What is Goodwill Impairment?

By Kerri Finke

Goodwill is a critical yet often misunderstood intangible asset in the business world. Linked to a company's customer loyalty, brand reputation, or other non-physical attributes, goodwill plays a significant role, especially during mergers and acquisitions. While internally developed goodwill remains off the balance sheets, acquired goodwill must be reported on the buyer’s financial statements, reflecting the premium paid over the fair value of tangible and identifiable intangible assets and liabilities. This article delves into the fundamentals of goodwill, its valuation, and the implications of impairment on financial reporting, shedding light on the nuanced accounting rules that govern this complex asset.

The value of goodwill is determined by deducting, from the cost to buy a business, the fair value of tangible assets, identifiable intangible assets and liabilities obtained in the purchase. It reflects the premium the buyer of a business pays over its fair value.

Investors are interested in tracking goodwill because it enables them to see how a business combination fares in the long run. In accounting periods after the acquisition date, acquired goodwill must be monitored for impairment. That happens when market conditions cause the fair value of goodwill (an indefinite-lived intangible asset) to fall below its cost.

Goodwill Impairment write-downs reduce the carrying value of goodwill on the balance sheet. They also lower profits reported on the income statement.

The accounting rules for measuring and reporting impairment have been modified several times over the years, leading to some confusion among business owners, investors and other stakeholders. Notably, different rules apply to public companies than to private entities.

Under U.S. Generally Accepted Accounting Principles (GAAP), public companies that report goodwill on their balance sheets can't amortize it. Instead, they must test goodwill at least annually for impairment. When impairment occurs, the company must write down the reported value of goodwill.

Testing should also happen for all entities whenever a "triggering event" occurs that could lower the value of goodwill. Examples of triggering events include the loss of a key customer, unanticipated competition or negative cash flows from operations. Impairment may also occur if, after an acquisition has been completed, there's an economic downturn that causes the parent company or the acquired business to lose value.

The Financial Accounting Standards Board (FASB) has granted private companies some practical expedients to simplify the subsequent accounting of goodwill and other intangibles. Specifically, Accounting Standards Update (ASU) No. 2014-02, Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill, gave private companies that follow GAAP the option to amortize acquired goodwill over a useful life of up to 10 years.

The test that private businesses must perform to determine whether goodwill has lost value was also simplified in 2014. Instead of automatically testing for impairment every year, private companies are required to test only when there's a triggering event.

The FASB proposed changing the accounting rules for public companies. The proposal would have given public companies the option to amortize goodwill over a useful life of up to 10 years. However, after reviewing public comments and holding roundtable discussions, the FASB decided to table the proposal in 2022.

Understanding goodwill impairment is crucial for business owners and investors to assess the long-term success of mergers and acquisitions. With evolving accounting rules and distinctions between public and private companies, staying informed about regulatory changes is essential. Vigilant monitoring and recognition of impairment events ensure accurate financial reporting and maintain investor confidence. Contact us to learn more about how the accounting rules for testing goodwill, estimating fair value and recording impairment losses apply to your situation.