The Financial Accounting Standards Board has tentatively decided it will make the goodwill impairment test simpler for public companies by dropping the dreaded second step in the current two-step test to determine the markdown.

FASB decided to take a fresh look at the controversial two-step test for determining whether a company should write down any goodwill in its balance sheet when the board agreed to its Private Company Council’s proposal for a simpler approach for private companies. Rather than requiring private companies to carry goodwill at cost and test it annually for impairment, FASB now allows private companies to amortize goodwill over 10 years. Impairment testing would only be required when triggering events occur suggesting its value is not holding up.

For public companies, FASB is not planning to follow the same amortization model. Instead, the board decided it will follow a phased approach to modify the rules, with the first phase simplifying the current impairment test by dropping the second step of the current two-step test. In the second phase, FASB will work with the International Accounting Standards Board to address any further concerns about accounting for goodwill.

The current two-step test requires entities first to determine if the carrying value of goodwill on the balance sheet exceeds the fair value. If the answer is yes, then the second step requires a hypothetical purchase price allocation for the reporting unit, which means establishing fair values for all assets and liabilities in the unit to determine a value for goodwill. The difference between the carrying value and the fair value of goodwill as measured in that second step produces the markdown that must be taken in financial statements.

Accounting purists like the current requirement because it establishes a more precise values for goodwill, which is a number that arises in the balance sheet as a result of a business acquisition. Investors pay attention to goodwill as an indicator of whether a company got its money’s worth when it purchased that business unit. Preparers, however, say the current accounting requirements are complex and costly.

FASB’s plan will reduce the cost of annual impairment testing for public companies and make the GAAP model more consistent with the requirements under International Financial Reporting Standards, says Greg Franceschi, managing director at valuation and corporate finance firm Duff & Phelps. “By removing the second step of the test when the reporting unit carrying value exceeds the reporting unit’s fair value, the impairment test has been simplified,” he says. “The impairment will be measured as the amount that carrying value exceeds the fair value of the reporting unit.”

FASB decided if a reporting unit has zero or negative carrying value for goodwill and it is more likely than not that goodwill is impaired, then the company would be required to write off the full amount of goodwill allocated to that reporting unit. The staff will do further research on how entities would perform the simplified test based on a qualitative assessment of goodwill for reporting units with zero or negative carrying value.

The board also decided it will require companies to follow the new method on a prospective basis, so they will not go back to earlier periods and adjust those figures based on the new rule. The standard will not permit an option to continue performing the second step of the impairment test, even if there were some reason an entity would want to do so.

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