Impairment Testing Presentation

1. Long Live the Asset!
Impairment Testing in the
Current Environment
February 24, 2009

2. Valuation Research Corporation
• Formed in 1975, VRC has eight U.S. offices and eight international
affiliates.
• VRC provides M & A advisory services, fairness and solvency opinions in
support of corporate transactions, and valuations of intellectual property
and tangible assets for financial reporting and tax purposes
purposes.
• VRC maintains relationships with corporations, lenders, accountants,
investment banks, private equity firms, and law firms.
• VRC was instrumental in forming the Appraisal Issues Task Force (AITF), a
valuation industry group that meets quarterly to discuss financial reporting
related valuation issues.
Valuation Research Corporation 2

3. P.J. Patel, CFA
• Mr. Patel specializes in the valuation of businesses, assets and
liabilities for financial reporting purposes. In particular, he has
focused on the valuation of intellectual property/intangible assets such
as trademarks, technology, software, customer relationships and
IPR&D. He also values business interests for tax purposes.
• Mr. Patel is an active member of the AITF and is currently a member of
the Appraisal Foundation Working Group preparing a Practice Aid for
the valuation of customer relationships.
• Mr. Patel is a frequent presenter on valuation issues for financial
reporting purposes and has recently presented on valuation issues
relating to SFAS No. 141/141R, SFAS No. 142/144, SFAS No. 157
and other emerging issues. Mr. Patel recently spoke at the AICPA SEC
conference in Washington D.C.
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4. Edward Hamilton
• Mr. Hamilton specializes in the valuation of businesses, assets
and liabilities for financial reporting purposes. In particular, he has
focused on the valuation of intellectual property/intangible assets such as
trademarks, technology, software, customer relationships and IPR&D. He
also values business interests for tax purposes.
• Mr. Hamilton is an active member of the AITF and is currently involved with
the Appraisal Foundation Working Group preparing a Practice Aid for the
valuation of customer relationships.
• Mr. Hamilton is a frequent presenter on valuation issues for financial
reporting purposes and has recently presented on valuation issues relating
to SFAS No. 141/141R, SFAS No. 142/144, SFAS No. 157
and other emerging issues.
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5. Agenda – Issues in Accounting For Asset Impairment
• Guidance
• SFAS 142: Goodwill and Other Intangible Assets
• Goodwill Testing Consists of Two Steps
g p
• Comparison of the Fair Value of the Reporting Unit to its Carrying Value
• Recognition of an Impairment Amount
• SFAS 144: Accounting for the Impairment of Long-Lived Assets
• Timing/Triggering Events
• Determining Asset Groups
• Determining the Primary Asset
• Testing f R
T ti for Recoverability
bilit
• Allocating Impairment
• Impairment Testing Order
• C
Conclusion: P tti It All Together
l i Putting T th
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6. Sources of Information
Statement/EITF Issue
SFAS 142 The testing and impairment of goodwill and indefinite-
lived intangibles
SFAS 144 The testing and impairment of long-lived tangible and
intangible assets
i t ibl t
SFAS 157 Guidance on fair value measurements
EITF 02 7
02-7 Unit of accounting for the impairment testing of
indefinite-lived intangible assets
EITF 02-13 Treatment of deferred income taxes in goodwill
impairment testing
2008 SEC Inclusion of a control premium
Speeches Market cap reconciliation
Interim impairment testing indicators
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7. Summary of Impairment Testing
Accounting SFAS 142 SFAS 144
Guidance
Asset T
A t Type Goodwill
G d ill Indefinite-Lived
I d fi it Li d Long-Lived
L Li d
Intangible Assets Tangible &
Intangible Assets
Focus Goodwill carried at Indefinite-lived Test the
lower of FV or CV intangible assets recoverability of
carried at lower of long-lived assets
FV or CV & allocate
impairment
Methodology Two step One step Multiple steps
Frequency Annually/event Annually/event Event based
based based
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8. Impairment Testing
• Goodwill under SFAS 142
• Indefinite-Lived Assets under S S 142
f SFAS
• Long-Lived Assets under SFAS 144
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9. Goodwill Impairment Testing - Issues
• When to Test?
• Testing Methodology
• Current Issues
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10. When to Test for Goodwill Impairment?
• Paragraph 26 states that goodwill should be tested for impairment annually
or more frequently
• Paragraph 28 notes several events/circumstances causing g
g p g goodwill to be
tested between annual test dates:
a) Significant adverse change in legal factors or in the business climate.
b) An adverse action or assessment by a regulator
c) Unanticipated competition
d) A loss of key personnel
e)
) A more-likely-than-not expectation that a reporting unit or a significant portion of
y g g
a reporting unit will be sold or otherwise disposed of
f) The testing for recoverability under Statement 144 a significant asset group
within a reporting unit
g) Recognition of a goodwill impairment loss in the financial statements of a
subsidiary that is a component of a reporting unit.
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11. When to Test for Goodwill Impairment?
Issues:
• Can I carry forward the reporting unit’s fair value per Paragraph 27?
• What if the market capitalization drops below the book value of equity?
p p q y
• What if the book value of equity is negative?
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12. Step 1: Does Goodwill Impairment Exist?
• Paragraph 19 of SFAS 142 outlines step 1 of goodwill impairment
testing
• Step 1 i
St 1, is used to identify potential i
d t id tif t ti l impairment
i t
• If the fair value is greater than the carrying value, the reporting unit is
not impaired
• If the fair value is less than the carrying value, proceed to step 2 to
determine the level of impairment loss, if any
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13. Step 1: Does Goodwill Impairment Exist?
Issues:
• What is the appropriate level to calculate the fair value of the reporting unit?
Enterprise Value, Total Assets, Equity?
p , , q y
• Reconciling to the market cap?
• Estimation of a control premium? Mergerstat studies generally point to
control premiums ranging between 20-30%. However, the range of control
premiums is significant.
• SEC – No bright lines. Do a supportable valuation with sufficient analysis
to support position, especially if control premiums are significant.
• N specific d t or range of d t t determine control premium.
No ifi date f dates to d t i t l i
• If using an income approach, has the discount rate changed due to increased
risk and/or an increased cost of debt? Increased scrutiny should be applied
when determining the WACC using market participant inputs
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14. Step 1: Reconciling to the Market Cap
Your company has two reporting units that get tested annually for goodwill
impairment as of 9/30. Recently, your market capitalization has dropped below your
book value of equity. In light of this and current economic conditions you complete an
interim test for goodwill impairment as of 12/31/08. Reporting Unit 1 (
g p p g (RU1) has a
)
carrying value of $350 while Reporting Unit 2 (RU2) has a carrying value of $400.
The market capitalization of the company is $700 and there is no debt. The table
below summarizes the value conclusions.
Reporting Unit Fair Value Carrying Value Conclusion
RU1 $500 $350 No impairment
RU2 $300 $400 Impairment indicated
indicated,
proceed to step 2
Total $800 $750
Market Cap $700
Implied Control Premium 14.3%
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15. Step 2: Determine Implied Fair Value of Goodwill
• Paragraphs 20 & 21 of SFAS 142 outline step 2 methodology
• Steps
• SFAS 141 purchase price allocation
• Fair value of reporting unit equivalent to purchase price in a 141
• Allocate to fair value of all assets/liabilities (even if the assets/liabilities are not on
the books of the reporting unit)
• The allocation process is performed only for the purpose of testing goodwill for
impairment; an entity should not write up or write down a recognized asset or liability,
nor should it recognize a previously unrecognized intangible asset as a result of that
allocation process.
• The fair value of the goodwill is equal to the residual
g q
• The level of goodwill impairment is equal to the difference between the fair value
of goodwill and the book value of goodwill.
• After a goodwill impairment loss is recognized, the adjusted carrying amount
of goodwill shall be its new accounting basis Subsequent reversal of a
basis.
previously recognized goodwill impairment loss is prohibited once the
measurement of that loss is completed.
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16. Step 2: Determining the Level of Goodwill Impairment
• Reporting Unit 2 failed step 1 test
• Fair value = $300
• Carrying value = $400
• Assume for this example that book value of PP&E and i t
A f thi l th t b k l f d intangible assets are a
ibl t
reasonable of estimate fair value.
Reporting Unit 2 Book Value Fair Value Impairment
Net Assets $400 $300
Working Capital 70 70
PP&E 50 50
Intangibles 120 130
Goodwill 160 50 110
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17. Impairment Testing
• Goodwill under SFAS 142
• Indefinite-Lived Assets under SFAS 142
• Long-Lived Assets under SFAS 144
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18. Intangible Assets Not Subject to Amortization
• Guidance is in SFAS 142, paragraph 17
• Testing is annual with event based testing
• Largely consists of trademarks/brands, certain licenses
• Test compares fair value to carrying value
• If fair value i l
f i l is less th th carrying value, th diff
than the i l the difference i th
is the
impairment amount
• Subsequent reversal is prohibited
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19. When to Test Indefinite-Lived Intangibles
• Indefinite-lived intangibles are tested for impairment annually or due to an
event consistent with paragraph of SFAS 144.
• The following are examples of such events or changes in circumstances:
a. A significant decrease in the market price of a long-lived asset (asset group)
b. A significant adverse change in the extent or manner in which a long-lived asset
(asset group) is being used or in its physical condition
c. A significant adverse change in legal factors or in the business climate that could
affect the value of a long-lived asset (asset group), including an adverse action
or assessment by a regulator
d. An accumulation of costs significantly in excess of the amount originally expected
g y g y p
for the acquisition or construction of a long-lived asset (asset group)
e. A current-period operating or cash flow loss combined with a history of operating
or cash flow losses or a projection or forecast that demonstrates continuing
losses associated with the use of a long-lived asset (asset group)
long lived
f. A current expectation that, more likely than not, a long-lived asset (asset group)
will be sold or otherwise disposed of significantly before the end of its previously
estimated useful life.
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20. When to Test Indefinite-Lived Intangibles
Issues:
• Can I carry forward the fair value from one year to the next ?
• What if I plan on phasing out the trademark?
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21. Indefinite-Lived Intangibles: Impairment Testing
Your company has 2 indefinite-lived trademarks that get tested annually for goodwill
impairment as of 9/30. Recently, your market capitalization has dropped below your
book value of equity. In light of this and current economic conditions you complete an
interim test for impairment as of 12/31/08 Trademark 1 has a carrying value of $35
12/31/08.
while Trademark 2 has a carrying value of $45. The table below summarizes the
value conclusions.
Fair Value Carrying Difference Conclusion
Value
Trademark 1 $40 $35 $5 No impairment
Trademark 2 $40 $45 ($5) Impairment,
write down
asset by $5
b
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22. Impairment Testing
• Goodwill under SFAS 142
• Indefinite-Lived Assets under SFAS 142
• Long-Lived Assets under SFAS 144
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23. When to Test Long-Lived Assets for Impairment
• A long-lived asset (asset group) shall be tested for recoverability whenever events or
changes in circumstances indicate that its carrying amount may not be recoverable.
The following are examples of such events or changes in circumstances:
a. A significant decrease in the market price of a long-lived asset (asset group)
b. A significant adverse change in the extent or manner in which a long-lived asset (asset group)
is being used or in its physical condition
c. A significant adverse change in legal factors or in the business climate that could affect the
value of a l
l f long-lived asset (
li d t (asset group), i l di an adverse action or assessment b a
t ) including d ti t by
regulator
d. An accumulation of costs significantly in excess of the amount originally expected for the
acquisition or construction of a long-lived asset (asset group)
e. current-period
e A current period operating or cash flow loss combined with a history of operating or cash flow
losses or a projection or forecast that demonstrates continuing losses associated with the
use of a long-lived asset (asset group)
f. A current expectation that, more likely than not, a long-lived asset (asset group) will be sold or
otherwise disposed of significantly before the end of its p
p g y previously estimated useful life.
y
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24. Long-Lived Asset Impairment – Asset Grouping
• Assets are grouped at the lowest level for which identifiable cash
flows are largely independent.
• Likely consists of working capital, fixed assets, intangible assets
capital assets
• Asset group does not include goodwill unless the asset group is also
a reporting unit.
Company
Reporting
Reporting Unit 2
Unit 1
Asset Asset Asset Asset
Group Group 1 Group 2 Group 3
• Issue: How to determine asset groups?
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25. Step 1: Recoverability Test
Step 1: Test for recoverability
• The carrying value of the asset group is compared to the sum of
undiscounted cash flows.
• Cash flows are projected over the remaining useful life (depreciable or
amortizable life) of the primary asset of the asset group.
• “Only the future cash flows… that are directly associated with and that
are expected t arise as a di t result of the use and eventual
t d to i direct lt f th d t l
disposition of the asset (asset group). “
• Excludes interest and, per recent guidance from several leading firms,
taxes.
• Entity uses its own assumptions of asset use and should consider all
available information.
Issues:
• If I am using an asset at less than its full potential does that mean its
impaired?
• Is there a limitation on the life for purposes of determining the fair value of
the asset group?
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26. Step 1: Recoverability Test
Your company has 3 asset groups within reporting unit 2. In light of current
economic conditions you test your asset groups for impairment as of
12/31/08. The table below summarizes the value conclusions.
Reporting Undiscounted Carrying Conclusion
Unit Cash flow Value
Asset Group 1 $60 $50 No impairment
Asset Group 2 $70 $130 Impairment indicated,
p
proceed to fair value test
Asset Group 3 $30 $60 Impairment indicated,
proceed to fair value test
Total $160 $240
Goodwill $160 Unallocated as the asset
groups are components of
the reporting unit
p g
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27. Step 2: Determine Fair Value and Allocate Impairment
• The asset group is impaired by the amount its carrying value
exceeds its fair value
value.
• The impairment is allocated, on a pro-rata basis to the assets
group’s long-lived assets.
• An asset cannot be impaired lower than its fair value
value.
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28. Step 1b: Fair Value Test
The next step is to calculate the fair value of the asset groups that failed the
undiscounted cash flow test.
Reporting Unit Undisc.
Undisc Fair Value Carrying Conclusion
Cash flow Value
Asset Group 1 $60 $100 $50 No Impairment
Asset Group 2 $70 $150 $130 No Impairment
Asset Group 3 $30 $50 $60 Impairment indicated,
proceed to step 2
Total $160 $300 $190
Goodwill $160 Unallocated as the asset
g oups a e co po e s o
groups are components of
the Reporting Unit
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29. Step 2: Determine the Level of Asset Impairment
The next step is to calculate the fair value of the asset groups that failed the
undiscounted cash flow test. Asset Group 3 is showing impairment of $10.
Asset Group 3 Book % of Fair Pro –Rata Allocation of Adjusted
Value Total Value Allocation impairment Book
Value
Working Capital $10 n/a 0 0 $10
Fixed Assets 20 40% 18 4 2 18
Customer 10 20% 12 2 0 10
relationships
Technology 20 40% 7 4 8 12
Total 60 10 10 50
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30. Priority
144.13. Other than goodwill, the carrying amounts of any assets (such as accounts
receivable and inventory) and liabilities (such as accounts payable, long term debt,
and asset retirement obligations) not covered by this Statement that are included in
an asset group shall be adjusted in accordance with other applicable g
g p j pp generally
y
accepted accounting principles prior to testing the asset group for recoverability.
142.29. If goodwill and another asset (or asset group) of a reporting unit are tested for
impairment at the same time, the other asset (or asset group) shall be tested for
time
impairment before goodwill. For example, if a significant asset group is to be tested
for impairment under Statement 144 (thus potentially requiring a goodwill impairment
test), the impairment test for the significant asset group would be performed before
the goodwill impairment test. If the asset group was impaired the impairment loss
test impaired,
would be recognized prior to goodwill being tested for impairment.
• Indefinite-Lived Assets under SFAS 142
• Long-Lived Assets under SFAS 144
• Goodwill under SFAS 142
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31. Conclusions: Putting It All Together
• Reporting Unit 2 failed step 1 test
• Fair value = $300
• Carrying value = $400
• Impairment of an indefinite-lived asset of $5
I i t f i d fi it li d t f
• Impairment of long-lived assets of $10
Reporting
g Fair Carrying
y g Asset Adjusted
j Conclusion
Unit Value Value Impairment Carrying
Value
RU1 $500 $350 0 $350 No Impairment
RU2 $300 $400 $15 $385 Impairment still
indicated,
proceed to step 2
Total $800 $750
Market cap $700
Implied Control 14.3%
Premium
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32. Conclusion: Putting It All Together
• Reporting Unit 2 failed step 1 test
• Fair Value = $300
• Carrying Value = $400; Adjusted Carrying Value = $385
• Assume for this example that book value of PP&E and i t
A f thi l th t b k l f d intangible assets are a
ibl t
reasonably estimate of fair value.
Reporting Unit 2
R ti U it Book Value Adj t d
B kV l Adjusted Fair V l
F i Value 142/144
Carrying Impairment
Value
Net Assets $400 $385 $300
Working Capital 70 70 70
PP&E 50 48 50 2
Intangibles
I t ibl 120 107 130 13
Goodwill 160 160 50 110
Total Impairment 125
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33. Summary & Order of Impairment Testing
Asset Type Indefinite-lived Long-lived Goodwill
Intangible Assets Tangible &
Intangible Assets
Accounting SFAS 142 SFAS 144 SFAS 142
Guidance
Focus Indefinite-lived Test the Goodwill carried at
Intangible assets recoverability of lower of FV or CV
carried at lower of FV long-lived
long lived assets
or CV
Methodology One step Multiple steps Two step
Frequency Annually/event based Event based Annually/event based
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34. Contact Information
PJ Patel
ppatel@valuationresearch.com
609-243-7030
609 243 7030
Ed Hamilton
ehamilton@valuationresearch.com
609-243-7018
Valuation Research Corporation 34

35. U.S. Office Locations
Boston Milwaukee San Francisco
101 Federal Street 330 East Kilbourn Avenue 50 California Street , Suite 3050
Boston, MA 02110 Milwaukee, WI 53202 San Francisco, CA 94111
617.342.7366 414.271.8662
1 2 1 8662 415.277.1800
1 2 1800
Chicago New York Tampa
200 W. Madison Street 500 Fifth Avenue 777 S. Harbour Island Blvd.
Chicago, IL 60606 New York, NY 10110
, Tampa, FL 33602
813-463-8510
312.957.7500 212.983.3370
Cincinnati Princeton
105 East Fourth Street 200 Princeton Corporate Center
Cincinnati,
Cincinnati OH 45202 Ewing, NJ 08628
513.579.9100 609.452.0900
Valuation Research Corporation 35

36. International Affiliate Office Locations
Buenos Aires London Monterrey
Franklin D. Roosevelt 2445 Cloister House Antonio Gaona No. 2000-401
Piso 10 Riverside Col. Florida
Buenos Aires C1428 BOK New Bailey Street Monterrey, N.L.
Argentina Manchester, M3 5AG C.P. 64810
Mexico
Caracas Madrid
Oficina 1-3, Torre Charan, Alcalá, 265, Edificio 2
Avenida Los Mangos 28027 Madrid São Paulo
Las Delicias, Caracas 1050 Spain Rua Alvarenga 1757 Butantã
Venezuela 05509-004 São Paulo SP
Brazil
Hong Kong Melbourne
22nd Floor Siu On Centre
Floor, Level 10, 470 Collins St
10 St.
188 Lockhart Road Melbourne, Victoria 3000
Wanchai, Hong Kong Australia
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