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

    The goodwill to assets ratio is a ratio that measures how much ...
  2. Purchase Acquisition

    Purchase acquisition is used in mergers and acquisitions where ...
  3. Negative Goodwill

    Negative goodwill is an accounting gain that occurs when the ...
  4. Impairment

    Impairment is an accounting principle that describes a permanent ...
  5. Identifiable Asset

    An identifiable asset is an asset of an acquired company that ...
  6. Acquisition Premium

    An acquisition premium is the difference between the estimated ...
Related Articles
  1. Investing

    How Does Goodwill Affect Stock Prices?

    Intangibles like goodwill have a role in stock prices, but just how much really?
  2. Investing

    Can You Count on Goodwill?

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

    The Ins and Outs of In-Process R&D Expenses

    Are these charge-offs fair accounting or earnings manipulation? Learn more here.
  4. Investing

    How to Evaluate a Company's Balance Sheet

    Asset performance shows how what a company owes and owns affects its investment quality.
  5. Investing

    Ben Graham on Interpreting Financial Statements

    Seven pieces of advice from Benjamin Graham on understanding financial statements.
  6. Investing

    What's Fair Value?

    Fair value has three different meanings depending on the context.
  7. Investing

    Lady Godiva Accounting Principles

    Find out how and why these rules can help companies "come clean" in post-Enron Wall Street.
  8. Investing

    Digging Into Book Value

    This calculation will serve up your portion of the shareholder pie.
  9. Taxes

    The Top Nonprofit Organizations

    Did you know basketball and volleyball were invented by instructors at a charity?
  10. Tech

    Amazon Will Now Deliver Whole Foods Groceries in 2 Hours

    E-commerce giant Amazon will introduce quick free shipping to Prime subscribers in select cities before rolling out its new service to the rest of the U.S..
RELATED FAQS
  1. How is impairment loss calculated?

    Learn how companies re-evaluate their assets and compare them against book values to recognize impairment and why this strategy ... Read Answer >>
  2. How do you write off impaired assets from the financial statement?

    Learn what an impaired asset is and how it effects a company's financial statements. Understand how an accountant writes ... Read Answer >>
  3. How fair value is calculated in futures market?

    Learn how the fair value for futures stock index contracts is calculated, and understand how differences between those numbers ... Read Answer >>
  4. Why should an investor understand accounting?

    Learn why an investor should understand business accounting to perform investment and credit analysis. Find out about asset ... Read Answer >>
  5. How Are Book Value and Market Value Different?

    Book value and market value are two financial metrics used to determine the valuation of a company and whether the stock ... Read Answer >>
Trading Center