AKS Company’s common shares are publicly traded. AKS has a single reporting unit, which sells high- end consumer electronics. AKS has a March 31 fiscal year- end.
On April 1, 2010, AKS acquired a competitor, BMN, for $ 20.0 million. The purchase price was approximately 10 times BMN’s projected fiscal 2012 income. After completing the purchase price allocation, the goodwill from this acquisition was recorded at $ 10.0 million. In compliance with ASC 350, AKS was required to perform the first step in the two- step goodwill impairment test. The first step of the goodwill impairment test identifies potential impairment by comparing the fair value of a reporting unit with its carrying amount, including goodwill. AKS decided it would perform this test annually in January. The company determined that there was one reporting unit (AKS in total) at which the goodwill would be tested for impairment. In January 2011, as directed by the CFO, the controller of AKS initiated the process to determine whether there was any impairment of the goodwill. Because this was a new process, the controller decided to hire a certified specialist in the valuation business to prepare the valuation. Below is information available regarding the valuation process:
• The valuation specialist used the income approach using a discounted cash flow model to derive the fair value.
• The weighted- average cost of capital (WACC) to AKS was 7%.
• Revenue growth attributed to BMN in the cash flow model was 10% in fiscal 2012 and 15% in fiscal 2013.
• Income projections prepared as part of the acquisition work indicated expected growth in AKS’s consolidated income of 10%, to $ 22.0 million, in fiscal 2012 and 15%, to $ 25.3 million, in fiscal 2013 from BMN.
• Expenses other than for cost of goods sold were budgeted to remain flat for the next two years. Based on the valuation, the fair value of the reporting unit exceeded its carrying amount by 20%. AKS concluded that, based on this quantitative analysis, there was no goodwill impairment in fiscal 2011.
In September 2011, ASU 2011- 08, Intangibles – Goodwill and Other ( Topic 350) – Testing Goodwill for Impairment, was issued in response to concerns about the cost and complexity of performing the first step of the goodwill impairment test. This ASU bulletin provides management the option to first assess qualitative factors to make a determination of whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after a full qualitative assessment, an entity determines it is more likely than not that the fair value of a reporting unit is more than its carrying amount, then performing the quantitative assessment using the two- step process is unnecessary. In January 2012, you have assumed the role of the controller. You are now responsible for performing the annual impairment testing for goodwill. The CFO believes that there is no impairment issue given that a valuation was just performed in the prior year, which indicated a fair value 20% over carrying value and also because the fiscal results for 2012 have remained stable so far. He has advised you to take advantage of the option to use the qualitative approach in an effort to eliminate the $ 100,000 appraisal fee incurred in the prior year. The CFO believes this approach will be simple and should reduce the accounting department’s workload. During discussions with the AKS executive team early this month, you gained the following insights:
• The BMN acquisition has been successful and there are no intentions to sell any portion of the business. The BMN management team remains intact and is still operating under a non compete agreement for another year. The executive team for AKS is also expected to remain consistent.
• The price of AKS’s stock has been stable this year and is not expected to change significantly in the fourth quarter. The stock prices of AKS’s public competitors have also been fairly stable. At December 31, 2011, AKS had total assets of $ 100 million and net equity of $ 10.0 million. Additional financial information following is based on actual results for the first three quarters of fiscal 2012, ended December 31, 2011, and projected results for the fourth quarter ended March 31, 2012. Auditors of AKS have performed reviews of quarterly results to date for fiscal 2012. There have been no restatements.
• Revenues are projected to increase by 18%. This increase is primarily driven by the acquisition of BMN ( approximately 11% of the increase) and the addition of three large customers, which were taken away from competitors ( approximately 5% of the increase); the balance is the result of increased demand for AKS’s products.
• The demand for AKS’s products was very strong in the first six months. During the ­second half of the year, the economy softened and the demand for AKS’s products began to drop. The forecasted decrease in units sold for the last six months is estimated to be 3% to 4%.
• In the fourth quarter, AKS began offering pricing concessions to maintain sales. The price concessions offered so far in the fourth quarter have been in the range of 2% to 3%, and have helped mitigate the decline in units sold.
• Income for the year is forecasted to be $ 24.0 million.
• The discount rate for AKS is expected to remain at 7%.
• Expenses other than for cost of goods sold increased by 1%.
• The S& P 500 index has dropped 5% since the prior year. The S& P index for public companies within AKS’s industry is down on average 1%.
Required
• For fiscal 2012, perform the qualitative assessment.
• Document your judgment in a draft memorandum format that you will provide to the CFO (not to exceed three pages). Be sure to include specific references and quotes to applicable guidance.