Evaluating intangible assets for impairment is an important but complex aspect of financial reporting.
This article will clearly define intangible asset impairment and provide practical examples to demonstrate its relevance for businesses and investors.
We'll start by examining key concepts like intangible assets, impairment, and carrying value versus market value. Then we'll explore real-world case studies of impairment in the media and consumer goods industries. You'll also learn about differences in impairment testing under US GAAP versus IFRS standards.
Understanding Intangible Asset Impairment and Its Relevance
Intangible assets are long-term assets that have no physical substance but provide economic value to a business, such as patents, trademarks, copyrights, and goodwill. These assets are recorded on the balance sheet at their purchase or acquisition cost, known as the "carrying value."
Over time, intangible assets may lose some or all of their ability to generate economic benefits for the company. When this happens, accounting rules require the company to write down or "impair" the value of the intangible asset on its balance sheet. This impairment loss gets recorded as an expense on the income statement, negatively impacting net income and earnings per share.
Defining Intangible Assets and Their Role on the Balance Sheet
Intangible assets lack physical substance but give a company certain rights or competitive advantages. Common examples include:
- Patents: Provide the exclusive right to make and sell an invention for a limited period.
- Trademarks: Protect names, slogans, logos that identify a company's products or services.
- Copyrights: Grant exclusive rights to reproduce and distribute creative works like books, music, films.
- Goodwill: An intangible asset that arises when a company acquires another company for more than the fair value of its net assets.
Intangible assets have a useful life and get amortized over time. But some intangible assets like goodwill have an indefinite useful life and do not get amortized.
On the balance sheet, intangible assets are recorded at their historical purchase or acquisition cost less accumulated amortization. This carrying value may differ significantly from the intangible asset's current fair market value.
The Concept of Impairment: Carrying Value vs. Market Value
An intangible asset impairment occurs when the asset's market value drops below its carrying value on the balance sheet. This usually happens due to:
- Technological obsolescence or loss of competitive advantage
- Lower than expected financial performance
- Legal issues that negatively impact the value of patents or trademarks
- An economic downturn that lowers demand for the company's products or services
By recording impairment losses, the balance sheet better reflects the intangible asset's diminished fair market value.
Overview of Impairment Accounting Rules under GAAP and IFRS
In the U.S., accounting for impairment of intangible assets falls under ASC 350 Intangibles - Goodwill and Other standard. International Financial Reporting Standards (IFRS) handles impairment under IAS 36 Impairment of Assets.
While some differences exist between U.S. GAAP and IFRS on impairment testing approaches, both require companies to periodically review intangible assets for impairment triggers and record impairment losses when appropriate.
Accurately identifying and recording intangible asset impairments has become an increasingly important issue for businesses worldwide. Understanding the concept of impairment can help managers, investors, and stakeholders better interpret financial statements.
What are examples of impairment assets?
Intangible assets like patents, trademarks, goodwill, and other long-term assets can become impaired over time. Here are some common examples:
Goodwill
Goodwill impairment occurs when the carrying value on the balance sheet exceeds the asset's fair market value. For example, if a company acquires another company and records goodwill, but the acquired business underperforms expectations, the goodwill may need to be written down.
Patents
If a patent is not generating sufficient licensing revenue or competitive advantages as initially expected, it may be impaired. For instance, if a new technology makes the patent obsolete, its ability to produce future economic benefits decreases, requiring an impairment analysis.
Other Intangible Assets
Brand names, licenses, trademarks, and other intangibles can also face impairment if revenues, profits, cash flows or other metrics fall short of estimates used to value the assets. Oftentimes, impairment occurs because the amortization or depreciation was underestimated.
PP&E
Property, plant and equipment like machinery, equipment, and real estate can be subject to impairment losses when carrying amounts exceed market values or income-generating capacity declines. This may happen due to obsolescence, physical damage, or other factors affecting usefulness or productive output.
In summary, impairment often relates to overvalued assets on the balance sheet, where realizable value or cash generation ability falls below expectations used to record the asset's initial cost. Impairment losses aim to write-down inflated asset values to better reflect financial position and performance.
What is impairment of intangible assets ASC 350?
ASC 350 provides guidance on testing indefinite-lived intangible assets, including goodwill, for impairment.
Indefinite-lived intangible assets
Indefinite-lived intangible assets, such as trademarks, are not amortized but rather tested for impairment annually or more frequently if events or changes in circumstances indicate the asset may be impaired. ASC 350-30 outlines the impairment testing procedures for these assets.
The impairment test consists of comparing the fair value of the intangible asset to its carrying value on the balance sheet. If the carrying value exceeds the fair value, an impairment loss must be recognized on the income statement for the difference. This reduces the asset's value on the balance sheet.
Goodwill
Goodwill impairment testing is covered under ASC 350-20. Goodwill must be tested for impairment at least annually at the reporting unit level.
The initial step is a qualitative assessment to evaluate if events or circumstances exist indicating the fair value of the reporting unit is less than its carrying value. If further testing is necessary, a quantitative two-step impairment test is performed:
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Compare reporting unit fair value to carrying value. If fair value is less, proceed to step 2.
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Compare implied fair value of goodwill to carrying value. Record impairment for any excess carrying value.
An impairment loss recognized for goodwill cannot be reversed in future periods.
Summary
ASC 350 provides specific guidance for testing and recognizing impairment losses for indefinite-lived intangible assets and goodwill. Impairment testing procedures are aimed at ensuring these assets are not overstated on the balance sheet. Recognizing impairment losses when appropriate provides more accurate financial reporting.
What are examples of intangible assets?
Intangible assets are non-physical assets that play an important role in a company's operations and financial statements. Here are some common examples of intangible assets:
Goodwill
Goodwill represents assets that are not separately identifiable. It often arises when a company acquires another company and pays more than the fair value of the target company's identifiable net assets. Goodwill may include brand recognition, customer loyalty, superior management, or patents that haven't been recorded on the target company's balance sheet.
Brand Recognition
A company's brand, including its name, logo, and slogans, can be considered an intangible asset if it helps drive sales and business growth. Brand recognition is the asset that allows customers to identify and trust a company's products or services.
Copyrights
Copyrights protect original creative works like books, songs, films, and artwork from being used commercially without permission. Copyrights are intangible assets that have value for companies focused on creative works and can generate licensing revenue.
Patents
Patents provide companies with exclusive rights to inventions or discoveries for a certain period, usually 20 years. Patents prevent competitors from using protected inventions like new technologies, processes, or designs. They can generate value as defensive assets or licensing revenue.
Trademarks
Trademarks protect names, slogans, logos, or symbols associated with a company's products and services. By distinguishing a company's brand, trademarks help prevent confusion with competitors and build brand loyalty.
So in summary, intangible assets range from intellectual property like patents and copyrights to goodwill like brand recognition and customer loyalty. They derive value by supporting business operations, driving revenue growth, or providing competitive advantages.
What is the meaning of impairment of tangible assets?
An impairment loss occurs when the carrying value of an asset on the balance sheet exceeds its recoverable amount. The recoverable amount is defined as the higher of the asset's fair value less costs to sell and its value in use.
Intangible assets refer to long-term assets that lack physical substance, such as patents, trademarks, copyrights, and goodwill. Tangible assets are physical in nature and include things like property, equipment, and inventory.
Some key things to know about impairment of tangible assets:
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Tangible assets are recorded on the balance sheet at historical cost less accumulated depreciation/amortization. If the market value declines below this carrying value, impairment may need to be recognized.
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Common tangible assets include land, buildings, machinery, equipment, vehicles, furniture, fixtures, and inventory.
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Indicators of impairment for tangible assets can include obsolescence, physical damage, significant changes in technology or business environment, idle capacity, and declining financial performance.
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To test for impairment, the recoverable amount of the asset is compared to the carrying value on the books. If lower, an impairment loss must be recorded for the difference.
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The impairment loss is recorded as an expense on the income statement, which reduces net income. Future depreciation/amortization expenses will also be lower since the asset's cost basis is written down.
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Reversing an impairment loss in future periods is prohibited under most accounting standards like IFRS and US GAAP.
In summary, impairment of tangible assets occurs when there is a significant and unexpected decline in the service potential of the asset. This leads to a write-down of the asset's carrying value to better reflect its diminished utility and contribution to future cash flows.
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Goodwill Impairment: Identification, Measurement, and Testing
Goodwill is an intangible asset that represents the excess value of a business over its tangible assets. It arises when a company acquires another company for more than the fair value of its net assets.
Recognizing Indicators of Goodwill Impairment
There are several potential indicators that a company's goodwill may be impaired, requiring further testing:
- A significant, prolonged decline in the company's share price or market capitalization
- Poor financial performance of the business unit associated with the goodwill
- Loss of key personnel, customers, contracts, or other assets in the business unit
- Unfavorable industry or economic trends negatively impacting the business unit
- Changes in regulations that adversely affect the company's ability to operate profitably
If any of these factors are present, companies are required to test goodwill for impairment.
Goodwill Impairment Testing Procedures under US GAAP and IFRS
The specific procedures for testing goodwill impairment differ slightly between US GAAP and IFRS:
US GAAP
Companies first assess qualitative factors to determine if goodwill may be impaired. If so, a quantitative two-step test is performed:
- Compare the business unit's fair value to its carrying value on the balance sheet. If lower, there is impairment.
- Calculate the implied fair value of goodwill. Compare this to the carrying value of goodwill to determine the impairment loss to record.
IFRS
Companies can first assess qualitative factors, or directly perform a quantitative one-step test:
- Compare the business unit's recoverable amount (higher of fair value and value in use) to its carrying value. Any excess of carrying value over recoverable amount is an impairment loss recognized on the income statement.
In both standards, goodwill impairment losses cannot be reversed even if conditions improve. Regular impairment testing procedures are essential for accurately reporting performance.
Accounting for Impairment Losses on Intangible Assets
Documenting Impairment Losses on Financial Statements
When an intangible asset is tested for impairment and the carrying value exceeds the recoverable amount, an impairment loss must be recognized on the financial statements.
The impairment loss is calculated as the difference between the asset's carrying value and its recoverable amount. The carrying value is the asset's historical cost less accumulated amortization, while the recoverable amount is the higher of the asset's fair value less costs to sell or its value in use.
On the balance sheet, the impairment loss reduces the carrying value of the intangible asset. It is recorded as a debit to the impairment loss account and a credit to the intangible asset account.
On the income statement, the impairment loss is recorded as an operating expense. This reduces net income for the period.
For example, if an intangible asset with a historical cost of $100,000 and accumulated amortization of $20,000 was determined to have a recoverable amount of $60,000, the entries would be:
Impairment Loss 20,000
Intangible Asset 20,000
This $20,000 impairment charge would be recorded as an operating expense on the income statement.
Disclosure Requirements for Impairment Losses under GAAP and IFRS
Under US GAAP, the notes to the financial statements must include details on any material impairment losses recorded during the period. At a minimum, the company should disclose:
- A description of the impaired intangible asset and the facts and circumstances leading to the impairment
- The amount of the impairment loss and how fair value was determined
- The caption in the income statement in which the impairment loss is aggregated if no separate caption exists
- The business segment affected, if applicable
Similarly, IFRS requires extensive disclosures about impairment testing and losses, including the events and circumstances that led to recognizing the impairment, plus assumptions used in estimating recoverable amounts.
SEC registrants may have additional disclosure requirements around uncertainty, events, trends, demands, or commitments related to intangible asset impairment losses.
Effects of Impairment on Earnings Per Share and Net Income
By reducing net income, an impairment loss negatively impacts key financial metrics like earnings per share (EPS) and return on equity.
For example, if net income was projected at $100,000 for the year and an unexpected $20,000 impairment loss occurs, net income would decrease to $80,000. With 100,000 shares outstanding, this would reduce EPS from $1.00 to $0.80 per share.
Likewise, return on equity would decline as the impairment loss causes lower net income without impacting shareholders’ equity. Careful financial analysis is needed to assess these effects.
Real-World Examples of Intangible Asset Impairment
In this section, we'll walk through real-world examples of intangible asset impairments for companies across industries.
Case Study: Goodwill Impairment in the Media Industry
A notable example of a goodwill impairment comes from The Walt Disney Company in relation to their acquisition of ESPN. As viewing habits shifted from cable to streaming services, ESPN's growth stalled, leading Disney to record a $2.9 billion goodwill impairment charge in 2018 related to the declining value of the ESPN brand and business. This large write-down reflects that the carrying value of ESPN on Disney's balance sheet was significantly higher than its fair value based on lower projected future cash flows.
Other media companies like ViacomCBS, Discovery, AMC Networks, and Fox Corporation have also recently recorded goodwill impairments related to their cable networks as the industry evolves. These write-downs correct overoptimistic valuations from past acquisitions in the face of changing market dynamics.
Case Study: Brand and Trademark Impairment in Consumer Goods
Several major consumer product goods companies have recorded impairments related to brands and trademarks in recent years. For example, Kraft-Heinz took a $15.4 billion write-down in 2019, largely attributed to impairments of the Oscar Mayer and Kraft brands as changing consumer preferences negatively impacted brand value.
Procter & Gamble also wrote down Gillette's razor business by $8 billion in 2018 amid new competition and a slower-than-expected transition from non-disposable to higher margin disposable razors. And Coca-Cola recorded a $143 million impairment on the Odwalla juice brand in 2020 before deciding to discontinue the product line altogether due to declining revenues.
These examples demonstrate how shifting consumer behaviors, increased competition, and outdated brand perceptions can lead to significant trademark and brand asset impairments for major CPG companies. The write-downs account for overoptimistic past valuations and reset the balance sheet to better reflect current market realities.
Comparative Analysis: US GAAP vs. IFRS in Impairment Accounting
Differences in Goodwill Impairment Testing Between GAAP and IFRS
Under US GAAP, companies are required to test goodwill for impairment annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The test involves comparing the fair value of a reporting unit to its carrying amount. If the carrying amount exceeds the fair value, an impairment loss must be recognized.
In contrast, IFRS allows companies to choose between performing an annual impairment test of goodwill or doing an impairment test only when there are indications of impairment. IFRS also requires companies to compare the carrying amount of goodwill with its recoverable amount, which is the higher of the asset's fair value less costs of disposal or its value in use. An impairment loss is recognized if the recoverable amount is below the carrying amount.
A key difference is that GAAP focuses on fair value while IFRS focuses on recoverable value. GAAP is also more prescriptive in requiring annual testing for all companies. The differences can result in variations in the timing and measurement of goodwill impairment between companies following GAAP vs. IFRS.
Impairment of Fixed Assets and Long-term Assets: A Comparative View
For the impairment of fixed assets and long-term assets other than goodwill, GAAP and IFRS have more similarities than differences, although some variations exist.
Both require recognition of an impairment loss if the carrying amount exceeds the recoverable amount. GAAP defines recoverable amount as the higher of an asset's fair value less costs to sell or its value in use. Similarly, IFRS defines recoverable amount as the higher of fair value less costs of disposal or value in use.
However, GAAP does not require periodic impairment testing for these assets in the absence of impairment indicators. IFRS requires an annual impairment test for intangible assets with indefinite useful lives.
GAAP also measures an impairment loss as the excess of carrying amount over fair value, while IFRS measures it as the excess over recoverable amount. The timing of reversal of impairment losses also differs.
So while the fundamental mechanics are similar, differences in the details can still result in quantitative and qualitative differences in impairment outcomes between GAAP and IFRS.
The Amortization and Impairment of Intangible Assets
We'll delve into the concepts of amortization and impairment, explaining how they differ and how they affect the valuation of intangible assets.
Understanding Amortization of Intangible Assets
Amortization is the process of allocating the cost of an intangible asset over its estimated useful life. Unlike physical assets, intangible assets like patents, trademarks, and copyrights don't deteriorate over time. However, their value to a company declines as they approach the end of their legal or useful lives.
Here are some key points about amortization of intangible assets:
- Amortization is recorded on the income statement as a non-cash expense, reducing net income
- The amortization expense is calculated by dividing the asset's cost by its estimated useful life
- Useful life is based on legal, contractual, regulatory, economic, or other limits
- Trademarks can have indefinite useful lives and may not require amortization
- Straight-line amortization is most common, spreading the cost evenly over the life
Amortization does not reflect changes in the asset's market value, only its cost allocation. It differs from impairment, which is recognized when fair value declines below book value.
Recording Amortization and Impairment on the Income Statement
Both amortization and impairment expenses are recorded on the income statement:
- Amortization is a non-cash expense shown regularly during an asset's useful life
- An impairment is recognized as a loss when an asset's market value drops
Impairment losses are irregular and indicate a decline in value. Both reduce net income and earnings per share. However, only impairment indicates issues with the asset's underlying value or the company's management of it.
Under GAAP and IFRS, impairment losses on finite-lived assets cannot be reversed in future periods. However, losses on indefinite-lived intangibles like goodwill can be reversed if value recovers. Reversals help restore net income and EPS.
In summary, amortization allocates costs on the income statement while impairment recognizes asset value declines. Both impact financial performance, but impairment signals problems compared to routine amortization expenses over an asset's life.
Conclusion: The Importance of Intangible Asset Impairment in Financial Reporting
Recapitulation of Intangible Asset Impairment and Its Significance
Intangible asset impairment refers to a reduction in the recoverable value of intangible assets such as patents, trademarks, copyrights, goodwill, etc. below their carrying value on the balance sheet. Impairment can occur due to unfavorable changes in the business, technological obsolescence, competitive pressure, or overall economic conditions.
Recognizing and recording impairment losses is critical for accurate financial reporting and transparency for investors. It provides insight into the true economic health of a company by reflecting the realizable value of its intangible assets.
Reaffirming the Impact of Impairment on Businesses and Investors
Failing to recognize impairment can artificially inflate profits and asset values. This masks underlying problems and presents an overly optimistic view to investors. Recording impairments reduces net income and earnings per share. But it leads to balance sheets better reflecting reality.
For investors, impairment losses provide signals to reassess their valuation models and perceptions of management effectiveness. It may indicate deeper issues requiring further investigation. Understanding impairments leads to better-informed investment decisions.
In summary, intangible asset impairment and its proper accounting treatment helps uphold accuracy and transparency in financial reporting. This builds trust and enables stakeholders to make sound financial judgments regarding businesses.
