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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks before the 2009 AICPA National Conference on Current SEC and PCAOB Developments


Evan Sussholz

Professional Accounting Fellow, Office of the Chief Accountant
U.S. Securities and Exchange Commission

Washington, D.C.
December 7, 2009

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect those of the Commission or of the author's colleagues upon the Staff of the Commission.


Good morning. Today, I would like to spend some time talking about a couple of issues related to goodwill impairments and the development of market participant assumptions for fair value measurements.

Goodwill Impairment

First, I would like to lead off with a few comments related to goodwill impairment analyses and the calculation of the fair value of a reporting unit. As you may know, Codification Topic 350 indicates that the purpose of the first step of a goodwill impairment test is to identify potential impairment by comparing the fair value of a reporting unit to its carrying amount, including goodwill. Furthermore, Topic 350 indicates that the fair value of a reporting unit is the price that would be received to sell the reporting unit as a whole in an orderly transaction between market participants at the measurement date.

One question that has come up several times in the application of this topic is whether the reference to the fair value of a reporting unit in the standard refers to its equity value or its enterprise value,1 which is commonly defined as the sum of the fair value of debt and equity. In many circumstances, the staff does not anticipate that the selection of equity vs. enterprise value as the approach for a step one test would impact the result, that is whether the reporting unit passes or fails step one. However, one example when the selected approach could impact the result is when carrying value of equity in a reporting unit is negative.

As you may know, the fair value of equity in a reporting unit cannot be less than zero. As a result, in a circumstance when the carrying value of equity is negative, a reporting unit would seemingly always "pass" a step one goodwill impairment test performed on an equity basis, despite the fact that significant goodwill may exist and the underlying operations of that entity may be deteriorating. In this example, a step one test performed on an enterprise basis would likely provide a better indication of whether a potential impairment of goodwill exists and a step two test should be performed.

Therefore, in absence of further authoritative guidance, the SEC staff believes that a reporting entity may want to consider whether utilizing an alternative approach to a step one test such as enterprise value would be a better economic indicator of goodwill impairment. In making this determination, an analysis of a subject entity's operations, market participant assumptions, the potential structure of a hypothetical sale transaction, along with other factors should be performed. However, regardless of the approach selected, the composition of the carrying value must be the same as the composition of the fair value determination. In other words, if the carrying value is based on equity, then the test must be at the equity level. Alternatively, if the carrying value is comprised of debt and equity, then the test must be at an enterprise level.

Lastly, if there is evidence that performing the test on an equity basis versus an enterprise basis would significantly affect the result (that is, pass vs. fail), we would expect management to exercise reasonable judgment to determine if the second step of a goodwill impairment test is necessary.

Market Participant Assumptions

Now, I'd like to provide a few thoughts on developing market participant assumptions when measuring fair value.

As many of you know, Codification Topic 820 requires that fair value measurements be performed from the perspective of market participants. While this requirement is easy to understand conceptually, the staff understands that some practitioners have encountered challenges trying to implement it in practice for assets and liabilities where observable pricing information is not available. In limited instances, market participant assumptions may not be readily available without undue cost and effort. Furthermore, it is possible that assumptions may vary substantially based on the facts and circumstances of each category of market participants. As a result, the lack of information or inability to obtain consistent information may present challenges in developing market participant assumptions when measuring fair value.

Understanding these challenges, I wanted to provide you with our views of how one could look at developing market participant assumptions for fair value measurements. In general, I anticipate that most fair value measurements of assets or liabilities that trade in inactive markets or for which a market doesn't exist will begin by looking at a reporting entity's own assumptions. These assumptions may include the reporting entity's expected use of the asset, the asset's life, and any related cash flow estimates from the use or sale of the asset. Using those assumptions as a starting point, reasonable judgment should be applied to determine if an entity's own assumptions are representative of market participant assumptions. We would suggest a reporting entity consider the following questions when performing this analysis. In order to illustrate how one might consider these questions in practice, I have also included a simplified example of a customer related intangible asset.

Question #1: What are the potential exit markets for an asset and what is the asset's principal or most advantageous market?

For an actively-traded financial asset, the principal (or most advantageous) market may simply be an exchange such as the NYSE or NASDAQ. However, for many assets such as non-financial assets, determining the principal (or most advantageous) market could be more difficult as the market for these assets may be inactive or non-existent and observable pricing information may not be readily available. Furthermore, certain defining characteristics of individual markets may have an impact on the timing and ultimate selling price of an asset. When performing an analysis of each potential exit market, it may be important for a reporting entity to understand the following:

  • Is the market for the asset active, inactive, or has it recently become inactive?
  • Are there distinct groups of potential market participants in that market such as strategic buyers and financial buyers? Within these groups, are there clusters of potential participants (i.e. small vs. large, profitable vs. unprofitable, etc.)
  • What is the competitive nature of the market (i.e. perfect competition, monopolistic or oligopolistic competition, fragmented markets)?

To begin our example, let's assume that there are two potential exit markets for the customer related intangible asset being measured including the customer list broker market and the mergers and acquisitions (M&A) market. Each of these markets has defining characteristics such as level of activity, groups of market participants, and differing levels of competitiveness. While a reporting entity may be able to obtain some pricing information from both markets, significant adjustments may be required to determine an estimated selling pricing for the specific customer related intangible asset being measured.

Question #2: What is the highest and best use for the asset?

To answer this question, a reporting entity should identify all of the potential uses of the asset within each potential exit market and determine if the value of the asset would be maximized by using the asset on a stand-alone basis (that is, an in-exchange valuation premise) or in conjunction with other assets (that is, an in-use valuation premise).

For example, market participants may derive value from a customer related intangible asset through its use as a stand-alone asset such as renting the customer list to third parties. Alternatively, a market participant may derive value from a customer related intangible asset through its use in combination with other assets such as trademarks, fixed assets, and goodwill. The reporting entity should determine the asset's highest and best use based on the use that maximized the fair value of the individual asset or group of assets in which the asset is being used.

Question #3: Who are the potential market participants and what are their distinguishing characteristics?

As you may know, Codification Topic 820 does not require a reporting entity to identify specific market participants. However, when measuring fair value it is important to understand the characteristics that distinguish market participants. The identification of these characteristics will play a significant role in understanding how market participants would use the asset being measured, along with the value that those market participants would place on that asset.

For example, let's say there are two broad groups of market participants within the M&A market for a customer related intangible asset: financial buyers and strategic buyers. The strategic buyer group can be divided further into two categories: regional competitors and national competitors. In this example, the financial buyers, the regional competitors, and the national competitors would acquire this asset as a part of an M&A transaction for the entire entity and maximize value by operating this asset in conjunction with the other assets of the target business. However, the ultimate value that each group would place on the customer related intangible may depend on many factors including financial capacity, acquisition strategy, market participant synergies, market share, complementary assets, management capabilities, etc.

Question #4: How do the market participant characteristics compare to the reporting entity's own characteristics?

To answer this last question, a reporting entity should reconcile the significant distinguishing characteristics of the identified market participant groups to those of the reporting entity. The results of this reconciliation process will determine if the entity's own assumptions should be adjusted to appropriately measure the fair value of an asset.

In our example, the reporting entity has determined the principal (or most advantageous) market, the highest and best use of the asset, along with the distinguishing characteristics of the potential market participants. For illustrative purposes, let's say that the reporting entity has determined that a regional competitor would be the most likely market participant to acquire the customer related intangible asset and maximize value by operating this asset in conjunction with other assets. The reporting entity would then compare its own characteristics (both quantitative and qualitative factors) to those of a regional competitor to determine if its own assumptions are representative of market participant assumptions.

We anticipate that there may be instances when a reporting entity determines that its own assumptions are not significantly different than those of market participants. However, it is our expectation that a reporting entity will apply reasonable judgment when making this determination. The items that I just highlighted are just examples of the questions that I anticipate a reporting entity would consider in determining market participant assumptions. There are likely to be additional factors that one could consider when performing this analysis. Additionally, I would like to point out that the process of determining market participant assumptions can be iterative. Therefore, it is likely that questions will not always be answered sequentially, but will be answered continuously throughout the process of determining market participant assumptions

Lastly, I think it is reasonable to anticipate that the staff will continue to inquire about the process employed and judgments made by a reporting entity when developing market participant assumptions. Furthermore, we have observed that conversations are generally more productive when a reporting entity has documented how market participant assumptions were developed when performing a fair value measurement.

Thank you


1 The term "enterprise value" is sometimes referred to in practice as "invested capital" or "total invested capital".


Modified: 12/08/2009