Goodwill impairment definition
/What is Goodwill?
Goodwill is the excess of the purchase price paid for an acquired entity and the amount of the price not assigned to acquired assets and liabilities. It arises when an acquirer pays a high price to acquire another business. This asset only arises from an acquisition; it cannot be generated internally.
What is Goodwill Impairment?
Goodwill impairment occurs when the carrying amount of a goodwill asset is greater than its fair value. The amount of the impairment is the difference between the two figures. Organizations are required by the accounting standards to examine whether their goodwill assets have been impaired at least once a year, as well as when certain triggering events occur.
What Causes Goodwill Impairment?
Goodwill impairment is caused by a decline in the projected cash flows associated with the acquired entity, which reduces its fair value. When this impairment is recorded, it results in the recognition of a loss in the current period. Goodwill impairment can be a particular concern during recessionary periods, when cash flows from operations are more likely to decline. The result is unusually large charge-offs of goodwill to expense during recessions.
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Goodwill Impairment Testing
A goodwill impairment test is required by the accounting standards at least once a year, and more frequently if certain indicators are present, such as adverse regulatory activity or a decline in economic conditions. The exact amount of impairment to recognize can be subject to interpretation, since it is supposed to be the difference between the fair value of a reporting unit and its carrying amount, and fair value is difficult to calculate. The usual approach is to derive fair value by creating a projected cash flow model.
Goodwill Amortization
The effort required to monitor the goodwill asset is considered to be excessive for private companies, while the usefulness of goodwill information is also considered to be limited. Consequently, a private company is allowed to amortize goodwill on a straight-line basis over a ten-year useful life. The entity may amortize goodwill over a shorter period if it can demonstrate that a shorter useful life is more appropriate. The amortization of goodwill will eventually reduce the carrying amount of an organization’s goodwill asset so much that goodwill impairment will be quite unlikely, thereby reducing the need to spend time on such testing.