May 25, 2020

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Finite Lived vs Indefinite Lived Intangible Assets – How to test for impairment?

A question came across my desk about the differences between finite lived assets vs indefinite lived assets.

First and foremost, the basics. The ASC Master Glossary defines intangible assets as “assets (not including financial assets) that lack physical substance.” The guidance separates out Goodwill from the rest of the intangibles, so for the purposes of this post, I am not discussing Goodwill.

Often intangibles are recognized and recorded as part of a business combination or acquisition. Some of the more common ones that I see are significant contracts (customer contracts), under market rate leases, tradenames, other IP such as trade secrets or patented technology. See ASC 805 for how to account for these types of acquired assets.

Now, however, there is one important distinction between finite lived and indefinite lived. It is well established that Goodwill is an indefinite lived asset that is not subject amortization, however, Goodwill does have it’s own guidance (ASC 350-20) vs other intangibles other than good will (ASC 350-30). In my personal experience, the number of intangible assets that are considered to be indefinite lived (other than Goodwill) is VERY limited. Part of this may be because in actuality there are few things in this world that we legitimately expect to have an indefinite economic usefulness to us, however, part of it also may be that companies apply the guidance very stringently on these types of assets due to some impairment work, or perhaps (since not subject to amortization) increased scrutiny from external auditors when a conclusion that something is indefinite lived is reached.

So let’s go through some of the main important differences in accounting.

Nature: Finite lived intangible assets have an expected useful life that is limited in nature.  This may be different from legal rights (e.g., perpetual licenses may provide an indefinite right, however the economic usefulness of said rights is theoretically limited due to changes in technology.  I have never seen a company make an argument that perpetual licenses are indefinite lived assets, at least not yet).  Indefinite-lived intangible assets are basically the opposite.  These are assets where there is no legal, regulatory, contractual, or economic factors that could limit the economic life (useful life) to a company.  i.e., there is no credible reason to assume that the company will ever not utilize said intangible in perpetuity.  Some examples of indefinite lived intangibles may be certain trademarks (If I bought Coca-Cola, I would probably make the argument that this is indefinite lived as the brand is so valuable and pervasive in every business activity that I doubt any logical argument can be made that this is anything but indefinite lived).  Perpetual franchise agreements may be another example.  Again, this decision brings a certain amount of scrutiny, so just make sure you’ve thought through not only the legal, but economic factors when arriving at your decision.

Amortization:  Real simple.  Finite lived assets are amortized over useful life.  The actual rule here states that a company should try to amortize in a pattern consistent with the timing that the economic benefits of said asset are recognized.  (i.e., if 40% of the value of the intangible will be consumed in year 1, take 40% amortization in year one).  However, if no specific pattern can be reasonable determined, the default then becomes straight line in practice (and is allowable under US GAAP).  Indefinite lived intangibles are NOT AMORTIZED.  (What period would you amortize them over?)  This is partly where the additional scrutiny from auditors may come from.  No amortization and essentially no P&L impact from receiving the benefit of the asset over time.  However, because the intangible asset will remain on your balance sheet at purchase date fair value (assuming acquired in a business combination), this places more importance on the asset impairment assessment (see below).

Impairment: Although a company may benefit from not recording amortization related to their indefinite lived intangibles, there is a downside in terms of logistics.  The impairment rules are different for indefinite lived intangibles (other than Goodwill) vs finite lived.  Finite-lived intangibles are tested for impairment in accordance with ASC 360 (not 350).  Testing for impairment of finite-lived assets is required whenever events or circumstances indicate that the carrying amount of a long lived asset may not be recoverable.  ASC 360 prescribes a two step test whereby an impairment charge is recognized if the carrying amount is not recoverable, and the amount is measured as the carrying value over fair value (most likely you are familiar with this already).   Indefinite lived intangibles, on the other hand, are tested for impairment in accordance with ASC 350.  Testing is required at least annually and more frequently if events or changes in circumstances indicate that the asset might be impaired.  This can be an administrative burden.

In 2012, the FASB issued ASU 2012-02, which essentially gave indefinite live intangibles the same shortcut method that ASU 2011-08 provided for Goodwill impairment testing.   Prior to ASU 2012-02, this assessment was required to be quantitative.  The new ASU inserts a step before a quantitative assessment which is qualitative in nature.  The first step is assessing qualitative factors in order to determine whether it is more likely than not that an indefinite-lived intangible is impaired.  More likely than not is generally considered more than 50%.  FASB provided the following list of factors in Topic 350 in the FASB ASC that could significantly affect inputs used to estimate the fair value of indefinite-lived intangibles:

  • Cost factors such as increase in raw materials, labor, or other costs that have a negative effect on future expected earnings and cash flows
  • 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
  • Legal, regulatory, contractual, political, business, or other factors, including asset-specific factors
  • Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation
  • Industry and market consideration such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (in both absolute terms and relative to peers), or a change in the market for an entity’s products or services due to the effects of obsolescence, demand, competition, or other economic factors (such as the stability of the industry, known technological advances, legislative action that results in an uncertain or changing business environment, and expected changes in distribution channels)
  • Macroeconomic conditions such as deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets
So one can clearly see how ensuring that a company has appropriately defined its indefinite-live intangibles is important as this assessment will have P&L impacts as well as create a recurring requirement and responsibility on Management to at least annually assess all indefinite lived assets for impairment.

P.S.  A common question arises as to the unit of accounting to apply the impairment test on (if I have multiple trade names can I bundle them and perform one assessment?).  Please refer to ASC 350-30-35-21 through 35-28 for guidance on unit of account considerations.

Unit of Accounting for Purposes of Testing for Impairment of Intangible Assets Not Subject to Amortization

35-21   Separately recorded indefinite-lived intangible assets, whether acquired or internally developed, shall be combined into a single unit of accounting for purposes of testing impairment if they are operated as a single asset and, as such, are essentially inseparable from one another.

35-22   Determining whether several indefinite-lived intangible assets are essentially inseparable is a matter of judgment that depends on the relevant facts and circumstances. The indicators in paragraph 350-30-35-23 shall be considered in making that determination. None of the indicators shall be considered presumptive or determinative.

35-23  Indicators that two or more indefinite-lived intangible assets shall be combined as a single unit of accounting for impairment testing purposes are as follows:
a. The intangible assets were purchased in order to construct or enhance a single asset (that is, they will be used together).
b. Had the intangible assets been acquired in the same acquisition they would have been recorded as one asset.
c. The intangible assets as a group represent the highest and best use of the assets (for example, they yield the highest price if sold as a group). This may be indicated if it is unlikely that a substantial portion of the assets would be sold separately or the sale of a substantial portion of the intangible assets individually would result in a significant reduction in the fair value of the remaining assets as a group.
d. The marketing or branding strategy provides evidence that the intangible assets are complementary, as that term is used in paragraph 805-20-55-18.

35-24   Indicators that two or more indefinite-lived intangible assets shall not be combined as a single unit of accounting for impairment testing purposes are as follows:

a. Each intangible asset generates cash flows independent of any other intangible asset (as would be the case for an intangible asset licensed to another entity for its exclusive use).

b. If sold, each intangible asset would likely be sold separately. A past practice of selling similar assets separately is evidence indicating that combining assets as a single unit of accounting may not be appropriate.

c. The entity has adopted or is considering a plan to dispose of one or more intangible assets separately.
d. The intangible assets are used exclusively by different asset groups (see the Impairment or Disposal of Long-Lived Assets Subsections of Subtopic 360-10).

e. The economic or other factors that might limit the useful economic life of one of the intangible assets would not similarly limit the useful economic lives of other intangible assets combined in the unit of accounting.

35-25   Paragraph superseded by Accounting Standards Update No. 2010-07

35-26   All of the following shall be included in the determination of the unit of accounting used to test indefinite-lived intangible assets for impairment:

a. The unit of accounting shall include only indefinite-lived intangible assets—those assets cannot be tested in combination with goodwill or with a finite-lived asset.

b. The unit of accounting cannot represent a group of indefinite-lived intangible assets that collectively constitute a business or a nonprofit activity.

c. A unit of accounting may include indefinite-lived intangible assets recorded in the separate financial statements of consolidated subsidiaries. As a result, an impairment loss recognized in the consolidated financial statements may differ from the sum of the impairment losses (if any) recognized in the separate financial statements of those subsidiaries.

d. If the unit of accounting used to test impairment of indefinite-lived intangible assets is contained in a single reporting unit, the same unit of accounting and associated fair value shall be used for purposes of measuring a goodwill impairment loss in accordance with paragraphs 350-20-35-9 through 35-18.

35-27  If, based on a change in the way in which intangible assets are used, an entity combines as a unit of accounting for impairment testing purposes indefinite-lived intangible assets that were previously tested for impairment separately, those intangible assets shall be separately tested for impairment in accordance with paragraphs 350-30-35-18 through 35-20 prior to being combined as a unit of accounting.

35-28   Examples 10 through 12 (see paragraphs 350-30-55-29 through 55-38) illustrate the determination of the unit of accounting to use in impairment testing.

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