Goodwill impairment occurs when the carrying value of goodwill on a company’s financial statements exceeds its fair value. Goodwill is an intangible asset that arises when a company acquires another business and pays a price exceeding the identifiable net value of its assets and liabilities.
Goodwill impairment often happens when the acquired assets underperform in generating cash flows, causing the goodwill’s fair value to drop below its book value. A noteworthy example is the $54.2 billion goodwill impairment loss reported in 2002 following the AOL Time Warner merger, the largest ever at that time.
Key Takeaways
- Understanding Goodwill Impairment: This accounting charge is recognized when the fair value of goodwill falls below its previous recorded value post-acquisition.
- Nature of Goodwill: Goodwill reflects an intangible asset encompassing proprietary or intellectual property, brand recognition, patents, and other elements that are not easily quantifiable.
- When Impairment Happens: It occurs if the acquired assets fall short in yielding expected financial returns.
- Annual Testing Requirement: GAAP mandates that a goodwill impairment test must be conducted annually at a minimum.
How Goodwill Impairment Works
Goodwill impairment is documented as an earnings charge on a company’s income statements when there is clear evidence indicating that the asset linked to the goodwill cannot match the financial performance anticipated at the time of its purchase.
Goodwill, as an intangible asset, comes into play predominantly during acquisitions where the purchase price is higher than the net fair value of identifiable tangible and intangible assets. This excess purchase price accounts for elements like a reliable customer base, positive employee relations, strong brand name, and innovatory proprietary technology.
Impairment is necessitated when unforeseen factors lower the expected cash flows from these acquired assets, thus, reducing the fair value of previously recorded goodwill.
Special Considerations
Changes in Accounting Standards for Goodwill
During the 2000-2001 accounting scandals, many firms superficially inflated their balance sheets due to excessive goodwill values, which then could be amortized over their useful life. This reduced the apparent expense of those intangible assets annually, leading to skewed financial representations.
Revised accounting regulations now compel businesses to report goodwill more realistically, with no amortization but annual impairment tests based on current fair values.
Annual Test for Goodwill Impairment
GAAP obligates enterprises to reassess the impairment of goodwill annually at the reporting unit level. Factors triggering impairments may include economic downturns, increased competition, loss of key staff, or regulatory interventions. Reporting units, critical to these tests, are distinct business lines, geographic segments, or subsidiaries evaluated separately by company management.
The Financial Accounting Standards Board (FASB) provides a structured methodology for conducting these impairment tests, established in “Accounting Standards Update No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.”
Related Terms: intangible asset, carrying value, fair value, acquisition, impairment.
References
- U.S. Securities and Exchange Commission. “AOL Time Warner Inc. Form 10-K For the fiscal year ended December 31, 2002”, Page F-80.
- Time. “What AOL Time Warner’s $54 Billion Loss Means”.
- Financial Accounting Standards Board. “ACCOUNTING FOR GOODWILL IMPAIRMENT”.
- KPMG. “Should goodwill amortisation be reintroduced”?
- Financial Accounting Standards Board. “SUMMARY OF STATEMENT NO. 141”.
