 Hello and welcome to the session in which we would look at goodwill impairment. This topic is covered in intermediate accounting and advanced accounting as well as the CPA exam. So it's very important whether you are an accounting student or a CPA candidate to understand how goodwill and goodwill impairment works. Now at this point I'm assuming you are you know what goodwill is although I'm going to go over brief overview how to compute goodwill initially. Now if you are an accounting student or a CPA candidate I strongly suggest you take a look at my website forhatlectures.com. I don't replace your CPA review course. I am a useful edition alternative explanation backup explanation that's going to help you understand the material better and by doing so you'll be able to understand your CPA review better and my courses are aligned with your CPA review course which in turn you'll be able to pass your exam. Now your risk with me is one month of subscription you can try it if you like it you keep the subscription if not you cancel your potential gain is passing the exam and if not for anything take a look at my website to find out how well or not well your university doing on the CPA exam and the list of other courses that I teach. If you have not connected with me on LinkedIn please do so and take a look at my link take a look at my LinkedIn recommendation like this recording share it with other connect with me on Instagram Facebook Twitter and Reddit. So let's talk about goodwill. How is goodwill created for example when you want one company purchase another company goodwill is created how so let's assume you're buying a company and they have a fair value of their assets is 100 000 that's the fair value of their assets the fair value of their liabilities is six stages for the sake of illustration so the fair value of their book value is 40 000 now let's assume you paid you paid 75 000 for this company you paid 75 000 for something that's worth 40 000 so you paid an access of 25 000 and to make the simple we're going to assume you could not find any identifiable asset to allocate this 25 000 whether it's tangible or intangible so if you cannot allocate this 25 000 to any asset or liability sometime what you need to do the remaining will be goodwill so goodwill is created when one company purchase another company in access of their fair market value and that access first will have to be allocated to identifiable tangible or intangible asset if not any remaining goes to goodwill now this 25 000 sits on the books but what do we have to do with it well the first thing we do is we're gonna we're gonna consider it that it has indefinite life and this is important when we're dealing with goodwill and intangibles it's very important to know that if something has an indefinite life indefinite life means we don't do any amortization if we don't do any no amortization what we do is we do impairment so we have to check for to see if the value of that asset went down so there's no rationale about there's no need for this rationale and systematic manner reduction like in depreciation on amortization so we don't amortize we don't depreciate what we do is we're going to impair and goodwill impairment the loss itself is basically an operating item it goes on the income statement as one line of losses then we perform this goodwill based on what's called the reporting unit and we're going to talk about the reporting unit a little bit more detail within a combined entity so we would look at the reporting unit and we will test for impairment on the reporting unit so each reporting unit is will be separately subject to that periodic impairment review and what's that periodic usually annually sometime we do it more than annually if circumstances arise but usually at least annually we have to do this impairment we have to check to see is our reporting unit impaired now how do we how do we say we have a reporting unit that's important what what is reporting unit or units okay what is what is that reporting unit first of all it has to be it has its own operating line it's distinct operating line so it's basically a separate business and that separate business has to be responsible for its assets liabilities and earn its own profit the unit itself it's part of the company but it's accounted for separately and it reports earning to top management for support and decision-making so simply put it's like an independent unit within the overall entity we call this a report reporting unit and what we do is we test the reporting unit the goodwill for that reporting unit okay so following the business combination we have identifiable assets and liabilities that are assigned to that reporting unit so we have those so any amount assigned to goodwill expected to benefit from the synergies of the combination so we have a goodwill for that reporting unit specifically okay so any individual reporting unit where goodwill resides is the appropriate level for goodwill impairment testing so when we buy a company and we have a reporting unit ABC well we're gonna have goodwill for A goodwill for B and goodwill for C each one will have their own assets their own liabilities and their own unit and to show you a real example let's take a look at AT&T AT&T identify its principal operating unit or one level below them as a reporting unit and let's take a look at their script of their annual report goodwill is tested by comparing the book value and we're going to talk about this later of each reporting unit deemed to be our principal operating segment to one level below them and these are the operating unit business solutions entertainment group consumer mobility mexico wireless brazil and pan america and the international market at the fair value so we compare the book value to the fair value and they use discounted cash flow as well as market multiple approach this is the way that they do the impairment we'll discuss this shortly okay so notice all goodwill impairment testing is performed at the reporting units what they do is they look at the mexican unit separately mexican wireless and they would compare the book value to the fair value and what do they use when they do so well the book value is the balance sheet the fair value they use either discounted cash flow or they might take a look at market multiple basically how much would the market value that reporting unit today in the actual market based on some multiple okay and this what what happens when you when you look at each reporting unit separately okay what's that gonna do it's not gonna mask so for example if entertainment groups goodwill went down and consumer mobility went up if you combine them they will cancel each other you don't want to do that so you want to report each one separately so not one of them will mask the other mask the decrease in the other okay so one goes up the other goes down they cancel each other out you don't want to do that if one goes down you will account for that separately now what do you do how do you how do you how do you how do you find out how do you start this whole process well impairment testing can be very costly therefore it's well although it's yearly but you know to do the impairment testing itself using numbers it's costly so what fast be what fast be recommended is you can do what's called qualitative analysis to assess whether testing procedures are appropriate so you don't start the testing immediately because it's costly because you have to do cash flow analysis you have to collect data so you do what's called qualitative analysis now what are the qualitative analysis there are many factors that will tell you whether to do to perform impairment testing well what are those factors i'm going to show you a list this is not the complete list you can think of other list one is macroeconomic conditions like what general economic conditions like the economy is contracting there's a foreign currency fluctuation where you are exposed to that foreign currency there is a decrease in credit market something happened in the macroeconomic condition that affect your company maybe maybe you want to take a look at that reporting unit maybe at lost some value industry and market consideration this could be deterioration deterioration in the environment in which you operate for example during the real estate crisis if you are if you if your company deals with real state if it's exposed to the real estate there's a deterioration in your markets you want to take a look at your goodwill to see if it's impaired or there's an increase in competitive environment you have new companies that are coming onto the market that are better and they provide better service at a lower cost than you a decline in the market-dependent multiple of matrixes both is an absolute and relative value and this could take many those matrixes matrices could take any value like the stock market maybe your stock price went down and either an absolute or relative relative to the peers and change in the market or an entity product or services there's a major change in your product that's no longer useful or a regulatory or political development or guess what let's assume it's it's it's a medication the FDA says take it out it's dangerous you know then what's going to happen that reporting unit might the goodwill of that reporting unit might be impaired so those are qualitative tests just basically looking for events that trigger that you know and do I have do I have a goodwill impairment those are the events that you look for cost factor if the cost if the cost that goes into your product went up like raw material labor there's a shortage could have a negative effect on earning well your company might be your reporting unit might be impaired other financial performance like negative or declining cash flow and this is on the CPA exam they always tell you negative negative or declining cash flow it's really a red flag for goodwill and testing for goodwill impairment or a decline in the actual or planned revenue earning so if you have a unit and it's not going to be generating revenue in the future guess what it might be impaired then what if they have a goodwill guess what if that's had the goodwill test the goodwill for impairment and we're going to see how do we do that in moment changes in management sometime let's assume Elon Musk leaves Tesla who knows maybe Tesla tanks is like you know what maybe it's if they have any goodwill they have to maybe test that goodwill key personnel strategy or customers any event could trigger goodwill now this event that has to be more likely than not now how do you define more likely than not it's 50 plus so if the reporting fair value unit is deemed to be greater than than the carrying amount of there's more than 50 chance that the fair value is greater than you don't do anything you just say okay no further impairment tests are necessary but if the reporting unit fair value so we'd look we would compare fair value versus book value if the fair value is less than we think we think it's less than the book value 50 plus a chance then what we do we have to do further testing now again we do this annually but remember we don't have to wait annually for example when covid hit in march of 2020 or you know march or february it doesn't matter what happened is then if you purchase some businesses recently you have to test them for if there's any goodwill impairment because businesses are going down okay so you don't have to wait yearly more frequent impairment assessment is required if events or circumstances change that make it more likely than not that the reporting unit fair value is now below the carrying value so it doesn't have to be annually but at least annually but if something happened before it's annually then you will do it let's take a look at an example assume on january 1st 2022 investors from new call corporation can to consolidate the telecommunication operation of dsm and vision talks in a deal that's worth 2.2 billion so those two companies consolidate dsm and vision talk new call organizes each former firm as an operating unit and recognizes 215 million as goodwill at the merger date then allocate this amount to three different unit so what they did they said well our total goodwill is 215 and they have three reporting unit the dsm wire dsm wireless and vision talks and what they do they allocated this 215 million to those three units 22 million for dsm 150 dsl wired a wireless 155 and vision talk 38 million now at the end of the year what they have to do they have to examine any relevant event what i showed you earlier in the prior slide in circumstances to determine the fair value of the reporting unit tell what did the analysis revealed well it revealed that the fair value of each reporting unit likely exceeds its carrying amount except for this dsm wireless this dsm wireless it seems that they have a difficulty realizing expected cost savings synergies with vision talk so what they did they assume dsm wireless when they first merge that because of that merger they're going to save the cost at the end of the year they find out this saving cost did not really materialize it means our cost went up guess what more likely than not that this reporting unit is subject to goodwill impairment now we're going to have to look at this unit separately the other two they're good dsm wired is good vision talk is good why because the fair value at the end of the year is greater than the book value this one fair value greater than the book value i don't have to do anything now we must proceed with the impairment testing so let's do the impairment testing okay now we compute the impairment testing and we find out the fair value is 650 the carrying amount is 720 the book value carrying amount what happened is the difference between them is 70 million 70 million the difference between them is 70 million okay what does that mean well we have 155 of goodwill impairment and now we're gonna goodwill we're gonna have to reduce it by 70 million so we're gonna take the 70 million and report 70 million of impairment loss is on a separate line in the operating section it's basically businesses by other businesses and as a result they have goodwill as a result that goodwill could be impaired it's a regular loss it's an impairment loss it's not unusual or anything okay as of December 31st 2022 new call reports only 85 million of goodwill remember there were 155 they have to subtract 70 because we're gonna debit a loss impairment loss credit goodwill for 85 for 70 million that's the entry impairment loss impairment loss credit goodwill therefore we reduce the goodwill by 70 million the other two units they're good we don't have to do anything now we also have to do additional disclosure such as facts and circumstances to why we did this impairment the method that we use to determine the fair value remember the fair value was 650 how did we come up with fair value did we use discounted cash flow did we use market multiple okay what did we do did we compare dsm wireless to some other business that's compared to us okay now bear in mind impairment loss cannot exceed the carrying amount of any particular reporting units goodwill so simply put let's assume we find out that good word impairment loss is 160 million well guess what we can only take 155 it cannot exceed that this is basically a summary of goodwill impairment once again at the end of this recording i'm gonna remind you that your study for your cpa exam once in your lifetime you pass it you move on with your life don't shortchange yourself i don't replace your cpa review course i'm a useful addition give me a try study hard for the cpa exam it's worth it it's you pay you pay for it once it's gonna pay different for the next 30 to 40 years good luck study hard and of course stay safe