Accounting for Goodwill Impairment for Credit Unions [White Paper]

Introduction

Goodwill has been a contentious subject since the Financial Accounting Standards Board (“FASB”) required the use of purchase accounting in 2009. Over the recent decade, FASB worked to soften the rules allowing for qualitative testing and easing the required quantitative tests.

FASB continues to monitor goodwill testing. In 2018, FASB added a goodwill accounting project to its technical agenda with the intent of simplifying the accounting. Unfortunately, FASB abandoned the project in the summer of 2022. FASB is considering adding goodwill back to its technical agenda in 2026 – no decision has yet been made.

Thus, credit unions, like other organizations with goodwill, must continue to follow the required accounting.

Accounting for Goodwill Impairment for Credit Unions

FAS ASC 805 Business Combinations requires credit unions to use purchase accounting and to record the transaction at fair value. This requires the determination of the fair value of the credit union to be merged in (“acquired credit union”) and of all its assets and liabilities. The valuation must also include potential intangible assets such as the core deposit intangible and goodwill. A credit union can then elect to amortize the goodwill, or it can periodically test the goodwill for impairment.

We begin by describing how goodwill can arise through a merger transaction. Next, we describe how to amortize or test the goodwill for impairment. We then describe FASB’s simplification of the goodwill impairment assessment model which was issued in January 2017. The revision eliminated the comprehensive Step Two Quantitative test. Finally, we discuss how goodwill is treated for regulatory capital purposes.

Goodwill Background

The acquiring credit union must record the fair value of the acquired credit union on the date of the merger. The fair value of the acquired institution is based on the determination of:

• Overall value of the acquired credit union;
• Fair value of the acquired credit union’s financial assets and liabilities;
• Fair value of the acquired credit union’s non-financial assets and liabilities;
• Fair value of any intangible assets – the most common being the core deposit intangible;
• Value of the trade name; and
• Amount of Goodwill/Bargain Purchase Gain resulting from the transaction.

Goodwill arises when the overall value of the acquired credit union in total is greater than the fair value of its assets, liabilities, and intangible assets. In other words, goodwill arises when the overall value of the credit union in total is greater than the sum of its parts. We note a bargain purchase can also result through a business combination. However, this white paper focuses specifically on goodwill as we believe a merger transaction will generally result in goodwill, as opposed to a bargain purchase gain. In fact, GAAP requires the acquiring credit union to “double check” its work before recording a bargain purchase¹. Please refer to our white paper “Accounting for Credit Union Mergers” for an in-depth review of the fair value determination process of an acquired credit union.

The resulting goodwill can be amortized or remain on the balance sheet at recorded value subject to annual impairment testing. These two methods are described in detail in the next section of this paper.

Accounting for Goodwill

As we noted, the acquiring credit union can elect to amortize the goodwill over a period of time not to exceed 10 years.

Wilary Winn cautions that in order to use this method, the credit union must make an irrevocable accounting election. The election affects the existing goodwill, as well as any additional goodwill acquired in the future².

If the credit union does not make the election to amortize the goodwill, it is subject to annual impairment testing. The process begins by determining the entity to be assessed. Perhaps counter-intuitively, the goodwill test is nearly always performed at the combined entity level instead of at the level of the acquired credit union. The test would be performed at the acquired credit union level only if it were deemed to be a separate operating segment or a component of a separate operating segment. An entity must have all of the following characteristics to be deemed a separate operating segment³:

• It engages in business activities from which it may earn revenue and incur expenses;
• Its discrete financial information is available; and
• Its operating results are regularly reviewed by the chief operating decision maker (“CODM”) to make decisions about resources to be allocated to the segment and assess its performance.

Wilary Winn believes it would be rare for an acquired credit union to be considered a separate operating segment. This implies that the branches of the acquired credit union would have separate pricing, separate asset liability management, etc. We further believe that over time members will migrate from the acquired credit union’s branches to the acquiring credit union’s branches and vice versa, further clouding the distinction.

The assessment for goodwill impairment can be qualitative or quantitative.

Qualitative Testing

A credit union may assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of the reporting unit is less than its carrying amount, including goodwill. In evaluating whether to perform the qualitative test, the guidance requires an entity to assess relevant events and circumstances. Examples of such events and circumstances including the following⁴:

• Macroeconomic conditions, such as deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets.
• Industry and market considerations, such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline (both absolute and relative to its peers) in market-dependent multiples or metrics, a change in the market for an entity’s products or services, or a regulatory or political development.
• Cost factors, such as increases in raw materials, labor, or other costs that have a negative effect on earnings.
• Overall financial performance, such as negative or declining cash flows or a decline in actual or planned revenue or earnings.
• Other relevant entity-specific events, such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation.
• Events affecting a reporting unit, such as a change in the carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing all, or a portion of, a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit.

Wilary Winn believes a qualitative test can be used if:

• The acquiring credit union meets all of the qualitative factors and passed a previous Step One quantitative test with a substantial cushion; or
• The acquiring credit union so clearly meets the qualitative factors that it is obvious it would pass Step One⁵.

If the acquiring credit union has not passed a previous quantitative test by a reasonable margin or does not clearly meet all of the qualitative factors, Wilary Winn believes it should perform a quantitative test.

Quantitative Testing

If, after assessing the totality of events or circumstances described in the paragraphs above, a credit union determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the credit union must perform a quantitative goodwill impairment test.

The quantitative test (previously called “Step One”) determines whether the fair value of the combined entity exceeds its book value using the income and market approaches described at the beginning of this white paper. If the fair value of the combined entity exceeds the book value, the goodwill is not impaired⁶. If the fair value of the combined entity does not exceed book value, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value.
As we stated previously, FASB allowed entities to forgo the rigorous Step Two quantitative testing which involved marking the entire balance sheet to fair value to assess impairment.

Wilary Winn notes that FASB issued guidance in January 2017 that eliminates the requirement to calculate the implied fair value of goodwill (e.g., Step Two of the previous goodwill impairment test) to measure a goodwill impairment charge. Entities will rather record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value (e.g., based on today’s Step One). The revised standard did not change the guidance on completing Step One of the goodwill impairment test. Additionally, an entity can still perform the current qualitative goodwill impairment test prior to determining whether to proceed to Step One.

FASB’s main objective in revising the goodwill impairment model was to reduce the cost and complexity of testing for goodwill impairment. The previous Step Two required a full fair value determination of all the assets and liabilities of the entity, similar to performing a detailed merger valuation.

Risk-Based Capital Implications

The NCUA formally adopted the Risk-Based Capital (“RBC”) rule for credit unions in October 2015 with the final rule taking effect on January 1, 2022. The final rule increases the minimum risk-based capital ratios for credit unions greater than $500 million to 8.00% in order to be considered “adequately capitalized” and to 10.00% to be considered “well capitalized.” In calculating the risk-based capital ratio, the risk-based capital amount will be divided by the organization’s risk-weighted assets. Risk-based capital will be based on total capital less certain deductions, including goodwill and the NCUSIF capitalization deposit. The goodwill deduction is subject to a 10-year phase-in for goodwill arising from a supervisory merger or combination that was completed on or before December 28, 2015. The goodwill arising from these transactions can be included in risk-based capital until January 1, 2029.

We note the CCULR (net worth ratio) is an option for the following institutions to meet their risk-based net worth requirement without having to calculate an RBC ratio. We note credit unions do not deduct goodwill from this ratio.

• CCULR of 9 percent or greater
• Total off-balance sheet exposures of 25 percent or less of total assets
• Sum of total trading assets and total trading liabilities of 5 percent or less of total assets
• Sum of total goodwill and total other intangible assets of 2 percent or less of total assets

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Endnotes

1. FAS ASC 805-30-25-4 ↩︎
2. FAS ASC 350-20-35-62 ↩︎
3. FAS ASC 280-10-50-1 ↩︎
4. FAS ASC 350-20-35-3C ↩︎
5. FAS ASC 350-20-35-3D ↩︎
6. FAS ASC 350-20-35-4 ↩︎