Summary of the Facts
Galaxy Sports Inc. (Galaxy) has three reporting units, Fitness Equipment,
Golf Equipment, Hockey Equipment. In December 2009, Galaxy contracted Big
Time LLC (Big Time) to perform an annual ASC 350, Intangibles - Goodwill and
Other, for each of their reporting units. In late January 2010, Big Time
determined that for each of Galaxyʼs reporting units the fair value of goodwill
exceeded its book value, meaning there was no need for impairment. In each of
Galaxyʼs first three quarters of 2010 they reported earnings lower than expected
and common share prices fell. Galaxy cited reduced customer spending and
competition from sports equipment manufactured in China. At year-end 2010,
Galaxy determined to carry over the fair value determinations provided by Big
Time in 2009 for both the Fitness Equipment and Hockey Equipment reporting
units. Also, Galaxy decided for the Golf Equipment reporting unit to update Big
Timeʼs fair value analysis using the same growth rate and discount rate as the
previous year.
Question 1: Should management have performed an interim goodwill impairment
test as of September 30, 2010?
Response: Yes, Galaxyʼs management should have performed an interim
goodwill impairment test as of September 30, 2010 . According to ASC 350-2035-30, “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,” and
cites “unanticipated competition” as one such circumstance. Galaxy states that
one of the reasons for its earnings being below expectations is that the slowing
economy is causing them to see an increase in competition from sports
equipment manufactured in China. This fits the guidelines, provided by ASC
350-20-35-30, to require testing for impairment between annual tests. When
trying to determine fair value, ASC 350-20-35-22 states that, “Quoted market
prices in active markets are the best evidence of fair value.” In this respect,
Galaxyʼs common share price has fallen from $56.75 as of December 31, 2009 to
$31.50 as of September 30, 2010. This is almost a 50% decrease which would
reasonably cause one to believe that fair value has decreased, possibly below
book value, since Big Timeʼs 2009 determinations.
Question 2: Assume no interim test is required. Was management justified in
carrying forward the prior-year goodwill impairment test for the Fitness
Equipment and Hockey Equipment reporting units?
Response: Yes, management was justified in carrying forward the prior-year
goodwill impairment test for the Fitness Equipment and Hockey Equipment
reporting units. According to ASC 350-20-35-29, the determination of a fair value
may be carried over to the next year if it meets three criteria. The first criteria is
that the reporting unitʼs assets and liabilities have not changed significantly since
the last determination. According to Galaxy, “assets and liabilities of the Fitness
Equipment and Hockey Equipment reporting units had not significantly changed.”
This satisfies the first criteria. The second criteria is that the most recent
determination of fair value was substantially greater than the book value.
According to Galaxy, “The most recent fair value determinations for both
reporting units resulted in an amount that exceeded the carrying amounts by
substantial margins.” This satisfies the second criteria. The final criteria is that
based on analysis of events and circumstances nothing has changed that would
reasonably cause fair value to fall below book value. According to Galaxy, “on
the basis of its analysis, there have been no significant events or circumstances
that would cause the fair value to fall below book value for both reporting units.”
This satisfies the third criteria. Since all three criteria of ASC 350-20-35-29 have
been met, Galaxy management was justified in carrying forward the fair values
for both its Fitness Equipment and Hockey Equipment reporting units.