Lesson 25 - Advanced Accounting Course

Lesson 25: Goodwill Impairment Testing in Consolidated Financials

When a company acquires another, it often records goodwill in its financial statements. Goodwill represents the excess of the purchase price over the fair value of the acquired company’s identifiable assets and liabilities.

Over time, this goodwill might lose value, which is why impairment testing is essential. If goodwill is impaired, it must be written down to reflect its reduced value.

In this lesson, we will cover:

• ✅ What goodwill is
  
  

• 🧠 How to perform impairment testing
  
  

• 📈 When goodwill should be tested for impairment
  
  

• ⚖️ How to handle impairment losses
  
  

• 🚨 Common mistakes to avoid
  
  

🤔 What Is Goodwill?

Goodwill arises when a company acquires another business, and the purchase price exceeds the fair value of the identifiable assets and liabilities of the acquired company.

It reflects:

• Brand reputation
  
  

• Customer relationships
  
  

• Intangible assets not separately identifiable
  
  

• Synergies expected from combining the businesses
  
  

🧠 Why Is Goodwill Tested for Impairment?

Goodwill can lose its value due to:

• Economic downturns
  
  

• Poor performance by the acquired company
  
  

• Changes in market conditions or business environment
  
  

• A decline in expected synergies
  
  

Goodwill is not amortized like other intangible assets. Instead, it is subject to impairment testing annually (or more frequently if needed) to ensure it’s still accurately valued.

🔍 When to Test Goodwill for Impairment

1. Annual Test

• Goodwill must be tested for impairment at least once a year. This is typically done at the end of the company’s fiscal year, or when there is a triggering event (e.g., significant loss of value).
  
  

2. Triggering Events

These are events or changes that could indicate goodwill might be impaired. Examples include:

• A significant drop in market value
  
  

• A major restructuring or reorganization
  
  

• Negative changes in the business or operating environment
  
  

• Decline in the performance of the acquired company
  
  

🧮 How to Test for Goodwill Impairment (IFRS vs. US GAAP)

Step 1: Determine the Cash-Generating Unit (CGU)

Goodwill is allocated to Cash-Generating Units (CGUs), which are the smallest groups of assets that generate cash independently of other assets.

Step 2: Compare the Recoverable Amount with the Carrying Amount

• Recoverable amount: The higher of the CGU's fair value (market value) or value in use (present value of future cash flows).
  
  

• Carrying amount: The current book value of the CGU, including goodwill.
  
  

If the recoverable amount is less than the carrying amount, goodwill is impaired, and a loss is recognized.

Step 3: Measure Impairment Loss

If the recoverable amount is lower than the carrying amount, the difference is the impairment loss. This loss should be recognized in the income statement.

Step 4: Write Down the Goodwill

The impairment loss is allocated to goodwill first, and then, if needed, to other assets of the CGU.

📉 Example of Goodwill Impairment Testing

Let’s say Company A bought Company B for $1,000,000. After the acquisition, goodwill of $200,000 was recorded. Now, after a year, Company A needs to test the goodwill for impairment.

• Recoverable amount of the CGU: $850,000 (based on future cash flows and fair market value)
  
  

• Carrying amount of the CGU (including goodwill): $950,000
  
  

The difference between the carrying amount and the recoverable amount is $100,000.

• Impairment loss = $100,000
  
  

In this case, Company A would write down the goodwill by $100,000, recognizing the impairment loss in its income statement.

⚖️ Treatment of Impairment Losses

Under IFRS:

• Goodwill impairment losses cannot be reversed once they are recognized.
  
  

• The impairment is permanent and must be written down in the balance sheet.
  
  

Under US GAAP:

• The impairment loss is also permanent and cannot be reversed.
  
  

• However, goodwill is tested at the reporting unit level (a similar concept to CGUs in IFRS).
  
  

🚨 Common Mistakes in Goodwill Impairment Testing

✅ Best Practices for Goodwill Impairment Testing

1. Conduct annual tests or tests when there are triggering events.
   
   

2. Define your CGUs properly—ensure they reflect how your company operates and generates cash.
   
   

3. Use reliable forecasts to determine the recoverable amount (future cash flows should be realistic).
   
   

4. Track changes in market conditions and other external factors that could indicate impairment.
   
   

5. Disclose impairment losses clearly in the financial statements, providing transparency to investors.
   
   

📑 Quick Recap