extent or manner in which a long-lived asset (asset group)
is being used or in its physical condition
c. A significant adverse change in legal factors or in the business climate that could affect the
l f l li d t ( t ) i l di d ti t bvalue of a long-lived asset (asset group), including an adverse action or assessment by a
regulator
d. An accumulation of costs significantly in excess of the amount originally expected for the
acquisition or construction of a long-lived asset (asset group)
e A current period operating or cash flow loss combined with a history of operating or cash flowe. A current-period operating or cash flow loss combined with a history of operating or cash flow
losses or a projection or forecast that demonstrates continuing losses associated with the
use of a long-lived asset (asset group)
f. A current expectation that, more likely than not, a long-lived asset (asset group) will be sold or
otherwise disposed of significantly before the end of its previously estimated useful life.p g y p y
23Valuation Research Corporation

24. Long-Lived Asset Impairment – Asset Grouping
• Assets are grouped at the lowest level for which identifiable cash
flows are largely independent.
• Likely consists of working capital fixed assets intangible assetsLikely consists of working capital, fixed assets, intangible assets
• Asset group does not include goodwill unless the asset group is also
a reporting unit.
Company
Reporting
Unit 1
Asset
Reporting Unit 2
Asset Asset Asset
• Issue: How to determine asset groups?
Asset
Group
Asset
Group 1
Asset
Group 2
Asset
Group 3
24Valuation Research Corporation

25. Step 1: Recoverability Test
Step 1: Test for recoverability
• The carrying value of the asset group is compared to the sum of
undiscounted cash flows.
• Cash flows are projected over the remaining useful life (depreciable or
amortizable life) of the primary asset of the asset group.
• “Only the future cash flows… that are directly associated with and that
t d t i di t lt f th d t lare expected to arise as a direct result of the use and eventual
disposition of the asset (asset group). “
• Excludes interest and, per recent guidance from several leading firms,
taxes.taxes.
• Entity uses its own assumptions of asset use and should consider all
available information.
IIssues:
• If I am using an asset at less than its full potential does that mean its
impaired?
Is there a limitation on the life for purposes of determining the fair value of• Is there a limitation on the life for purposes of determining the fair value of
the asset group?
25Valuation Research Corporation

26. Step 1: Recoverability Test
Your company has 3 asset groups within reporting unit 2. In light of current
economic conditions you test your asset groups for impairment as of
12/31/08. The table below summarizes the value conclusions.
Reporting
Unit
Undiscounted
Cash flow
Carrying
Value
Conclusion
Asset Group 1 $60 $50 No impairment
Asset Group 2 $70 $130 Impairment indicated,
proceed to fair value testp
Asset Group 3 $30 $60 Impairment indicated,
proceed to fair value test
Total $160 $240Total $160 $240
Goodwill $160 Unallocated as the asset
groups are components of
the reporting unit
26Valuation Research Corporation
p g

27. Step 2: Determine Fair Value and Allocate Impairment
• The asset group is impaired by the amount its carrying value
exceeds its fair valueexceeds its fair value.
• The impairment is allocated, on a pro-rata basis to the assets
group’s long-lived assets.
• An asset cannot be impaired lower than its fair value• An asset cannot be impaired lower than its fair value.
27Valuation Research Corporation

28. Step 1b: Fair Value Test
The next step is to calculate the fair value of the asset groups that failed the
undiscounted cash flow test.
Reporting Unit Undisc Fair Value Carrying ConclusionReporting Unit Undisc.
Cash flow
Fair Value Carrying
Value
Conclusion
Asset Group 1 $60 $100 $50 No Impairment
Asset Group 2 $70 $150 $130 No Impairment
Asset Group 3 $30 $50 $60 Impairment indicated,
proceed to step 2proceed to step 2
Total $160 $300 $190
Goodwill $160 Unallocated as the asset
groups are components ofg oups a e co po e s o
the Reporting Unit
28Valuation Research Corporation

29. Step 2: Determine the Level of Asset Impairment
The next step is to calculate the fair value of the asset groups that failed the
undiscounted cash flow test. Asset Group 3 is showing impairment of $10.
Asset Group 3 Book
Value
% of
Total
Fair
Value
Pro –Rata
Allocation
Allocation of
impairment
Adjusted
Book
Value
Working Capital $10 n/a 0 0 $10
Fixed Assets 20 40% 18 4 2 18
Customer
relationships
10 20% 12 2 0 10
Technology 20 40% 7 4 8 12
Total 60 10 10 50
29Valuation Research Corporation

30. Priority
144.13. Other than goodwill, the carrying amounts of any assets (such as accounts
receivable and inventory) and liabilities (such as accounts payable, long term debt,
and asset retirement obligations) not covered by this Statement that are included in
an asset group shall be adjusted in accordance with other applicable generallyg p j pp g y
accepted accounting principles prior to testing the asset group for recoverability.
142.29. If goodwill and another asset (or asset group) of a reporting unit are tested for
impairment at the same time the other asset (or asset group) shall be tested forimpairment at the same time, the other asset (or asset group) shall be tested for
impairment before goodwill. For example, if a significant asset group is to be tested
for impairment under Statement 144 (thus potentially requiring a goodwill impairment
test), the impairment test for the significant asset group would be performed before
the goodwill impairment test If the asset group was impaired the impairment lossthe goodwill impairment test. If the asset group was impaired, the impairment loss
would be recognized prior to goodwill being tested for impairment.
• Indefinite-Lived Assets under SFAS 142
• Long-Lived Assets under SFAS 144
• Goodwill under SFAS 142
30Valuation Research Corporation

31. Conclusions: Putting It All Together
• Reporting Unit 2 failed step 1 test
• Fair value = $300
• Carrying value = $400
I i t f i d fi it li d t f $5• Impairment of an indefinite-lived asset of $5
• Impairment of long-lived assets of $10
Reporting Fair Carrying Asset Adjusted Conclusiong
Unit Value
y g
Value Impairment
j
Carrying
Value
RU1 $500 $350 0 $350 No Impairment
RU2 $300 $400 $15 $385 Impairment still
indicated,
proceed to step 2
Total $800 $750Total $800 $750
Market cap $700
Implied Control
Premium
14.3%
31Valuation Research Corporation
Premium

32. Conclusion: Putting It All Together
• Reporting Unit 2 failed step 1 test
• Fair Value = $300
• Carrying Value = $400; Adjusted Carrying Value = $385
A f thi l th t b k l f PP&E d i t ibl t• Assume for this example that book value of PP&E and intangible assets are a
reasonably estimate of fair value.
R ti U it 2 B k V l Adj t d F i V l 142/144Reporting Unit 2 Book Value Adjusted
Carrying
Value
Fair Value 142/144
Impairment
Net Assets $400 $385 $300$400 $385 $300
Working Capital 70 70 70
PP&E 50 48 50 2
I t ibl 120 107 130 13Intangibles 120 107 130 13
Goodwill 160 160 50 110
Total Impairment 125
32Valuation Research Corporation

33. Summary & Order of Impairment Testing
Asset Type Indefinite-lived
Intangible Assets
Long-lived
Tangible &
Intangible Assets
Goodwill
Intangible Assets
Accounting
Guidance
SFAS 142 SFAS 144 SFAS 142
Focus Indefinite-lived
Intangible assets
carried at lower of FV
Test the
recoverability of
long lived assets
Goodwill carried at
lower of FV or CV
carried at lower of FV
or CV
long-lived assets
Methodology One step Multiple steps Two step
Frequency Annually/event based Event based Annually/event basedFrequency Annually/event based Event based Annually/event based
33Valuation Research CorporationValuation Research Corporation

34. Contact Information
PJ Patel
ppatel@valuationresearch.com
609 243 7030609-243-7030
Ed Hamilton
ehamilton@valuationresearch.com
609-243-7018
34Valuation Research CorporationValuation Research Corporation

35. U.S. Office Locations
Boston
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Boston, MA 02110
Milwaukee
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San Francisco
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Chicago
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414.271.8662
New York
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Tampa
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Cincinnati
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,
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813-463-8510
Cincinnati, OH 45202
513.579.9100
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609.452.0900
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36. International Affiliate Office Locations
Buenos Aires
Franklin D. Roosevelt 2445
Piso 10
London
Cloister House
Riverside
Monterrey
Antonio Gaona No. 2000-401
Col. Florida
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Argentina
Caracas
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New Bailey Street
Manchester, M3 5AG
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Venezuela
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Spain
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Melbourne, Victoria 3000
Australia
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