 Hello, and welcome to this session in which we will discuss impairment of intangibles or impairment of intangible assets, including goodwill. It's very important to understand where this session fits within the lesson. We are discussing consolidation of the balance sheet. And when we consolidate, when we, when we have a subsidiary as a result, we could have created intangibles. We could have, we could have created goodwill. And this is what we did in the prior session. In the prior session, we purchased a company, a subsidiary, and as a result, we created, so this was the purchase of the subsidiary. And we created as a result of this transaction, intangibles and goodwill. Now, bear in mind, this session is designed for CPA candidate. If you want to view the prior session by all means, it's very important. The reason I'm saying this session is designed for CPA candidate, because if you want to learn a little bit more about impairments, go to my advanced accounting course where I discuss impairment of both intangibles and goodwill. In this session, I would also again cover impairment, but it may not be in depth as much as you would like. But if you already know, have an idea what an impairment is, it will be a great review. So impairment of intangibles. Again, what are intangibles? Intangibles are asset that lack physical existence. Now, what do we mean by impairment? What does it mean that the intangible or any asset could be impaired? Specifically, here we're talking about, we are talking about intangibles. Impairment means somehow the asset lost its utility, lost some of its value. Why? It could be many reasons. Maybe a new technology made your asset made your asset obsolete. You had a piece of technology currently that you paid for it a million dollar. Now there's a newer, faster, more efficient technology and it's cheaper than yours than technically yours lost its value. It's impaired. Or maybe there was a legal decision that made your asset obsolete. Well, the government says you can no longer use this asset or this asset or the product that comes out of this asset is no longer legal. Well, guess what? That made your asset obsolete. So impairment is when the asset lost utility. Now, how do we have to deal with this? Okay, as I previously mentioned in the prior session, intangible assets are subject to impairment test and it differ whether the asset has a finite life or an indefinite life. What does that mean? It means we have two types of intangible assets. One with finite life and two with indefinite life. Finite life means it has a limited amount of time. It's going to serve you five years, seven years, nine years, 10 years. An indefinite life useful asset. It means the asset can serve the business forever, can serve the business forever. So let's talk about how do we deal with those type of issues? Okay, intangible asset with finite life. So if we have a finite life asset, it means it has a limited amount of time that, you know, it might serve you for 10 years. An intangible asset with a finite useful life is tested for impairment using a two step process. And this happened when changes in condition or circumstances indicate then the carrying value will not be recovered. So what happened is this something will happen. There's a legal, there's a legal judgment against your company and as a result, some of your assets are impaired. Some of your intangible asset know what you do is this, you would say, okay, now what do I need to do? Well, I need to find out if my asset can recover my book value. What is my book value? Well, it's the asset minus any accumulated amortization. The book value. Let's assume the book value of the asset equal to $800,000. And now you estimate that all the future value, all the future cash flow that this asset can generate is $600,000. So this is the maximum cash flow. I'm discounted. Not discounted that this asset can generate. Well, guess what? This asset cannot generate enough cash to cover its book value. This is step one. So this is what you do in step one step one. You look at the book value and you compare the book value of the asset book value or carrying value to how much cash can this asset generate. This is called the recoverability test. The first test of the model known as the recoverability test consists of determining whether the asset impaired or not. So this is the answer is yes, impaired or no. In this example, yes, it's impaired because the cash cannot recover the book value. In this step, the carrying value is compared to the undiscounted, remember, undiscounted cash flow. Future cash flow expected to be generated. Well, we're not going to, we're not going to be generating enough cash. If the answer is yes, it's impaired. You go to the second step. You go to the second step. So if it's impaired, you go to the second step in the second step determine the value of the impairment. Now we need to know how much impairment we need to book. Well, how much impairment we need to book. Again, we're going to compare the book value, which is 800,000 to the fair value of the asset. And let's assume the fair value is 550. Well, the difference between 800 and 550 is the amount of the impairment. Now, bear in mind, sometimes they don't give you the fair value. They tell you that discounted cash flow is 550 or they tell you the fair value is 550. So be careful. Discounted cash flow is equivalent. So when we say discounted cash flow, you can consider this as fair value. Notice there is discounted and there is, let me highlight it in yellow. Undiscounted, that's used in step one. The undiscounted cash flow is used in step one. Discounted is used in step two, assuming you are not giving the fair value of the fair value is giving. That's easy. So we said at the end, the carrying value of this asset was 800,000. We said the fair value is 550. The difference between them is your impairment loss. So the first test is yes, we have an impairment. The second test is we compute the dollar amount of loss. This is for finite useful life intangible asset. Let's assume the asset, the intangible asset will have an indefinite unlimited useful life. Well, if it has an unlimited useful life, we cannot do test one. Why? Because test one, you have to estimate your future cash flow, your future cash flow. How can you estimate your future cash flow? If you think the asset can last you forever, you can do it. Therefore, intangible asset with indefinite useful life are tested for impairment at least annually. And guess what? Using only one step model. So here we have one step model. And it's very simple. You compare the fair value to the book value. Again, we look at the book value and we compare it immediately to the fair value. If the book value is, let's look at it from a fair value perspective. If the fair value is less than the book value, then the asset is impaired. Or if the carrying value of the asset exceeds, so if the book value is 800,000 and the fair value is 600,000, now we have a loss of 200,000. Okay. The difference represent the impairment loss and it should be recognized in the income statement. Again, the reason why we use only one step because it's impossible to estimate the future cash flow from an indefinite life asset. It's also important to note under US GAAP, the restoration of previously recorded impairment loss is prohibited unless the asset, the asset that you are impairing is held for sale. So we have two type of assets. We have one asset that could be used in operation and under those circumstances, if the asset is used in operation, once you write it down, you cannot write it back up to its book value. However, if the asset is used, is not used for operation, it's held for sale. In other words, you are, you put this asset on the side, you're planning to sell it. If you impaired it, you can write it back up up to the original book value, not original book value to its book value where the impairment took place. So let's take a look at this example to illustrate the concept. On December 31st, year two, a corporation tested its asset for impairment before the preparation of the financial statement, a patent with the remaining life of seven years. What does that mean? It means this asset will have a definite life. It means we're going to have to use the two-step process was recorded on the books for 25,000. This is the book value. The estimation shows that the corporation will generate an annual revenue of 35. Well, let's see. If we let's take a look at our calculators and we said the asset will generate 35,000 for the next seven years. That's going to give us 245,000. Well, the first, the first test book value equal to 250, the cash flow on discounted cash flows to 45. Yes, we have an impairment. These, these inflows have a present value of 210 and the discounted cash flow equal to 210. Do we have an impairment? And the answer is yes. Why? Because 245 is less than 250. The answer is yes. Now, how much is the impairment? Now you compare the book value, which is 250 to the discounted cash flow, which is 210. And we have an impairment loss debit impairment loss of 40 credit the intangible asset patent 40,000. Now let's take a look at Goodwill impairment. Same thing. Just like intangible can be impaired. Also Goodwill is impaired, could be impaired. In other words, you bought a company and as a result you generated Goodwill. What does that mean? It means you overpaid. You paid more than the fair value of the identifiable and non identifiable intangible. So you paid way and above the value of the company. You created Goodwill. Why did you pay? Well, because you thought the company has a good future. Well, now you find out. It's not as good as you thought. Now, what once you figure this out, you have to impair your intangible. Okay. Although Goodwill is an intangible with an indefinite life, it's tested for impairment differently. So the testing for Goodwill is a little bit different. Bear in mind it has an indefinite life and there's a small exception. We'll talk about it shortly under US gap. Goodwill is tested for impairment at the reporting unit level with the reporting unit being an operating segment also referred to as a component or one unit below operating segment. Usually on the exam, they will tell you what the reporting unit is. Okay. And if there is two or more component have similar economic characteristic, they're aggregated together in a single reporting unit. Just know for gap, you would use a reporting unit for the impairment test. Now, how do you test Goodwill for impairment? Okay. The test for impairment consists of comparing. Listen to me carefully. The carrying value of the reporting unit. So the book value of the unit, including Goodwill. So you include Goodwill to the fair value of that unit including Goodwill. So you'd look at the book value, including Goodwill to the fair value, including Goodwill if the carrying value is simply put if the book value exceeds the fair value, what it means to fair? It means the company lost, lost lost some value lost some value. Why? Because the book value is higher than the fair value. Then the goodwill of that reporting unit is impaired. Now bear in mind that the impairment loss is limited to the amount of the goodwill recorded for that specific reporting unit. So you cannot write down the goodwill more than the goodwill that exists. It's important to note that goodwill may be impaired in one reporting unit without being impaired in other reporting unit. You might have several reporting unit. You have to do this test on several reporting unit and will work an example. Just I want to let you know about a small exception. It could be on the CPA exam alternative for private companies. Now if you're a small private company, not small, just private companies, guess what? You are allowed to use a different accounting method for goodwill impairment, okay? You might choose to amortize goodwill on a straight line basis over an appropriate useful life. So you can consider goodwill as a definite life asset. And you can test for impairment either at the reporting level or the entity level. Whenever an event indicate that the fair value of the unit has fallen, the fair value has falling, okay? It's worth noting that goodwill is less likely to be impaired when it's being amortized because why because you are reducing the goodwill constantly with the amortization. When a private company elects to amortize goodwill, it must do so to all existing and subsequently generated goodwill. So once you select this method, you have to stick to it. Let's look at an example to see how this works. XYZ company has two reporting units and this is not a private, this is public. At the end of year two, unit A had a book value of 320 and a fair value of 307. So we have unit A and unit B. Unit A, book value equal to 320, fair value equal to 307. While unit B has a book value of 510 and a fair value of 700 and all these figures including goodwill. We don't have to worry about B because the fair value is greater than the book value. Well, we have to look at A. We might potentially we could have some impairment. In addition, at that date, goodwill reported in unit A and B amounted to 10,000 and 30,000. I already took out B because it's not going to be impaired. But we see that in unit A, we have 10,000 of goodwill. So there's 10,000 here and 10,000 here. Remember, we include the goodwill. Determine whether goodwill reported at each of the two reporting unit is impaired and determine the value of the impairment. Well, let's take a look. We kind of determined B is out. Let's look at A. Goodwill is an intangible asset with an indefinite useful life. It's tested for impairment at the reporting level. The book value of unit A 320 exceeds the fair value by 13,000. Well, we do have impairment. How much is the impairment? Given that unit A reported goodwill of 10,000, which is less than 13,000, we are limited to 10,000. So you're going to write down company A goodwill by 10,000. Although we lost 13,000, the total loss and value is 13,000, you are limited to the amount of the goodwill. On the other hand, the fair value of unit B exceeds its book value. There is no impairment at this level. What should you do now? Go to farhatlectures.com, work MCQs and exercises that's going to help you understand this topic better. Invest in yourself. Don't shortchange yourself. The CPA exam is worth it. It's an investment for your future. Good luck, study hard, and of course, stay safe.