Purpose: To comply with GAAP, all companies with fiscal years that start after December 15, 2001, must apply the provisions Statement of Financial Accounting Standards No. 142 (SFAS 142), which requires that acquired goodwill no longer be amortized and, instead, that it be periodically tested for impairment.

SFAS 142 eliminates the amortization of acquired goodwill and introduces an annual (or in some cases, more frequent) impairment test. In the first step of the two-step impairment test, potential impairment is determined by comparing the fair value of a reporting unit with its carrying value, including goodwill. The fair value of a reporting unit is the amount at which that unit could be bought or sold as a whole in a current transaction between willing parties, that is, other than in a forced or liquidation sale. If the carrying value is greater than fair value, the second step of the goodwill impairment test must be performed to determine the amount of the impairment, if any.

The second step is the equivalent of apurchase price allocation. In a purchase price allocation, each asset and liability of the reporting unit must be identified and valued. Guidance for assigning values to assets and liabilities is provided in SFAS 141. The amount by which the fair value established in step one exceeds the amount allocated to the assets and liabilities of a reporting unit is the implied fair value of goodwill. The excess of the carrying amount of goodwill over the fair value of that goodwill determines the amount of the goodwill impairment.

Compliance with SFAS 142 will be of particular concern to companies with publicly traded stock, because in certain cases it will cause greater volatility in reported income. The change will initially cause some businesses to report higher earnings because they no longer are required to amortize goodwill, while others will report lower earnings because they will need to recognize substantial impairment charges.

Who can test and what will it cost? In certain cases, companies may have the ability to internally prepare their goodwill impairment tests. These situations, however, will be the exception to the rule. Lynn E. Turner, former Chief Accountant of the SEC observed, “Whether it is in conjunction with the acquisition of a business, the performance of the impairment test or the evaluation of recorded intangible assets at transition, in almost every instance, companies will be required to obtain the assistance of a competent and knowledgeable professional to assist in the valuation of these intangible assets.” Cost drivers for valuation services are the size and complexity of the business, the number of reporting units, the number and type of identifiable intangibles, and the availability of information.