Christian Heuer
Mary Ann K. Travers

At a Glance

Accounting standards for valuing goodwill and intangible assets are becoming more rigorous for not-for-profit organizations:

  • Not-for-profit healthcare organizations need to test for goodwill impairment at least annually.  
  • Impairment testing is a two-stage process: initial analysis to determine whether impairment exists and subsequent calculation of the magnitude of impairment.  
  • Certain "triggering" events compel all organizations-whether for-profit or not-for-profit-to perform an impairment test for goodwill or intangible assets.  

Updated accounting standards raise the bar for not-for-profit healthcare organizations. No longer exclusive to for-profit entities, Accounting Standards Codification (ASC) 350 (Intangibles-Goodwill and Other) and ASC 360 (Property, Plant and Equipment) present dramatic changes for not-for-profits, especially in the healthcare sector. Not-for-profits need to gear up for annual testing of goodwill impairment.

Assets are no longer confined to tangible assets (such as land and buildings), but also include intangible assets, such as patents, intellectual property, brand names, noncompete agreements, and licenses.

Any not-for-profit entity that has made an acquisition since Jan. 1, 2010, is likely to have recorded goodwill and intangible assets as part of that transaction.a Under ASC 350, not-for-profit organizations are now required to test goodwill and certain intangible assets for impairment at least annually and to determine their respective fair values.b Fair value can be viewed as the market price for an asset, as determined by market participants, at the date of measurement and, thus, may differ from the book value.

Historically, not-for-profit entities recorded assets acquired in an acquisition or merger at book value. ASC 958 now requires that upon an acquisition, the purchase price be allocated to the assets of the acquired entity. The excess of the purchase price over the fair value of separately identifiable assets is recorded as goodwill.

Two-Step Process for Goodwill Impairment Testing

Impairment testing for goodwill is a two-step process, beginning with a thorough analysis that requires fair value estimates and a yes-or-no determination of impairment. If the answer to Step 1 is affirmative, the healthcare organization needs to proceed to Step 2 and determine the magnitude of the impairment.

Step 1: Initial analysis. Test for impairment of goodwill, using the fair value standard. Does fair value of the applicable reporting unit exceed carrying (book) value? If so, there is no impairment and the annual testing process would be complete. But if book value of a reporting unit is greater than fair value, then the second step will be necessary.

Step 2: Calculation of magnitude. After determining under Step 1 that impairment exists, a healthcare organization should determine the fair value of all its assets and liabilities, including both tangible assets (such as land, buildings, and equipment) and intangible assets and any contingent liabilities. The process is similar to the valuation and accounting required in a purchase price allocation upon consummation of an acquisition transaction. In the case of impairment testing under Step 2, these fair values are not recorded in the financial statements; rather, the values are used only to determine the amount of goodwill.

Next, the implied fair value of goodwill is determined by comparing the Step 1 fair value of the reporting unit with the total Step 2 fair value amounts assigned to all assets and liabilities (other than goodwill). The excess of the fair value of the reporting unit (Step 1) over the total fair value assigned to net assets and liabilities (Step 2) is the implied fair value of goodwill. If the implied fair value of goodwill is less than the carrying amount of goodwill, an impairment charge is taken to reduce goodwill to the implied fair value. This adjusted carrying amount is the new accounting basis of goodwill, and the impairment loss may not be reversed in future periods.

The exhibit below provides a hypothetical example of the two-step process for goodwill impairment testing.



Two-Step Process for Amortizable Intangible Assets

Impairment testing for amortizable intangible assets is also a two-step process, but it differs from the process for goodwill. In contrast to ASC 350, where fair value is the sole standard for goodwill, ASC 360 also prescribes the use of undiscounted cash flows to test amortizable intangible assets (that is, assets with a finite life, such as a medical device patent or a covenant not to compete) for recoverability.c Another significant difference is the use of market-participant assumptions for purposes of ASC 350 and company-specific assumptions for purposes of recoverability under ASC 360. Finally, rather than an annual impairment test, intangible assets are tested for impairment when an event or a change in circumstances indicates that the carrying amount might not be recoverable.

To test intangible assets subject to amortization, organizations need to compare undiscounted cash flows expected to result from the use of the asset, or an asset group, with the carrying value. If the undiscounted cash flows exceed carrying value, no further steps are required. However, if the sum of undiscounted cash flows is less than carrying value, an impairment loss would be recorded to the extent that the carrying value exceeds the fair value of the asset or asset group. Thus, for amortizable intangible assets, the two-step process involves a comparison of both undiscounted cash flows and fair value to determine impairment.

The exhibit below provides a hypothetical example of the two-step process for amortizable intangible assets.



Most Intangible Assets Can Be Amortized

Most intangible assets have limited lives. A research institution, for example, might have patents that expire after a given time. Even in the case of unpatented proprietary technology, the asset typically has a limited economic life, especially in the medical field, where procedures are continually being improved.

The valuation process requires well-reasoned judgment. A health system might have a well-known name but abandon this brand for other reasons. For example in 2010, the Clarian Health system of Indiana decided to realign with the Indiana University Health brand name.d This change could considerably increase the market value of the Indiana University Health brand while diminishing the Clarian brand. Another example of changing value would be a physician group with a five-year noncompete agreement with Dr. Frank. If Dr. Frank moves outside of the area covered by the agreement after two years, the physician group will likely need to write off the value of that noncompete agreement.

Testing Annually, or Sooner in the Case of Triggering Events

Some not-for-profit healthcare organizations considered performing impairment testing at the 2010 calendar year-end. Other finance executives decided this issue could wait until 2011. For example, if an organization made an acquisition that closed July 1, 2010, annual impairment testing would not need to be conducted until one year later, or on July 1, 2011. However, most organizations recognize that the annual impairment test is best performed well in advance of the fiscal year-end. The advantage is that, if impairment exists, the organization has sufficient time to perform a thorough Step 2 analysis without delaying the completion of year-end financial statements and the annual audit.

Exceptions in annual testing arise, however, in the case of triggering events, which can affect both not-for-profit and for-profit organizations. For example, take the case of Hospital A, which recently purchased Hospital B. The acquiring organization expected Hospital B to generate a certain level of earnings. In reality, Hospital B has been losing money since being acquired-an example of a triggering event that calls for impairment testing. Adverse changes in the business climate or market that may have a negative impact on the value of the organization or recoverability of intangible assets are generally considered to be triggering events.

Caution: Expertise Required

Some organizations conduct impairment analyses in-house. The time and expense saved, however, might be offset by the need for additional resources employed by an external audit firm reviewing the quality of the work. Typically, the parties conducting the analysis are expected to write a formal memorandum outlining the processes followed and documenting potential shortcomings.

External audit firms tend to have their own valuation specialists reviewing impairment analyses. They look for overall soundness and whether the analysis is cohesive and technically correct. Some common shortfalls that auditors find are a lack of overall support for the impairment analysis, especially with respect to rates used in discounted cash-flow models. Errors on forecasts are also fairly common. For example, amortization charges that are allowed to continue indefinitely, rather than terminating at the end of the life of the asset, can affect earnings. In addition, errors with respect to working-capital calculations and capital charges are fairly common. When a discounted cash-flow model is used to test goodwill impairment, the external auditors are likely to ask if that model contemplates an asset sale or stock sale. They will test whether an organization has correctly captured the nuances between those two structures in the discounted cash-flow model.

Errors are not limited to discounted cash-flow models. Healthcare organizations can make errors in calculating valuation multiples. For example, total value to earnings before interest, taxes, depreciation, and amortization (EBITDA) may not match the right time periods, or the healthcare organization may be comparing itself to another organization that is not reasonably similar.

Consequently, public and private healthcare organizations may benefit from expert advice in conducting impairment studies. Healthcare organizations are advised to work closely with valuation specialists, accountants, and external auditors to address the requirements of ASC 350 and ASC 360 before starting their analyses.

Noncompliance with the accounting requirements is inadvisable, and could potentially result in a qualified audit opinion. A qualified opinion from external auditors could limit an organization's ability to obtain bank financing, weaken bond-financing options, affect existing bond and loan covenants, and raise questions about the quality of corporate governance.

Don't Wait Too Long

Because of the detailed issues and nuances in valuing goodwill, it is a mistake to leave this task to the last minute. Depending on the complexity of the healthcare organization, the process can take several weeks. In a best-case scenario, no impairment is found and the work can be completed within a reasonable time frame. However, if impairment is indicated, the quantification of impairment can take several months to complete, depending on the complexity of the situation.

Consequently, healthcare organizations should consider starting this process at least two months in advance of a deadline and ideally several months before the end of the organization's fiscal year. Because auditors customarily review the valuation work performed by an organization or that of the organization's valuation specialist, time needs to be built in for back-and-forth information exchanges so the audit firm will be comfortable with the valuation work and documentation related to impairment testing. Waiting too long can cause organizations to miss audit deadlines, which can affect bond ratings and undermine reputation-a key asset for healthcare organizations.

Christian Heuer, CFA, ASA, CBA, is with Crowe Horwath LLP, Nashville, Tenn., and a member of HFMA's Tennessee Chapter (

Mary Ann Travers, ASA, is a partner with Crowe Horwath LLP, Oak Brook, Ill. (


a) Heuer, C. and Travers,M., "FASB Issues New Accounting Standards for Business Combinations," hfm,June 2010,pp 40-43.

b) ASC 350 includes the accounting guidance formerly known as the Statement of Financial Accounting Standards (SFAS) Statement No. 142.

c) ASC 360 includes the accounting guidance formerly known as SFAS No.144.

d) Wall,J.K., "Clarian Hospital System to Adopt IU Name," Indianapolis Business Journal, May 5,2010

Publication Date: Tuesday, February 01, 2011

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