Goodwill impairment is when the carrying value of goodwill exceeds its fair value. Goodwill is tested for impairment at least annually and the amount by which its carrying value exceeds its fair value is charged to income statement as an expense.
Goodwill is an (intangible) asset that arises in business combinations, i.e. when one company acquires another company at a price which exceeds the fair value of the acquiree’s net assets. Goodwill represents the x-factor of a company, a combination of the company’s history, reputation, brand value, culture, synergy, etc. It is calculated by subtracting the fair value of net assets of the acquiree’s from the sum of the fair value of shareholder’s equity of the acquiree already held by acquirer plus the consideration paid plus the fair value of non-controlling interest, if any.
Goodwill Impairment Test
Goodwill is carried on balance sheet at its historical cost. It has unlimited useful life which means it is not depreciated, however, it must be tested at least annually for impairment at the same time each year. It must be tested multiple times if there is any indication of its impairment:
If the carrying value of goodwill exceeds its fair value, the carrying value of goodwill is reduced and the goodwill impairment expense is charged as a separate line under the continuing operations on income statement.
Traditionally US GAAP required a two-step impairment test, but recently FASB simplified it as explained below. The legacy impairment test under US GAAP involved the following steps:
- Step 1: identify the reporting segments acquired, allocate the goodwill’s carrying value to reporting segments and compare the carrying value of the reporting segment with the fair value of reporting segment. If the fair value exceeds the carrying value, there is no impairment. However, if the fair value is lower than carrying value, there is impairment which is calculated in next step.
- Step 2: where the carrying value is higher than the fair value, compare the fair value of net assets of the reporting segment excluding goodwill with the fair value of the reporting segment to find out implied goodwill. If implied goodwill calculated above is lower than the goodwill allocated, the difference should be expensed out. If the implied goodwill is higher than goodwill allocated, there is no goodwill impairment.
Example: journal entry
Find out impairment loss if any given the following data for two reporting units:
|USD in million||Unit Alpha||Unit Beta|
|Carrying value of reporting unit (including goodwill)||400||250|
|Goodwill included in carrying value||40||25|
|Fair value of the reporting unit||380||260|
|Fair value of net assets excluding goodwill||360||220|
Let’s consider Unit Alpha. Because the fair value of the reporting unit ($380 million) is lower than its carrying value ($400 million), there is impairment of $20 million in the operating unit, which should be first written off against goodwill and then charged to any other assets in the operating unit.
Had you used the US GAAP older impairment test, you would need to work out goodwill implied by the difference between the fair value of the reporting unit and fair value of net assets. In case of Alpha, it is $20 million ($380 million - $360 million). Comparing it with goodwill carrying value of $40 million, we conclude that goodwill is impaired by $20 million. This should be recognized as follows:
|Goodwill impairment expense||$20 million|