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What is goodwill impairment?

June 10, 2024

Contributors: Thompson Reuters

Uncertain market conditions and rising interest rates have caused some companies to report significant goodwill impairment write-offs in recent accounting periods. Increased risk and higher interest rates translate to increased cost of capital, which may lower the value of goodwill.

In 2023, pretax goodwill impairments totaled an estimated $82.9 billion across 353 U.S. public companies. In the first quarter of 2024, for example, Walgreens recognized a $12.4 billion pretax impairment loss. More public and private companies are expected to follow suit this year. Which businesses are at risk? Let’s review the current accounting rules for measuring impairment losses.

The basics

Goodwill is an intangible asset that may be linked to such things as a company’s customer loyalty or business reputation. Many companies have internally developed goodwill that isn’t reported on their balance sheets. However, if goodwill is acquired through a merger or acquisition, it may be reported on the buyer’s financial statements.

The value of goodwill is determined by deducting, from the cost to buy a business, the fair value of tangible assets, identifiable intangible assets and liabilities obtained in the purchase. It reflects the premium the buyer of a business pays over its fair value.

Investors are interested in tracking goodwill because it enables them to see how a business combination fares in the long run. In accounting periods after the acquisition date, acquired goodwill must be monitored for impairment. That happens when market conditions cause the fair value of goodwill (an indefinite-lived intangible asset) to fall below its cost.

Impairment write-downs reduce the carrying value of goodwill on the balance sheet. They also lower profits reported on the income statement.

2 sets of rules

The accounting rules for measuring and reporting impairment have been modified several times over the years, leading to some confusion among business owners, investors and other stakeholders. Notably, different rules apply to public companies than to private entities.

Under U.S. Generally Accepted Accounting Principles (GAAP), public companies that report goodwill on their balance sheets can’t amortize it. Instead, they must test goodwill at least annually for impairment. When impairment occurs, the company must write down the reported value of goodwill.

Testing should also happen for all entities whenever a “triggering event” occurs that could lower the value of goodwill. Examples of triggering events include the loss of a key customer, unanticipated competition or negative cash flows from operations. Impairment may also occur if, after an acquisition has been completed, there’s an economic downturn that causes the parent company or the acquired business to lose value.

The Financial Accounting Standards Board (FASB) has granted private companies some practical expedients to simplify the subsequent accounting of goodwill and other intangibles. Specifically, Accounting Standards Update (ASU) No. 2014-02, Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill, gave private companies that follow GAAP the option to amortize acquired goodwill over a useful life of up to 10 years.

The test that private businesses must perform to determine whether goodwill has lost value was also simplified in 2014. Instead of automatically testing for impairment every year, private companies are required to test only when there’s a triggering event.

Important: The FASB proposed changing the accounting rules for public companies. The proposal would have given public companies the option to amortize goodwill over a useful life of up to 10 years. However, after reviewing public comments and holding roundtable discussions, the FASB decided to table the proposal in 2022.

For more information

Does your company report goodwill on its balance sheet? If so, your CPA can explain how the accounting rules for testing goodwill, estimating fair value and recording impairment losses apply to your situation.

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