Goodwill impairment testing plays a critical role in ensuring that a company’s financial statements accurately reflect the current value of acquired businesses. Because goodwill represents intangible factors and can be particularly sensitive to shifts in economic conditions and business performance. What happens when these benefits decline? Learn more about goodwill impairment testing under both US GAAP and IFRS guidance and how to ensure greater transparency, uphold reporting integrity, and provide stakeholders with a clear picture of financial health.
Understanding Goodwill Impairment Testing
What is Goodwill?
Goodwill is an intangible asset providing future economic benefits, despite lacking physical form. It conceptually represents the “premium” paid to acquire a business above the fair value of its identifiable net assets. Goodwill captures the value of non-physical factors like brand reputation, customer loyalty, strong customer relations, good employee relations, and proprietary technology not separately identifiable for accounting purposes.
Goodwill can't be bought or sold independently yet also has no foreseeable limit to its useful life. Other intangible assets such as licenses or patents can have a separately identifiable value and have a finite useful life.
Since goodwill is an indefinite-life asset, it is not amortized (systematically expensed). However, there is a US GAAP accounting alternative only available to private businesses and nonprofits permitting amortization and other simplifications. Whether goodwill is finite-lived or indefinite-lived, potential impairment of the asset may exist.
What is Goodwill Impairment?
Companies test indefinite-lived goodwill to see if its value has decreased (i.e., become impaired). If impaired, a loss is recognized on the income statement because the current market value of the acquired net assets (i.e., assets less liabilities) fell below the current book carrying value. Impairment reduces goodwill on the balance sheet and lowers the year's net income.
Goodwill impairment signals a failed acquisition, which may have resulted from poor management decisions, distorted asset values, market downturns, increased competition, loss of key personnel, poor integration, and other factors that may dilute the future earnings potential and overall value of the net assets of an entity previously acquired entity.
How Does US GAAP and IFRS Differ in Goodwill Impairment Testing?
US GAAP and IFRS differ in their goodwill impairment testing primarily in the testing level and the quantitative test structure.
IFRS uses a one-step approach comparing carrying value or book value to the higher of a) fair value less costs to sell or b) “value in use” (i.e., present value of the future cash flows) at the Cash-Generating Unit (CGU). In essence, determining the CGU’s recoverable amount. CGU is the smallest group of assets generating largely independent cash flows.
US GAAP mainly focuses on comparing carrying value to fair value at the Reporting Unit (RU) level after an optional qualitative assessment. RU is generally defined within the segment reporting framework (one level below an operating segment). There is an accounting alternative available to private businesses and nonprofits which permits assessing impairment at the entity level.
A Qualitative Assessment (Step 0) may be used to evaluate whether it is “more likely than not” (over 50% chance) that fair value is below carrying value before proceeding with a quantitative test. Triggers typically monitored for this assessment include macroeconomic, industry, or company-specific events (e.g., market downturns, loss of key personnel, poor performance).
What Triggers Goodwill Impairment Testing
Both US GAAP and IFRS require at least an annual test or more frequent testing if impairment indicators arise (i.e., triggering events). A triggering event for goodwill impairment is any significant internal or external event or circumstance indicating the fair value of a reporting unit or entity, if elected, might fall below its carrying value, prompting a required interim test. There is a US GAAP accounting alternative available to certain entities to only monitor triggering events at a reporting date.
Both US GAAP and IFRS measure the impairment loss as the amount by which the carrying value exceeds the fair value or recoverable amount but not exceeding the goodwill's carrying amount. If other assets, including long-lived, indefinite-lived intangibles, are impaired, record those losses before testing goodwill.
Critical Documentation for Goodwill Impairment Testing
Adequate documentation requires detailed records of the following:
The Impairment Trigger
Examples of events that would trigger goodwill impairment:
- Major economic downturn
- Increased competition or loss of key customers
- Significant financial underperformance (like negative cash flows)
- Negative changes in industry outlook or costs.
These events signal a potential decline in the acquired business's value, requiring management to assess if the goodwill recorded on the balance sheet needs to be written down.
The Defined Reporting Unit
Clearly define the specific reporting unit(s) to which the goodwill applies and how they align with segment disclosures. Note: Unless the accounting alternative to assess impairment at the entity level is adopted..
Fair Value Assessment
The fair value assessment includes methodology and key assumptions, like discount/growth rates and cash flow projections.
Impairment Loss Amount
You will also need adequate documentation of the amount from impairment loss.
Rationale
You will need to include the rationale for your decisions, including basis for key judgments, sensitivity analyses of key assumptions, like growth rates or discount rates, and supporting valuation reports from third parties if used. This includes specific disclosures explaining the facts and circumstances leading to the loss for transparency.
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