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M&A activity increases financial institutions’ goodwill amounts

Dec 30, 2020

The recent merger and acquisition activity within the financial institution world has created significant amounts of goodwill on many financial institutions’ balance sheets.

Goodwill and other intangible assets for all banks totaled approximately $409 billion at December 31, 2019, a 13% increase in the last five years. For community banks, the balance sheet increase was approximately 40%, or $18 billion, at December 31, 2019.

The COVID-19 pandemic has created significant economic uncertainty, which may indicate the existence of impairment indicators or triggering events and necessitate the need to perform a goodwill impairment analysis prior to the typical annual evaluation to determine whether the value of goodwill is less than its carrying amount. 

The accounting codification (ASC 350-20) gives several examples of triggering events, including but not limited to:

  • Deterioration in general economic conditions.
  • Industry and market considerations such as deterioration in the environment an entity operates in, an increased competitive environment or a decline in market-dependent multiples or metrics.
  • Overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods.
  • If applicable, a sustained decrease in share price (considered in both absolute terms and relative to peers).

Financial institutions should evaluate both positive and negative indicators when determining whether goodwill is impaired. If an impairment is determined to exist, the amount of the impairment must be written down through a charge to earnings at that time.

The accounting standards have, however, provided an alternative accounting treatment for goodwill for private companies. FASB’s Private Company Council (PCC) issued a GAAP alternative in 2014 (ASU 2014-02), allowing private companies to amortize their goodwill rather than carry goodwill on the books at its original value and test it for impairment annually.

In 2016, the FASB eliminated the effective date for this standard, meaning that companies can adopt at any time the alternative to amortize goodwill. So if a private company did not adopt the amortization method of accounting for its existing goodwill when the standard was established, it’s not too late to adopt this accounting treatment for existing goodwill on the private company’s balance sheet. This accounting standard allows private companies to elect to amortize goodwill on a straight-line basis over 10 years (or less, if the company demonstrates that another useful life is more appropriate).

Private companies adopting this standard would need to test goodwill for impairment only when a triggering event such as those listed above occurs vs. testing the goodwill for impairment annually. Because goodwill will become a lesser balance due to the amortization, which would be expensed on an ongoing basis, the likelihood of an impairment existing and being recognized immediately decreases over the amortization period.

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