Goodwill Impairment

Goodwill impairment is a reduction in the carrying amount of goodwill, the asset a buyer records when it pays more for a business than the fair value of that business's identifiable net assets. If the acquired business later performs worse than expected, the buyer must write the goodwill down and record the loss as an expense. Listed companies, their auditors and investors watch these charges closely because they show when an acquisition has not paid off.

Goodwill impairment is a special case of the general impairment charge. It differs from the general case in three ways: goodwill cannot be sold on its own, so it is tested as part of a larger unit; it must be tested at least once a year; and once written down it can never be written back up. The rules sit in IAS 36 and IFRS 3 under IFRS, and in ASC 350 under US GAAP.

Suppose you buy a neighbourhood bakery. The ovens, flour and shop fittings are worth 60,000, but you pay 100,000 because the bakery has loyal customers and a good name. The extra 40,000 is goodwill: you paid it for future profits you expect, not for anything you can touch.

A year later a large chain opens next door and half the customers leave. The ovens are still worth about the same, but the loyal-customer premium you paid has shrunk. Goodwill impairment is the bookkeeping step where you admit that part of that 40,000 is gone and record the loss, even though no money left your account that day.

In mergers and acquisitions, the buyer allocates the purchase price to the target's assets and liabilities at fair value, including identifiable intangible assets such as customer lists, patents and brands. Whatever is left over is goodwill. It reflects expected synergies, the assembled workforce, market position and sometimes simply overpayment. Under both IFRS and US GAAP for public companies, goodwill is not amortized; instead it stays on the balance sheet until it is impaired or the business is sold. Since 2014, US private companies may elect to amortize goodwill, generally over up to ten years, under an accounting alternative.

Under IAS 36, goodwill is allocated to the cash-generating units (or groups of units) expected to benefit from the deal. Each year, and whenever there is a warning sign, the company compares the carrying amount of the unit, including its goodwill, with the unit's recoverable amount: the higher of fair value less costs of disposal and value in use. Any shortfall is charged first against goodwill, then spread across the unit's other assets.

Under US GAAP, goodwill is tested at the level of the reporting unit. A company may start with a qualitative assessment (often called "step zero") and skip the numbers if it is not more likely than not that fair value is below carrying amount. ASU 2017-04, issued by the FASB in January 2017, removed the old second step that required calculating an "implied" goodwill figure. The charge is now simply the amount by which the reporting unit's carrying amount exceeds its fair value, capped at the goodwill allocated to that unit:

• $\text{CA}_{\text{unit}}$ is the carrying amount of the reporting unit, goodwill included.
• $\text{FV}_{\text{unit}}$ is the fair value of the reporting unit, often estimated by discounted cash flows or market multiples.
• $\text{Goodwill}_{\text{unit}}$ is the goodwill allocated to that unit.

Worked example: a reporting unit carries 500 million of net assets, including 120 million of goodwill. After a downturn its fair value is estimated at 430 million. The shortfall is 500 − 430 = 70 million, which is less than the 120 million of goodwill, so the impairment is 70 million and goodwill falls to 50 million. If fair value had dropped to 350 million, the shortfall of 150 million would be capped at 120 million, wiping out the goodwill.

The best-known example is AOL Time Warner, which wrote off about 99 billion US dollars of goodwill and other intangibles during 2002 after the 2001 merger, contributing to a net loss of roughly 98.7 billion dollars for the year. Large charges have tended to cluster in downturns such as the 2008 financial crisis, when lower forecasts and higher risk premiums push fair values down. Banks that bought other lenders before the crisis were among the heaviest writers-down. For banks, goodwill also matters for bank capital: under Basel III goodwill is deducted from Common Equity Tier 1, so an impairment hurts reported profit without reducing regulatory capital further.

Critics argue that impairment-only accounting lets goodwill sit on the books too long, because management controls the forecasts and the "headroom" from the acquired business can be shielded by growth in other parts of the same unit. Charges therefore often arrive years after investors have already marked down the stock. Supporters reply that amortization over an arbitrary life would be no more informative. The IASB has worked on a goodwill and impairment project aimed mainly at better disclosure of how acquisitions perform, while keeping the impairment-only model. Analysts usually exclude goodwill charges from earnings per share measures they use for valuation, but read them as evidence about management's deal-making record and the reliability of past valuation assumptions.

• IFRS Foundation
• Financial Accounting Standards Board