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| The past few years of economic uncertainty have had some predictable effects on intangible assets such as goodwill. Goodwill is the amount paid for an acquisition that exceeds the fair value of all identifiable assets. Impairment exists when the carrying amount of goodwill exceeds its fair value.
In the past 5 years, the goodwill on U.S. public company books ranged from a low $1.7 trillion in 2005 to a high of $2.2 trillion in 2007. The number of public companies with goodwill increased from 3,131 in 2005 to 3,316 in 2007. Goodwill remained relatively stagnant from 2007 to 2009 but did dip to $2.0 trillion in 2008. As of Q3 2010 goodwill on U.S. balance sheets dropped to $1.8 trillion, a significant decrease from 2009. The number of companies with goodwill decreased to a low of 2,431. Any increased deal activity will be countered with companies taking impairment charges. The chart below shows goodwill for all U.S. public companies and the economy’s impact on impairment charges.
Goodwill on Books
 The significant impairment charges taken by U.S. public companies in the years 2007 through Q3 2010 can be seen below:
Goodwill Impairment
 Goodwill impairments remained fairly low in 2005 through 2007 with a low of $11.2 billion. As the economy deteriorated in the fall of 2008, goodwill impairment charges spiked to a high of $216.0 billion in 2008, a 319.6% increase from the previous year. Companies rushed to take charges in 2008 (829 in total). Accounting rule clarifications and interpretations continue to bedevil the financial reporting for many companies. With continued economic uncertainty, there is a focus on accurate fair value measurements for intangible assets including goodwill. The Financial Accounting Standards Board (FASB) has recently proposed changes to the goodwill impairment test that could affect companies as early as December 31, 2010.
On October 5, 2010, the FASB proposed two critical changes to the way companies test for impairment of goodwill. The board adopted an equity premise to standardize the determination of the carrying amount of a reporting unit. Also, the FASB proposed that when a reporting unit’s carrying amount is zero or a negative amount, the second step of the impairment test must be performed when it is more likely than not that a goodwill impairment exists.
Currently, goodwill is not amortized under US GAAP. Instead, goodwill is tested for impairment at the reporting unit level. A two-step impairment test is used to identify potential impairment and measure the amount of impairment loss. If the carrying amount of equity exceeds the fair value of equity (Step 1), an entity must perform an additional test, similar to a purchase price allocation, to determine whether goodwill has been impaired and to calculate the amount of that impairment (Step 2).
Proposed Changes
Historically, an enterprise premise was sometimes used when an entity has reporting units with zero or negative equity carrying values. However, some entities with zero or negative carrying amounts of equity conclude that Step 1 is satisfied as the fair value of a reporting unit's equity will generally be greater than zero. The concern is that Step 2 of the test is not performed despite factors indicating that goodwill may be impaired.
The amendments proposed would affect all entities that have recognized goodwill and that either have previously applied an enterprise premise when applying Step 1 of the goodwill impairment test or have goodwill recorded in reporting units that have or may have zero or negative carrying amounts. The proposed changes to ASC 350 are:
The Result
The benefit of the proposed changes will be clarification that the only acceptable method of calculating the carrying amount of a reporting unit is the equity premise and as a result, would eliminate the diversity in practice that currently exits. Also, the proposed amendments will improve the application of the goodwill impairment test by requiring entities with reporting units with zero or negative carrying amounts to perform Step 2 if there are adverse qualitative factors that indicate that goodwill is more likely than not impaired.
The Timeline
For public companies, the amendments in the proposed rule would be effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption would not be permitted. For private companies, the effective date will be for fiscal years and interim periods within those years, beginning after December 15, 2011. Nonpublic reporting entities would be able to early adopt the proposed amendments using the effective date for public reporting entities.
Adams Capital, Inc.
Adams Capital’s professionals have significant experience in performing goodwill impairment testing (ASC 350) for financial reporting purposes. As the next fiscal year approaches, it is important for companies and their advisors to understand the implications of these proposed amendments to ASC 350 and how they relate to its financial reporting. Planning for this standard change will avoid issues with restatements or unexpected impairment issues. Our goodwill impairment testing methodology is conducted in anticipation of the amendments being finalized providing our client the flexibility to plan and file accurate and timely financial statements.
Merger and Acquisition Market Data
The overall median enterprise value to EBITDA multiple decreased from 9.8x during the period from May 1, 2010 to July 31, 2010 to 8.7x during the past three month period ending October 31, 2010. However, the overall median EBITDA multiple of 8.7x during past three month period ending October 31, 2010 is still above the median EBITDA multiple during the period from November 1, 2009 to January 31, 2010. EBITDA multiples in the financials industry showed the largest decrease from 16.0x during the period from May 1, 2010 to July 31, 2010 to 11.0x in the past three month period ending October 31, 2010. EBITDA multiples in the energy industry showed the largest increase from 8.6x from the period May 1, 2010 to July 31, 2010 to 10.7x in the past three month period ending October 31, 2010.
Overall Transactions During Latest Twelve Months 
The Overall Transactions chart indicates the number of closed mergers and acquisitions decreased while the mean transaction value increased during the latest three months. The overall level of transaction volume appears to be slowing from the levels seen during the fourth quarter of 2009 and the first quarter of 2010.
The transactions include both public and private companies and are grouped into three month periods. For more information regarding the transaction screen, click here.
Adams Capital recently assisted the board of directors of two closely held companies to determine each company’s fair market value of equity. The majority of the shareholders are the same for both companies. Currently, the companies are negotiating a transaction in which one company will acquire the stock of the other company. The acquiring company has significant net operating losses (“NOLs”) that it would like to use in the future without being subject to the limitation imposed by Internal Revenue Code (“IRC”) Section 382. IRC Section 382 imposes an annual limitation on the use of NOLs following a change of ownership in the loss corporation of more than 50 percentage points by one or more five-percent shareholders within a three-year period. Based on our valuation, it was determined that a change of control had not occurred; thus, the company will be able to use its full NOL balance without limit against future pre-tax income.
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For more information about Adams Capital please visit www.adamscapital.com
Adams Capital, Inc. is a national business valuation practice with clients in 50 states and more than 20 countries. We are recognized for our thoughtful approach to complex business valuation matters.
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