America Online 2010 Annual Report Download - page 67

Table of Contents
AOL INC.
PART II—ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
on values observed in recent market transactions. Determining fair value of our reporting unit requires the exercise of significant judgment, primarily related
to the premium used to arrive at a controlling interest equity value used in the market-based approach. Significant changes in the estimates and assumptions
used in deriving our control premium could materially affect the determination of fair value for our reporting unit which could impact the magnitude of an
impairment loss recognized or trigger future impairment. Due to the significant judgments used in deriving our control premium, the fair value of our single
reporting unit determined in connection with the goodwill impairment test may not necessarily be indicative of the actual value that would be recognized in
any future transaction.
Based on our interim impairment analysis as of June 30, 2010, we determined that the carrying value of our reporting unit exceeded its fair value.
Accordingly, step two of the goodwill impairment test was performed, where we used an independent valuation specialist to assist us in determining the fair
value of our individual assets and liabilities in order to perform a "hypothetical purchase price allocation" assuming that the estimated fair value of the
reporting unit was the purchase price paid. The implied fair value of goodwill in the hypothetical purchase price allocation was calculated by comparing the
estimated fair value of the reporting unit to the aggregate fair value of recorded assets and liabilities and unrecognized identifiable intangible assets. Our
unrecognized identifiable intangible assets consisted primarily of subscribers to our access service, advertiser relationships and technology related to our
advertising operations, and the fair value of such assets had the effect of increasing the magnitude of our goodwill impairment charge. Determining the fair
value of these unrecognized identifiable intangible assets in the step two evaluation requires significant judgment, including judgments about appropriate
discount rates and our estimated future cash flows, which are subject to change. As a result of our step two evaluation, we recorded a goodwill impairment
charge of $1,414.4 million during the second quarter of 2010.
Based on our year-end goodwill impairment analysis as of December 1, 2010, we determined that the estimated fair value of our sole reporting unit
exceeded its carrying value by approximately 42%. In determining the estimated fair value of our sole reporting unit for the annual impairment analysis, we
again used a market-based approach, calculating our market capitalization based on our stock price adjusted by a 25% control premium. As the estimated fair
value of our sole reporting unit exceeded its carrying value, the second step of the goodwill impairment test did not need to be performed and therefore no
additional impairment charge was recorded during 2010. However, a significant future decline in estimated fair value of our reporting unit could result in a
significant goodwill impairment charge. As the market-based approach is based on our market capitalization, volatility in our stock price could have a
significant impact on the estimated fair value of our sole reporting unit. Further, the use of a different control premium could have a significant impact on the
estimated fair value of our sole reporting unit.
Income Taxes
Subsequent to the spin-off, AOL began to file its own U.S. federal consolidated income tax return (beginning with the short period December 10 –
December 31, 2009) and income taxes are presented in the consolidated financial statements using the asset and liability method prescribed by the accounting
guidance for income taxes. Prior to the spin-off, income taxes as presented in the consolidated financial statements represented current and deferred income
taxes of Time Warner attributed to us in a manner that is systematic, rational and consistent with the asset and liability method prescribed by the accounting
guidance for income taxes. AOL's income tax provision prior to the spin-off was prepared under the "separate return method." The separate return method
applies the accounting guidance for income taxes to the standalone financial statements as if AOL were a separate taxpayer and a standalone enterprise.
Income taxes (i.e., deferred tax assets, deferred tax liabilities, taxes currently payable/refunds receivable and tax expense) are recorded based on
amounts refundable or payable in the current year and include the results of
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