Galaxy Sports Inc. is a publicly traded company based in the U. S, which manufactures sports equipment. Considering it is a public company, Galaxy is bound by the rules and regulations of the SEC in regards to its accounting and reporting standards. The SEC’s tight supervision of companies is important because the performance of a public company not only affects its owners and employees, but its shareholders, institutional investors, and other stakeholders as well.
For this reason, companies are required to issue a 10-K reporting their financial progress in an honest manner that is consistent with the FASB accounting principles. Galaxy’s business is comprised of three distinct segments, its Fitness Equipment, Golf Equipment, and Hockey Equipment; each of which requires their own separate reporting. Although many companies with multiple sources of revenue report as one unit, Galaxy does not because of the discrete nature of financial information for each separate segment. For this reason, each component is managed separately.
As is stated in the FASB Codification, “A component of an operating segment is a reporting unit if the component constitutes a business or a nonprofit activity for which discrete financial information is available and segment management, as that term is defined in paragraph 280-10-50-7, regularly reviews the operating results of that component” (350-20-35-34). “However, two or more components of an operating segment shall be aggregated and deemed a single reporting unit if the components have similar economic characteristics,” (350-20-35-35). Over the years, Galaxy has made various acquisitions over all segments of their business.
These acquisitions resulted in a total of $360 million of goodwill as of December 2011, $200 million attributed to the Fitness Equipment, $130 million attributed to Golf equipment, and $30 million attributed to the Hockey Equipment. In previous years, management had performed the annual goodwill impairment analysis internally, however, as of December 2011 the company decided to use Big Time LLC as a third party to perform their three annual ASC 350 impairment analysis. Galaxy’s decision to outsource the goodwill valuation was due to the complexities involved in the calculation, and to the lack of internal resources necessary to perform the impairment analysis properly.
Big Time’s impairment analysis of December 2011, demonstrated that Galaxy’s fair value exceeded their book value in all three segments by a significant amount. Given these facts, Big Time need not go further in their impairment test analysis to step 2, as is made clear in the FASB Codification, “If the carrying amount of a reporting unit is greater than zero and its fair value exceeds its carrying amount, goodwill of the reporting unit is considered not impaired; thus, the second step of the impairment test is unnecessary,” (350-20-35-6).
Management indicated that the company’s ability to pass step 1 of the goodwill impairment test with such ease, is likely a result of their strong sales in the final quarter of 2011, at which point their company’s shares were valued at $56. 75 a share. With management’s future projections of consistent sales growth for the upcoming quarters, their share value was destined to increase further; however, that was not the case.
The following year’s sales steadily declined in 2012 for four consecutive quarters due to the slowing economy, dropping their share value to a mere $21. 25 by year end. Despite their obvious decrease in sales, management withheld from implementing an interim goodwill impairment test to reassess their equity’s fair value. Knowing that historically their fourth quarter sales represented over 50 percent of their annual sales, they were confident that they would have a revenue comeback. Unfortunately for them, they were proven wrong yet again.
When it came time for the annual goodwill impairment test, Galaxy’s management determined that there had been no significant change in the assets and liabilities of the Fitness and Hockey Equipment units. In addition, Big Time’s 2011 reports resulted in fair value determination amounts that exceeded the carrying amounts by substantial margins, and from Galaxy’s perspective, no significant events had occurred that would leave them to believe otherwise. Therefore, management decided to skip step 1 for the two units altogether.
In regards to the Golf Equipment segment, management relied on Big Time’s analysis report from the previous year to test for 2012 impairment, using the growth rate and discount rate which Big Time had determined previously. The issue at hand is twofold. Firstly, should Galaxy have done an interim step 1 impairment test for 2012 upon noticing the heavy loss in sales? And if they were correct in not doing so, were they justified in performing a qualitative impairment assessment?
In order to properly address these issues, it must be made clear that it is completely acceptable perform a qualitative assessment and skip step 1 in certain situations, as is stated in the FASB codification, “An entity may first assess qualitative factors, as described in paragraphs 350-20-35-3A through 35-3G, to determine whether it is necessary to perform the two-step goodwill impairment test discussed in paragraphs 350-20-35-4 through 35-19.
If determined to be necessary, the two-step impairment test shall be used to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized (if any),” (350-20-35-3); the only question is if this is one of those situations. FASB states that there is a minimum requirement for companies to have an annual assessment of its goodwill, in order to investigate the possibility of impairment. “Goodwill of a reporting unit shall be tested for impairment on an annual basis and between annual tests in certain circumstances (see paragraph 350-20-35-30).
The annual goodwill impairment test may be performed any time during the fiscal year provided the test is performed at the same time every year. Different reporting units may be tested for impairment at different times,” (350-20-35-28). However, in the very next paragraph FASB points out, “Goodwill of a reporting unit shall be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
Additionally, if the carrying amount of a reporting unit is zero or negative, goodwill of that reporting unit shall be tested for impairment on an annual or interim basis if an event occurs or circumstances exist that indicate that it is more likely than not that a goodwill impairment exists,” (350-20-35-30). The events or circumstances that are being referred to in this paragraph were listed earlier in the Codification as situations where it may be appropriate to perform a qualitative assessment without having to test for impairment.
The list is as follows, “a. Macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets b. Industry and market considerations such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (consider in both absolute terms and relative to peers), a change in the market for an entity’s products or services, or a regulatory or political development c. Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows
d. 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 e. Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation
f. Events affecting a reporting unit such as a change in the composition or 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
g. If applicable, a sustained decrease in share price (consider in both absolute terms and relative to peers)” (350-20-35-3C). In this case it would seem that circumstances a. , d. , and g. are all very much applicable, therefore making an interim impairment test appropriate. It was mentioned in this case that the main cause of decreasing sales was from a macroeconomic event of slowing economy (a), and there is has clearly been an overall decline in financial performance (d) and ultimately decreased share value (g).
However, it is not quite that simple. Even though these events mentioned above may be sufficient enough to require the regular goodwill impairment test process, there is one more factor that must be considered. The codification points out “An entity 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 a reporting unit is less than its carrying amount, including goodwill,” (350-20-35-3A).
“If, after assessing the totality of events or circumstances such as those described in the preceding paragraph, an entity determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the first and second steps of the goodwill impairment test are unnecessary,” (350-20-35-3D). In conclusion, it is my opinion that Galaxy’s management acted appropriately and within the confines of FASB regulation.
Although it is true that some relevant circumstances existed that could have potentially contributed to an altered fair value, it is ultimately up to the judgment of management to make that assessment. The only time that FASB would require going through the first step of goodwill impairment is if, after assessing the totality of events or circumstances through qualitative assessment the company determines that it is more likely than not (more than 50% chance) that the fair value of a reporting unit is less than its carrying amount.
In this case, Galaxy obviously determined through their qualitative assessment that the likelihood of the fair value of the Fitness and Hockey segments dropping below the carrying amount was less than 50%. It is a judgment call on the part of management, and in the case of Galaxy their assessment brought them to the conclusion that despite the surrounding economic situation, a significant change in fair value has not occurred.
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