I. THE CASE

Background

SM Enterprises (SM), a public global conglomerate of consumer product manufacturers in the landscaping/gardening space, purchased 100 percent of the stock of two companies, SK Corporation (SK) and Joy Industries (Joy), in January 2015. This was a bold move for SM, as the acquisitions represented a new venture for the company and the entrance into a new segment in which it had no experience. As a result of the transactions, SM initially reported $3.2 million of goodwill on its consolidated balance sheet, $2 million relating to the acquisition of SK and $1.2 million relating to Joy.

The New Segment

SK produces and sells high-end household accessories in retail markets across the United States. The company's top selling products are its premium lines of kitchen and bathroom cabinet hardware and light fixtures. SK's products are primarily sold through large retailers and wholesalers in large metropolitan areas. In recent years, however, company management has made a focused effort on selling directly to consumers through the company website. Accordingly, SK marketing personnel have developed strategic advertising approaches to direct customers to its commerce website. Management anticipates that this initiative will greatly improve product margins and, thus, it is expected that direct-to-consumer sales will surpass sales through retailers/wholesalers within the next five years.

Joy is a manufacturer of premium home decor with an emphasis on quality decorative linens and unique wall decorations. The company mainly sells its products in company-owned retail stores located in upscale shopping districts in urban populations. However, a limited line of Joy products can be found at other selected brick-and-mortar retailers. Additionally, the company generates a small amount of revenue via its website. Due to the nature of the company products, Joy management has faced several challenges in developing a greater online presence, yet these struggles have also hampered the expansion of its competitors. Ultimately, management has plans to develop brand awareness that will allow for brick-and mortar expansion into more suburban areas.

Upon the purchase of SK and Joy, SM formally established a new segment, Household Goods, for financial reporting purposes. The segment is headed by an executive team, which provides oversight of the management teams at both companies. SM's corporate controller, Mr. Brown, was promoted to Vice President of FinanceHousehold Goods following the merger.

From 2015 to 2018, the strategic acquisitions proved to be wise investments, as both SK and Joy posted significant growth and continued to produce unique products each year. In 2019, however, the companies moved in opposite directions. SK continued its impressive growth. Joy, on the other hand, encountered significant competition and regulatory setbacks, leading to diminished profitability and derailing the company's strong start under SM's control. However, Joy did benefit from some strategic land acquisitions in prior years that have appreciated considerably in value.

Goodwill

Prior to the acquisitions, in response to changes in generally accepted accounting principles in the United States (i.e., U.S. GAAP) and in the interest of effective portfolio management, the company developed a policy of subjecting each reporting unit to formal quantitative impairment tests of goodwill every five years, with the first such test to take place for the fiscal year 2019 financial statements. Due to the success of SK and Joy each year and in comparison to competitors prior to 2019, SM financial reporting personnel concluded, year after year, that a formal quantitative goodwill impairment test was unnecessary.

However, pursuant to the new policy, the company made preparations toward the end of 2019 to test all of its reporting units. In conjunction with these tests, Mr. Brown indicated that multiple fixed asset groupings within Household Goods experienced significant declines in market value, and thus the segment personnel would be testing all fixed asset groupings for impairment. SM hired JP Progress, a large consulting firm specializing in corporate valuation, to conduct appraisals that are necessary for the goodwill impairment testing process. In addition, SM's Director of Financial Reporting requested financial information from the accounting records of SK and Joy from Mr. Brown, including relevant fair value information regarding both companies' assets and liabilities. That information, in conjunction with JP Progress' appraisal reports, will be used in goodwill impairment testing. JP Progress' reports highlighted December 31, 2019 fair values in the amounts of $11,339,000 and $14,070,000 for SK and Joy, respectively.

At the time the director made the request, Mr. Brown was in the final stages of overseeing impairment tests of the segment's fixed assets, finalizing the valuation of inventory, and reviewing the impact of interest rate changes on the fair value of the company's bond obligations. Essentially, Mr. Brown had compiled all of the necessary information for the consideration of these areas, and in the coming weeks, planned to run a final analysis to determine their impact on the financial statements. Mr. Brown was confident that all of the other assets and liabilities were reported at appropriate amounts that approximated fair values. The preliminary 2019 Balance Sheet Summary for each company provided by Mr. Brown is presented in Appendix A.

In addition, Mr. Brown also provided relevant information related to the ongoing impairment testing of property, plant, and equipment, valuation of inventory, and consideration of bonds payable:

Property, Plant, & Equipment, net, is reported at historical cost less accumulated depreciation (i.e., $15,000,000 for SK) on the preliminary 2019 Balance Sheet Summary. The tables in Appendix B contain information Mr. Brown has compiled for fixed asset impairment testing.

Current Assets on the preliminary 2019 Balance Sheet Summary includes inventory reported with the last-in-first-out (LIFO) approach, using the dollar-value LIFO method applied to a single inventory cost pool. Relevant information for these cost pools compiled by Mr. Brown for the analysis of inventory valuation is presented in Appendix C.

SK's Bonds Payable consists of a single issuance of 8,000 bonds, each with a face value of $1,000 and a maturity date of 12/31/2024. The bonds have a coupon rate of 6 percent (payable annually) and were issued at face value. At 12/31/19, the prevailing market rate was 5 percent. Joy's Bonds Payable includes a single issuance of 6,200 bonds, each with a face value of $1,000 and a maturity date of 12/31/2023. The bonds have a coupon rate of 4 percent (payable annually) and were issued at face value. At 12/31/19, the prevailing market rate was 5 percent.

II.REQUIREMENTS

1.This is the first year in which SM has implemented its policy of performing formal quantitative goodwill impairment tests. In preparation for the upcoming financial statement audit of SM and its subsidiaries, and for future audits, the board of directors of SM would like you to provide documentation of the process that should be used in determining the appropriate goodwill valuation in accordance with U.S. GAAP.

Please provide a step-by-step list or decision diagram/flowchart that details the general process of assessing goodwill impairment. There are at least three major decision steps within the process. Each major decision, though, has its own set of steps. Each step should be accompanied by a decision along with a justification for the course of action as indicated by the Financial Accounting Standards Board Accounting Standards Codification. You should prepare documentation such that it can be applied to a broad array of scenarios involving goodwill impairment and, thus, it must extend beyond the specific fact patterns presented in the case text.

2.Based upon your knowledge of the facts presented in the case and appropriate authoritative guidance, the board of directors of SM has asked you to oversee the testing of goodwill impairment for SK and Joy and to ultimately determine, based upon the information provided by Mr. Brown, the valuation of goodwill and the related impairment loss, if any, for the Household Goods segment. Please provide any relevant calculations for both cases:(1) early adoption of ASU 2017-04; and (2) application of current guidance.

3.Discuss pros and cons of ASU 2017-04, compared to the current guidance.

APPENDIX A Preliminary Balance Sheet Summaries

Panel A: SK Corporation

SK Corporation

Balance Sheet Summary

December 31, 2019

Assets

Current Assets

25,000,000

Property, Plant, & Equipment, net

15,000,000

Total Assets

Liabilities

40,000,000

Current Liabilities

21,000,000

Bonds Payable (maturity date-12/31/2024)

8,000,000

Total Liabilities Stockholders' Equity

29,000,000

Common Stock/Additional Paid-In-Capital

8,000,000

Retained Earnings

3,000,000

Total Stockholders' Equity

11,000,000

Total Liabilities and Stockholders' Equity

40,000,000

Panel B: Joy Industries

Joy Industries

Balance Sheet Summary

December 31, 2019

Assets

Current Assets

16,500,000

Property, Plant, & Equipment, net

11,500,000

Total Assets

Liabilities

28,000,000

Current Liabilities

13,800,000

Bonds Payable (maturity date-12/31/2023)

6,200,000

Total Liabilities Stockholders' Equity

20,000,000

Common Stock/Additional Paid-In-Capital

10,000,000

Retained Earnings

(2,000,000)

Total Stockholders' Equity

8,000,000

Total Liabilities and Stockholders' Equity

28,000,000

Panel A: SK Corporation

APPENDIX B

Property, Plant, and Equipment Information

Asset

Grouping

BookFair Market

ValueValue

Sum of Undiscounted

Future Cash Flows

1 1,250,000 800,000 1,500,000

2 3,400,000 3,600,000 4,200,000

3 960,000 850,000 900,000

4 1,080,000 900,000 1,200,000

5 3,800,000 3,850,000 3,900,000

6 1,600,000 1,750,000 2,000,000

7 440,000 300,000 400,000

8 820,000 600,000 1,000,000

9 750,000 860,000 980,000

10 900,000 1,075,000 1,200,000

15,000,000

14,585,000

17,280,000

Groups based upon lowest level in which related cash flows are independent of other assets.

Panel B: Joy Industries

AssetBookFair Market

GroupingValueValue

Sum of Undiscounted

Future Cash Flows

14,180,0004,265,0004,850,000

21,200,000900,000 1,100,000

3865,000 880,000 1,200,000

42,085,0003,980,0003,470,000

51,430,0002,480,0002,200,000

6295,0001,895,0002,800,000

71,445,0002,000,0002,150,000

11,500,00016,400,00017,770,000

Groups based upon lowest level in which related cash flows are independent of other assets.

APPENDIX C Inventory Information

Panel A: SK Corporation

Net Net Realizable

Dollar-ValueReplacementRealizable Value Less Normal

LIFO CostCostValue Profit Margin

5,000,0004,100,0006,000,0004,800,000

Panel B: Joy Industries

Net Net Realizable

Dollar-ValueReplacementRealizable Value Less Normal

LIFO CostCostValue Profit Margin

3,700,0003,850,0004,600,0003,300,000