Goodwill Impairment Accounting

Reducing the value goodwill down to its fair market value.

What is Goodwill Impairment?

Goodwill is created when an acquiring entity purchases another entity for more than the fair market value of its assets. Per accounting standards, goodwill should be carried as an asset and evaluated yearly for a goodwill impairment charge.  Private companies, however, may be required to expense a portion of the goodwill, periodically, on a straight-line basis, over a ten-year period, reducing the amount.

Companies should assess if an impairment is needed within the first half of the fiscal year. This impairment test will have a substantial financial impact on the income statement as it will be charged directly as an expense or written off until completely removed from the balance sheet.

 

Goodwill Impairment Accounting

 

How to test if there is Impairment in Goodwill?

Companies need to perform impairment tests annually or whenever a triggering event causes the fair market value to drop below the carrying value. Some triggering events that may result in impairment are – adverse changes in the general condition of the economy, increased competitive environment, legal implications, changes in key personnel, declining cash flows, and when current assets show a declining pattern of market value.

There are two methods commonly used to test for impairment:

  • Income approach – discounting estimated future cash flows to a single current value.
  • Market approach – examining the assets and liabilities of companies in the same market industry.

 

What amount should be recorded as an Impairment Loss?

Business assets should be properly measured at fair market value before testing for impairment. If goodwill has been assessed and identified as being impaired, the full impairment balance must be immediately written off as a loss. An impairment is recognized as a loss on the income statement and as a reduction in the goodwill account. The amount that should be recorded is the difference between the current fair market value of the company’s assets and the amount for which the assets were purchased.

 

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Example of a Goodwill Impairment

Here is an example of a goodwill impairment and its impact on the balance sheet, income statement, and cash flow statement.

Company BB acquires the assets of company CC for $15M, valuing its asset at $10M and recognizing goodwill of $5M on its balance sheet. After a year, company BB tests its assets for impairment and found out that company CC’s revenue has been declining significantly. As a result, the current value of company CC’s assets has decreased from $10M to $7M, having an impairment to the assets of $3M. This makes goodwill drop down from $5M to $2M.

#1 Impact on Balance Sheet

Goodwill reduces from $5M to $2M.

#2 Impact on Income Statement

An impairment charge of $3M is recorded, reducing net earnings by $3M.

#3 Impact on Cash Flow Statement

The impairment charge is a non-cash expense and added back into cash from operations.  The only change to cash flow would be if there was a tax impact, but that would generally not be the case as impairments are generally not tax deductible.

 

Additional resources

Thank you for reading this guide to goodwill impairment and the associated impacts to a company’s financial statements.  To keep learning and advancing your career as a financial analyst, check out these relevant resources: