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Goodwill impairment results when the fair market value of a company’s goodwill asset is less than its historical cost (or book value) as listed on the company’s balance sheet.

Generally accepted accounting principles (GAAP) require businesses that have the type of assets that might be impaired to make periodic tests to see if those assets are, in fact, impaired. Goodwill is the most common type of asset that is checked for impairment.

To check for impairment, auditors make a calculation based on the present value of the future cash flows of the asset that caused the goodwill.  Usually goodwill is based on intangibles such as high brand awareness or a large, loyal customer base.

If goodwill is impaired, then it must be written down to its lower fair market value. The difference between the book value and fair market value is recorded as a loss due to goodwill impairment in the company’s income statement.

Conglomo purchased XYZ as a subsidiary and recorded $50 million of goodwill relating to the purchase.  However, due to a drastic decline in market share for XYZ’s products, its discounted cash flow value dropped, resulting in a $45 million reduction in goodwill value. As a result, Conglomo must record a loss due to impairment of assets in the amount of $45 million in its current year income statement.  The goodwill associated with the XYZ purchase will now be listed at $5 million on the Conglomo balance sheet.

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