Valuation for Financial Reporting : Fair Value Measurements and ...

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Case Study 2: Impairment Under SFAS No. 142 101the latter), the mechanics of impairment testing will be similar, with the primarydifference being that private companies, lacking a readily ascertainable stock price,will place greater reliance on DCF or perhaps guideline company analyses for step onetesting. For step two, both public and private company valuations will rely primarilyon traditional methodologies (SFAS No. 157 Level 3 Hierarchy) such as the DCF.Returning to the example, one area of inquiry is to compare 2007 actual with the2007 forecast performed last year in conjunction with the purchase price analysis. Ascan be seen, actual operating results for 2007 lag well behind the forecast performed ayear ago.2006 Actual 2007 Forecast 2007 ActualNet Sales $60,000,000 $69,000,000 $56,000,000Cost of Sales 24,000,000 27,600,000 23,520,000Percent of Sales 40.0% 40.0% 42.0%Gross Profit $36,000,000 $41,400,000 $32,480,000Operating Expenses 18,000,000 20,700,000 17,360,000EBITDA 18,000,000 20,700,000 15,120,000EBITDA Percent 30.0% 30.0% 27.0%While still profitable, the reporting unit’s earnings before interest, taxes, depreciation,and amortization (EBITDA) were $15,120,000, 16% below 2006 actualEBITDA and 27% below the 2007 forecast. This information certainly suggests thatthe reporting unit’s value may be impaired, and we shall proceed with step one of theimpairment study—determining the fair value of the reporting unit and comparingthat value with its carrying amount. 22 If the carrying amount of a reporting unitexceeds its fair value, the second step of the goodwill impairment test is performed tomeasure the amount of goodwill impairment loss, if any. 23We suspect that impairment exists; now the challenge is to determine the fair valueof the reporting unit as of the current date, December 31, 2007. Quoted market pricesin active markets are considered the best evidence of fair value, 24 but the statementallows that present value techniques are often the best. In our example, the carryingvalue of the reporting unit exceeds its fair value, triggering step two.If a reporting unit fails step one, the interrelationship between SFAS Nos. 142 and144, Accounting for the Impairment or Disposal of Long-Lived Assets, can be a littleconfusing and warrants comment. SFAS No. 144 states:An impairment loss shall be recognized only if the carrying amount of a long-livedasset (asset group) is not recoverable and exceeds its fair value. The carrying amount ofa long-lived asset (asset group) is not recoverable if it exceeds the sum of theundiscounted cash flows expected to result from the use and eventual disposition ofthe asset (asset group). 25SFAS No. 144 provides guidance as to when to test for recoverability:A long-lived asset (asset group) shall be tested for recoverability whenever events orchanges in circumstances indicate that its carrying amount may not be recoverable. 26
102 Valuation for Financial ReportingIf goodwill and other assets are tested for impairment at the same time, the otherassets are to be tested for impairment before goodwill. 27 The relatively poor financialperformance described previously would probably be reason enough to test therecoverability of long-lived assets under paragraphs 7 and 8 of SFAS No. 144. As willbe seen later, the noncompete and customer base assets would pass the recoverabilitytest, which compares the assets’ undiscounted cash flows with carrying values, but thetechnology asset would fail.SFAS No. 144 contains similar language to SFAS No. 142 regarding thedetermination of fair value, stating a preference for quoted market prices but allowingother valuation techniques. 28 In our example, and surely most other situations, quotedmarket prices for intangibles will not be available (SFAS No. 157, Levels 1 and 2),requiring other techniques (SFAS No. 157, Level 3) as would be developed in an SFASNo. 142 step two analysis.Additionally, impairment testing of intangible assets not subject to amortization iscovered by SFAS No. 142, not SFAS No. 144. In reality, while SFAS No. 142 requires,‘‘If goodwill and another asset ...are tested for impairment at the same time, the otherasset...shall be tested before goodwill,’’ 29 impairment testing under SFAS Nos. 142and 144 will be performed simultaneously in most cases, but the final conclusion ofgoodwill will be determined subject to any revaluations of other assets.As described in Case Study 1, a year ago the fair value of the assets of the reportingunit was determined to be $209,000,000. Now, after a year’s depreciation, amortization(assuming MACRS-based depreciation for the depreciable tangible assets andstraight-line amortization for the amortizable intangible assets), and the SFAS No. 2charge for acquired in-process research and development, the carrying amount of theassets of the reporting unit is $188,713,000, as follows:December 31, 2006Fair ValueDecember 31, 2007Carrying AmountCash $1,500,000 $2,850,000Investments in Marketable Securities 8,000,000 7,000,000Accounts Receivable 17,000,000 13,000,000Inventory 12,000,000 10,500,000Prepaid Expenses 3,000,000 2,500,000Total Current Assets 41,500,000 35,850,000Land and Building 22,000,000 21,687,000Machinery and Equipment, net 19,000,000 16,216,000Total Fixed Assets 41,000,000 37,903,000Software 7,120,000 5,340,000Technology 16,560,000 13,250,000In-process Research and Development 4,530,000 0Trade Name 12,660,000 12,660,000Customer Base 7,090,000 6,080,000
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210 IndexBusiness Enterprise Analys
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