Goodwill impairment occurs when a company decides to pay more than book value for the acquisition of an asset, and then the value of that asset declines. The difference between the amount that the company paid for the asset and the book value of the asset is known as goodwill. The company has to adjust the book value of that goodwill down if it becomes impaired.
Accounting for Goodwill
A company accounts for its goodwill on its balance sheet as an asset. It does not, however, amortize or depreciate the goodwill as it would for a normal asset. Instead, a company needs to check its goodwill for impairment yearly.
If the goodwill asset becomes impaired by a decline in the value of the asset below the purchase price, the company would record a goodwill impairment. This is a signal that the value of the asset has fallen below the amount that the company originally paid for it.
Why Track and Assess Goodwill for Impairment?
A large amount of goodwill impairment could mean that a company is not making sound investment decisions in physical assets or that it could be paying more for an asset than it should.
Goodwill can represent a large part of a company's value or net worth. If a company doesn't test for goodwill impairment, it could overstate its value or net worth.
Since goodwill is an intangible asset, treating it like a normal asset and amortizing it does not give a clear picture as to the value of the asset. It needs to be tested for impairment once a year.