Loading the player...

What is 'Goodwill Impairment'

Goodwill impairment is a charge that companies record when goodwill's carrying value on financial statements exceeds its fair value. In accounting, goodwill is recorded after a company acquires assets and liabilities, and pays a price in excess of their identifiable value. Goodwill impairment arises when there is deterioration in the capabilities of acquired assets to generate cash flows, and the fair value of the goodwill dips below its book value.

BREAKING DOWN 'Goodwill Impairment'

Goodwill impairment is an earnings charge that companies record on their income statements after they identify that there is persuasive evidence that the asset associated with the goodwill can no longer demonstrate financial results that were expected from it at the time of its purchase. Because many companies acquire other firms and pay a price that exceeds the fair value of identifiable assets and liabilities that the acquired firm possesses, the difference between the purchase price and the fair value of acquired assets is recorded as a goodwill. However, if unforeseen circumstances arise that decrease expected cash flows from acquired assets, their fair value can be lower than what was originally paid for them, and a company must book a goodwill impairment.

Change in Accounting Standards for Goodwill

Goodwill impairment became an issue during the accounting scandals of 2000-2001. Many firms artificially inflated their balance sheets by reporting excessive values of goodwill, which was allowed at that time to be amortized over its estimated useful life. While bull markets previously overlooked goodwill and similar manipulations, the accounting scandals and change in rules forced companies to report goodwill at realistic levels. Current accounting standards require public companies to perform annual tests on goodwill impairment, and goodwill is no longer amortized.

Annual Test for Goodwill Impairment

U.S. accounting principles require companies to review their goodwill for impairment at least annually at a reporting unit level. Events that may trigger goodwill impairment include deterioration in economic conditions, increased competition, loss of key personnel and regulatory action. The definition of a reporting unit plays a crucial role during the test; it is defined as the business unit that a company's management reviews and evaluates as a separate segment. Reporting units typically represent distinct business lines, geographic units or subsidiaries.

Goodwill impairment is identified in two steps. First, a company must compare the fair value of a reporting unit to its carrying value on the balance sheet. Because observable market values are rarely present to determine the fair value of a reporting unit, management teams typically use financial models for fair value estimation. If the fair value exceeds the carrying value, no impairment exists, and companies are not allowed to write up their goodwill. If the fair value is less than the carrying value, the company must perform the second step by applying the fair value to the identifiable assets and liabilities of the reporting unit. The excess balance of the fair value is the new goodwill, and the carrying value of the goodwill must be reduced by booking a goodwill impairment charge.

RELATED TERMS
  1. Goodwill To Assets Ratio

    A ratio that measures how much goodwill a company is recording ...
  2. Goodwill

    An account that can be found in the assets portion of a company's ...
  3. Negative Goodwill

    A gain occurring when the price paid for an acquisition is less ...
  4. Impaired Asset

    A company's asset that is worth less on the market than the value ...
  5. Impairment

    1. A reduction in a company's stated capital. 2. The total capital ...
  6. Acquisition Accounting

    A set of formal guidelines describing how assets, liabilities, ...
Related Articles
  1. Investing

    Goodwill Impairment Test: When You Overpay in M&A

    Overpaying for acquisitions can result in goodwill impairment charges and loss in stock value. How do companies test whether they have paid too much?
  2. Investing

    Explaining Goodwill Impairment

    Goodwill impairment results when the fair market value of a company’s goodwill asset is less than its historical cost.
  3. Investing

    How Does Goodwill Affect Stock Prices?

    “If a business does well, the stock eventually follows.” - Warren Buffett
  4. Investing

    Can You Count On Goodwill?

    Carefully examine goodwill and its sources before considering the value of your investment.
  5. Investing

    Impairment Charges: The Good, The Bad And The Ugly

    Impairment charge is the term for writing off worthless goodwill.
  6. Investing

    How To Calculate Goodwill

    Despite being intangible, goodwill is quantifiable and an important part of a company’s valuation.
  7. Investing

    What is an Impaired Asset?

    An impaired asset is one where the fair market value of the asset is less than the historical cost (or book value) of the asset.
  8. Investing

    Impairment Charges: The Good, The Bad And The Ugly

    Impairment charge is a term for writing off worthless goodwill, but you need to know what its potential impact is on EPS.
  9. Investing

    How To Calculate Goodwill

    Goodwill is an intangible, but it is still possible to effectively calculate or estimate goodwill for a company.
  10. Investing

    How Does Goodwill Affect Financial Statements?

    Goodwill is a bit of a paradox--intangible, yet it is recorded as an asset on the purchasing company's balance sheet.
RELATED FAQS
  1. When and why does goodwill impairment occur?

    Understand what the goodwill of an asset is and how it's created. Learn how the goodwill of an asset can be impaired and ... Read Answer >>
  2. How is a goodwill impairment recorded on a company's financial statements?

    Learn about goodwill, how it's created and how it becomes impaired. Understand how goodwill impairment is recorded on a company's ... Read Answer >>
  3. What are the primary goodwill accounting rules to be aware of?

    Learn the basics of how goodwill is acquired and tested for impairment, as well as the FASB rule change allowing for the ... Read Answer >>
  4. How does goodwill amortize?

    Learn about the Financial Accounting Standards Board 's (FASB) rules for goodwill amortization, how the rules have changed ... Read Answer >>
  5. Is goodwill considered a form of capital asset?

    Learn more about capital assets of a business, and understand why goodwill is an intangible asset that is classified as a ... Read Answer >>
  6. How does goodwill increase a company's value?

    Learn about the basics of goodwill in the business world, what positive effects it can have on a company's overall value ... Read Answer >>
Hot Definitions
  1. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  2. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  3. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  4. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  5. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  6. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
Trading Center