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How to account for goodwill impairment

Goodwill impairment is an accounting charge that companies record when goodwill’s carrying value on financial statements exceeds its fair value. In accounting, goodwill is recorded after a company acquires assets and liabilities, and pays a price in excess of their identifiable net value.

Goodwill impairment arises when there is deterioration in the capabilities of acquired assets to generate cash flows, and the fair value of the goodwill dips below its book value. Perhaps the most famous goodwill impairment charge was the $54.2 billion reported in 2002 for the AOL Time Warner, Inc. merger.   This was, at the time, the largest goodwill impairment loss ever reported by a company.  

Key Takeaways

  • Goodwill impairment is an accounting charge that is incurred when the fair value of goodwill drops below the previously recorded value from the time of an acquisition.
  • Goodwill is an intangible asset that accounts for the excess purchase price of another company based on its proprietary or intellectual property, brand recognition, patents, etc., which is not easily quantifiable.
  • Impairment may occur if the assets acquired no longer generate the financial results that were previously expected of them at the time of purchase.
  • A test for goodwill impairment aligned with generally accepted accounting principles (GAAP) must be undertaken, at a minimum, on an annual basis.  

Goodwill Impairment

How Goodwill Impairment Works

Goodwill impairment is an earnings charge that companies record on their income statements after they identify that there is persuasive evidence that the asset associated with the goodwill can no longer demonstrate financial results that were expected from it at the time of its purchase.

Goodwill is an intangible asset commonly associated with the purchase of one company by another. Specifically, goodwill is recorded in a situation in which the purchase price is higher than the net of the fair value of all identifiable tangible and intangible assets and liabilities assumed in the process of an acquisition. The value of a company’s brand name, solid customer base, good customer relations, good employee relations, and any patents or proprietary technology represent some examples of goodwill.

Because many companies acquire other firms and pay a price that exceeds the fair value of identifiable assets and liabilities that the acquired firm possesses, the difference between the purchase price and the fair value of acquired assets is recorded as goodwill. However, if unforeseen circumstances arise that decrease expected cash flows from acquired assets, the goodwill recorded can have a current fair value that is lower than what was originally booked, and the company must record a goodwill impairment.

Special Considerations

Changes in Accounting Standards for Goodwill

Goodwill impairment became an issue during the accounting scandals of 2000–2001. Many firms artificially inflated their balance sheets by reporting excessive values of goodwill, which was allowed at that time to be amortized over its estimated useful life. Amortizing an intangible asset over its useful life decreases the amount of expense booked related to that asset in any single year.

While bull markets previously overlooked goodwill and similar manipulations, the accounting scandals and change in rules forced companies to report goodwill at realistic levels. Current accounting standards require public companies to perform annual tests on goodwill impairment, and goodwill is no longer amortized.    

Annual Test for Goodwill Impairment

U.S. generally accepted accounting principles (GAAP) require companies to review their goodwill for impairment at least annually at a reporting unit level.   Events that may trigger goodwill impairment include deterioration in economic conditions, increased competition, loss of key personnel, and regulatory action. The definition of a reporting unit plays a crucial role during the test; it is defined as the business unit that a company’s management reviews and evaluates as a separate segment. Reporting units typically represent distinct business lines, geographic units, or subsidiaries.

The basic procedure governing goodwill impairment tests is set out by the Financial Accounting Standards Board (FASB) in “Accounting Standards Update No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.”  

Goodwill is acquired and recorded on the books when an entity purchases another entity for more than the fair market value of its assets. Per accounting standards, goodwill is recorded as an intangible asset and evaluated periodically for any possible impairment in value.

Private companies in the US may elect to expense a portion of the goodwill periodically on a straight-line basis over a ten-year period or less, reducing the asset’s recorded value. This charge is called an amortization expense.

How to account for goodwill impairment

Companies should assess whether or not an adjustment for impairment to goodwill is needed each fiscal year. This impairment test may have a substantial financial impact on the income statement, as it will be charged directly as an expense on the income statement. In some cases, goodwill may be completely written off and removed from the balance sheet.

In accordance with both GAAP in the United States and IFRS in the European Union and elsewhere, goodwill is not amortized. In order to accurately report its value from year to year, companies perform an impairment test. Impairment losses are, functionally, like amortization.

How to Test if Impairment of Goodwill is Required

Companies need to perform impairment tests annually or whenever a triggering event causes the fair market value of a goodwill asset to drop below the carrying value. Some triggering events that may result in impairment are adverse changes in the economy’s general condition, increased competitive environment, legal implications, changes in key personnel, declining cash flows, and a situation where current assets show a pattern of declining market value.

There are two methods commonly used to test for impairment to goodwill:

  1. Income approach – Discounting estimated future cash flows Unlevered Free Cash Flow Unlevered Free Cash Flow is a theoretical cash flow figure for a business, assuming the company is completely debt free with no interest expense. to their present value
  2. Market approach – Examining and comparing the assets and liabilities of companies in the same industry

What Amount should be Recorded as an Impairment Loss?

Business assets Types of Assets Common types of assets include current, non-current, physical, intangible, operating, and non-operating. Correctly identifying and should be properly measured at their fair market value before testing for impairment. If goodwill has been assessed and identified as being impaired, the full impairment amount must be immediately written off as a loss. An impairment is recognized as a loss on the income statement and as a reduction in the goodwill account.

The amount that should be recorded as a loss is the difference between the asset’s current fair market value and its carrying value or amount (i.e., the amount equal to the asset’s recorded cost). The maximum impairment loss cannot exceed the carrying amount – in other words, the asset’s value cannot be reduced below zero or recorded as a negative number.

Example of a Goodwill Impairment

Here is an example of goodwill impairment and its impact on the balance sheet Balance Sheet The balance sheet is one of the three fundamental financial statements. The financial statements are key to both financial modeling and accounting. , income statement Income Statement The Income Statement is one of a company’s core financial statements that shows their profit and loss over a period of time. The profit or , and cash flow statement Cash Flow Statement​ A cash flow Statement contains information on how much cash a company generated and used during a given period. .

Company BB acquires the assets of company CC for $15M, valuing its assets at $10M and recognizing goodwill of $5M on its balance sheet. After a year, company BB tests its assets for impairment and finds out that company CC’s revenue has been declining significantly. As a result, the current value of company CC’s assets has decreased from $10M to $7M, having an impairment to the assets of $3M. This makes the value of the asset of goodwill drop down from $5M to $2M.

#1 Impact on Balance Sheet

Goodwill reduces from $5M to $2M.

#2 Impact on Income Statement

An impairment charge of $3M is recorded, reducing net earnings by $3M.

#3 Impact on Cash Flow Statement

The impairment charge is a non-cash expense Non-Cash Expenses Non cash expenses appear on an income statement because accounting principles require them to be recorded despite not actually being paid for with cash. and added back into cash from operations. The only change to cash flow would be if there were a tax impact, but that would generally not be the case, as impairments are generally not tax-deductible.

Additional Resources

Thank you for reading this guide to goodwill impairment and the associated impacts on a company’s financial statements Three Financial Statements The three financial statements are the income statement, the balance sheet, and the statement of cash flows. These three core statements are . To keep learning and advancing your career as a financial analyst, check out these relevant CFI resources:

  • Financial Analyst Guide The Analyst Trifecta® Guide The ultimate guide on how to be a world-class financial analyst. Do you want to be a world-class financial analyst? Are you looking to follow industry-leading best practices and stand out from the crowd? Our process, called The Analyst Trifecta® consists of analytics, presentation & soft skills
  • Analyzing Financial Statements Analysis of Financial Statements How to perform Analysis of Financial Statements. This guide will teach you to perform financial statement analysis of the income statement,
  • Financial Modeling Guide Free Financial Modeling Guide This financial modeling guide covers Excel tips and best practices on assumptions, drivers, forecasting, linking the three statements, DCF analysis, more
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Goodwill impairment occurs when a company decides to pay more than book value for the acquisition of an asset, and then the value of that asset declines. The difference between the amount that the company paid for the asset and the book value of the asset is known as goodwill. The company has to adjust the book value of that goodwill down if it becomes impaired.

Accounting for Goodwill

A company accounts for its goodwill on its balance sheet as an asset. It does not, however, amortize or depreciate the goodwill as it would for a normal asset. Instead, a company needs to check its goodwill for impairment yearly.

If the goodwill asset becomes impaired by a decline in the value of the asset below the purchase price, the company would record a goodwill impairment. This is a signal that the value of the asset has fallen below the amount that the company originally paid for it.

Why Track and Assess Goodwill for Impairment?

A large amount of goodwill impairment could mean that a company is not making sound investment decisions in physical assets or that it could be paying more for an asset than it should.

Goodwill can represent a large part of a company's value or net worth. If a company doesn't test for goodwill impairment, it could overstate its value or net worth.

Since goodwill is an intangible asset, treating it like a normal asset and amortizing it does not give a clear picture as to the value of the asset. It needs to be tested for impairment once a year.

The FASB’s new goodwill impairment testing guidance—ASU 2017-04, required for public SEC filers for periods beginning after December 15, 2019—while intended as a simplification, could result in less precise goodwill impairments for reporting entities.

Early and ongoing cross-functional coordination between accounting, valuation and tax professionals is critical to effectively navigating financial reporting complexities of the goodwill impairment model.

Companies should take a fresh look at existing processes and controls for assessing asset impairment, as proper identification of triggering events is integral to appropriately measuring goodwill impairment.

Why it matters

The revised guidance simplifies the goodwill impairment test to address concerns related to the existing test’s cost and complexity by eliminating Step 2 (see diagram) of the current goodwill impairment test. Step 2 requires a hypothetical purchase price allocation to measure the amount of a goodwill impairment. Upon adoption of the revised guidance, a goodwill impairment loss will be measured as the amount by which a reporting unit’s carrying amount exceeds its fair value, not to exceed the carrying amount of goodwill.

While the approach for measuring the amount of goodwill impairment has been simplified, there are nuances in how the revised impairment guidance will interact with the subsequent measurement of other assets (not goodwill) governed by other accounting standards. These complexities will be important for management and stakeholders to understand when adopting and applying the revised guidance.

Avoiding potential impairment testing problems

The revised goodwill impairment model does not change the sequencing of impairment testing for assets (or asset groups) held and used or held for sale. As with the existing model, getting the sequencing right can help avoid potential errors in assessing impairment. For example, for assets that are held and used, other assets (e.g. inventory, financial assets, etc.) and long-lived assets are assessed for impairment prior to testing goodwill.

The impairment models for assets other than goodwill may not require an impairment charge to be recognized under certain circumstances, even when the fair value is less than carrying value. As the new single-step approach for assessing goodwill impairment compares the fair value and carrying value of the entire reporting unit, the goodwill impairment charge (if any) may capture fair value declines, below their carrying values, for non-goodwill assets.

Consider the example of a company that has long-lived assets that are recoverable under ASC 360-10: Property, Plant and Equipment—but the fair value of its fixed assets or finite-lived intangible assets have fallen below their carrying amounts. Under the new guidance, the goodwill impairment charge would capture the decline in fair value of the long-lived assets. Additionally, recognition of the impairment of the long-lived asset that contributed to the goodwill impairment may occur at a later date. Without the more involved calculation that would have been performed when applying Step 2 (i.e., the implied fair value of goodwill is no longer calculated), there is a higher potential for a less precise amount of goodwill impairment.

Another example often seen is with companies that hold significant portfolios of financial assets which are carried at amortized cost. In rising interest rate environments, the fair value of these financial assets will often be significantly less than the carrying value, which consequently could lead to the impairment of goodwill to reflect the decrease in the fair value of the reporting unit.

Alternatively, when there is unrecognized appreciation in the fair value of other recognized or unrecognized assets in the reporting unit, the amount of the goodwill impairment charge will be less than under the current guidance.

Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually recognized and separately identified.

It is recorded and recognizes in the balance sheet as long-term assets when a company purchases another company and owning more than 50% of shares.

How to perform an impairment test for goodwill?

  • Assess qualitative factors such as increased costs, deterioration of macroeconomic conditions, declining cash flows, change in management, possible bankruptcy. Such factors help to review if further impairment testing is needed to be carried out.
  • Compare the fair value of the unit to it carrying amount and include goodwill in the carrying amount as well. If the fair value is greater than the carrying amount, then there is no impairment loss.
  • Calculate impairment loss as to the difference of carrying amount is greater than the fair value but limited to the value of carrying amount of goodwill.

Stage 1: Preliminary qualitative assessment:

The company must ensure whether the goodwill reflecting in the books would exceed its fair market value. It is to be checked on the basis of macroeconomic developments, political and legal changes, the existence of current competitors, management, and the structure of the company.

If this assessment shows that the goodwill in the balance sheet will not exceed its fair market value, then no further testing is required. But if it exceeds, then the preliminary qualitative assessment is required.

Stage 2: Quantitative assessment:

It consists of calculating the fair value of the reporting unit on which goodwill is based and then comparing the fair value with the book value of goodwill shown in the balance sheet. The company must calculate the relative impact of all factors that may materially affect the value of goodwill.

If this assessment reveals goodwill does not exceed the fair value, then the company must proceed to the next stage of the quantitative assessment.

Stage3: Quantitative assessment:

The company checks the value of individual assets and liabilities of the entity to find its fair value. On the basis of this analysis, if the company determines the goodwill to exceed the fair value, then excess goodwill is treated as an impairment to goodwill. This value is ultimately shown as an impairment loss in the books of accounts.

Journal entry for impairment of goodwill:

Proportionate goodwill and impairment review:

When goodwill has been calculated on a proportionate basis, it is necessary to gross up goodwill to carry the impairment test. Any impairment loss that arises is first allocated against the recognized and unrecognized goodwill in the normal proportion that the parent and its non-controlled entity share profits and losses.

Any amount which has been written off against the goodwill in the books will not affect the consolidated financial statements and the branch entity.

If the total impairment loss is more than the amount allocated against recognized and goodwill of books, the excess goodwill be allocated against any other assets on a pro-rata basis. This loss will be shared between the parent and non-controlling entity in the normal proportion of their usual sharing of profits and losses.

Gross goodwill and impairment review:

When goodwill has been calculated in gross, any impairment loss will be allocated between the parent and NCI in the normal proportion of their profit and loss sharing ratio.

Example of impairment review of proportionate goodwill:

The year-end impairment review is being conducted on a 65% owned subsidiary. At the date of the review, the carrying amount of assets of the subsidiary was 200 million, and goodwill attributable to the parent was 250 million, and the recovery amount of the subsidiary was 400 million.

Now it is necessary to gross up the goodwill so

Gross goodwill= 250*100/65=384.62 million

Now for the purpose of impairment review, the goodwill of 384.62 million and net assets of 200 million form the carrying amount of cash-generating unit.

The impairment loss, in this case, is less than the total of recognized and unrecognized goodwill, so in this case, goodwill is only impaired, not other assets.

Only the parent’s share of goodwill impairment loss will be recorded, i.e.65% of 184.62 million=120.003 million.

Impairment review of gross goodwill:

Example:

At the year-end impairment, a review is conducted on a 70% owned subsidiary. The carrying amount of net assets was 600 million and gross goodwill of 450 million out of which (60 million allocated to NCI) and the recoverable value of the subsidiary as 700 million.

The impairment review of goodwill is actually the impairment review of goodwill and net assets of NCI as a Cash generating unit for which we can calculate the recoverable value.

Carrying amount:

This impairment loss will be used to write down the value of goodwill so that goodwill will appear in books at 450-350=100 million

In the PL statement, an impairment loss of 350 million will be charged as an extra-operating expense.

Goodwill Impairment it is a deduction from the earnings that companies record on their income statement after identifying that the acquired asset associated with the goodwill has not performed financially as expected at the time of its acquisition.

US GAAP requires a goodwill Impairment Test wherein the balance sheet goodwill should be valued at-least-once annually to check if the balance sheet value is greater than the market value and if there is any resulting impairment. It should be written off as impairment charges in the Income Statement.

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Goodwill Impairment Formula

Common Methods of Goodwill Impairment Test

Goodwill can be affected by events like the deterioration of the economic condition, change in government policies or regulatory norms, competition in the market, etc. These events have a direct impact on the business and hence can affect the goodwill. The need for the goodwill impairment test is when any such events have an effect on the goodwill.

The two common methods are as below:

  • #1 – Income Approach – Estimated future cash flows are discounted to a single current value.
  • #2 – Market Approach – Examining the assets and liabilities of companies who are a part of the same industry.

Steps for Goodwill Impairment Test

Goodwill impairment testing is a multi-step process; it requires an assessment of the current situation, identification of the impairment, and calculation of the impairment. It is further explained below:

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1. Assessment of the Current Situation

The current condition of the acquired business needs to be assessed to understand whether impairment testing is needed. As mentioned above, events like a change in government policies, change in management, or fall in the share price, possible bankruptcy would trigger deterioration of the financial condition. A company is required to assess the fair value of the company or the reporting unit in the first half of a fiscal year as to whether or not an adjustment for impairment needs to be recorded.

2. Identification of the Impairment

3. Calculation of the Impairment

By comparing the current fair market value of the reporting unit to the carrying amount, if the carrying amount is greater, this would be the impairment that needs to be calculated. The maximum impairment value will be the carrying amount, as it cannot exceed this value.

Examples Of Goodwill Impairment Test

Example 1

A simple example would be of you buying a vintage bike. You buy it reading all the reviews on the internet regarding the brand and the model, and you are convinced in buying it at a rate that is higher than its actual value owing to its popularity among the masses. After a year or so, you realize the cost involved in maintaining the bike is far more than that what you spend on the fuel. That’s when you realize that the bike is not performing as per the expectation that was set at the time of purchase.

Similarly, companies are required to conduct an impairment test annually with respect to the goodwill of an acquired company.

Example 2

XYZ Inc. acquires the assets of ABC Inc. for $15 million; its assets were valued at $10 million, and goodwill of $5 million was recorded on its balance sheet. A year later, XYZ Inc. assesses and tests its assets for impairment and concludes that ABC Inc.’s revenue has been declining remarkably. Due to this, the current value of company ABC Inc.’s assets has gone down from $10 million to $7 million, thereby resulting in an impairment to the assets of $3 million. Eventually, the value of the asset of goodwill drops down from $5 million to $2 million.

Let’s see how impairment impact is recorded on the income statement, balance sheet, and cash flow statement.

Balance Sheet

Goodwill reduces from $5 million to $2 million.

Income Statement

An impairment charge of $3 million is recorded, which reflects a reduction in the net earnings by $3 million.

Cash Flow Statement

Important Points to Note

  • The assets should go undergo a thorough assessment to identify the fair market value before impairment testing.
  • If the assessment identifies impairment, the impairment charge should be entirely written off as a loss on the income statement.
  • The difference between the recorded value (historical value) and the current fair market value must be recorded as a loss on the income statementIncome StatementThe income statement is one of the company’s financial reports that summarizes all of the company’s revenues and expenses over time in order to determine the company’s profit or loss and measure its business activity over time based on user requirements.read more . Impairment cannot be recorded as a negative value.

Conclusion

  • The goodwill impairment test is an annual exercise that companies need to perform to eliminate worthless goodwill.
  • It is trigger by both internal and external factors like change in management, the decrease in share price, regulatory change, etc.

Recommended Articles

This article has been a guide to what is Goodwill Impairment and its definition. Here we discuss the steps to test goodwill for impairment along with its formula and practical examples. You can learn more about financing from the following articles –

Impairments are recorded similarly for both individual assets and Cash Generating Units (CGU). However, CGU impairment accounting includes an additional initial step, reducing any Goodwill associated with the CGU, first. Both IFRS (IAS 36) and ASPE (ASPE 3063) have similar guidelines for booking impairments.

Step 1: Cash Generating Unit Only

1. First, any goodwill which had been allocated to the CGU is written down.

2. The remainder of the loss is written down, pro-rata, based on each asset’s carrying amount. However, no individual asset can be written down below the highest of:

Fair Value less disposal costs,

The remaining losses are accounted for, pro-rata, using the table in Step 2, below.

Step 2: Individual Assets and CGUs

Individual assets do not have Goodwill associated with them, so step 1, from above, is skipped, and we start with the table, below. For CGUs with Goodwill associated with them, this will be Step 2.

If no revaluation had previously occurred

The entity can choose between the two options below, where the impairment loss is taken to Accumulated Depreciation.

P/L = Profit Loss section of the Income Statement. The Impairment loss will be considered an Expense in the P/L section.

Some entities choose the second approach because they need to disclose impairment losses in their notes. Having a separate account helps to keep track of the individual impairment losses. However, despite it being in a separate account, impairment should always be netted from the Asset amount on the Balance Sheet, similarly to how Accumulated Depreciation is treated.

If revaluation had previously occurred

Step 1: The impairment is considered as a revaluation loss, and the Revaluation Surplus is reversed.

This action empties out the Revaluation Surplus balance that was created earlier.

Step 2: If the Impairment Loss is greater than the revaluation surplus or this is the second impairment, we create a loss directly in the Profit and Loss section of the Income Statement.

P/L = Profit Loss section of the Income Statement. The Impairment loss will be considered an Expense in the P/L section.

The combined effect would be:

OCI = Other Comprehensive Income in the Income Statement. If you recall from our article on PPE Revaluations, Revaluation Surpluses are recorded in the Other Comprehensive Income section of the Income Statement.

This process may seem complicated at first, but the idea is fairly straightforward. It is very similar to revaluations, where first the initial action is reversed (ie: the creation of a Revaluation Surplus is reversed and the Revaluation Surplus is removed). Then, if there is more impairment or if this is the second impairment, the remainder is treated as a Loss and immediately recorded as an expense in the Profit/Loss section of the Income Statement.

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ACCOUNTING STANDARDS UPDATE NO. 2017-04, INTANGIBLES—GOODWILL AND OTHER (TOPIC 350): SIMPLIFYING THE TEST FOR GOODWILL IMPAIRMENT

Overview

On January 26, 2017, the FASB issued Accounting Standards Update No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The new guidance requires only a one-step quantitative impairment test, whereby a goodwill impairment loss will be measured as the excess of a reporting unit’s carrying amount over its fair value (not to exceed the total goodwill allocated to that reporting unit). It eliminates Step 2 of the current two-step goodwill impairment test, under which a goodwill impairment loss is measured by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill.

  1. Retains the optional qualitative assessment (Step 0) of goodwill impairment.
  2. Applies the same one-step impairment test to all reporting units, including those with zero or negative carrying amounts, and requires disclosure of the amount of goodwill allocated to reporting units with zero or negative carrying amounts.
  3. Provides guidance on issues related to income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. This guidance also is incorporated into the private company accounting alternative for goodwill.

Effective Dates

An entity should apply the amendments in this Update on a prospective basis. An entity is required to disclose the nature of and reason for the change in accounting principle upon transition. That disclosure should be provided in the first annual period and in the interim period within the first annual period when the entity initially adopts the amendments in this Update.

A public business entity that is a U.S. Securities and Exchange Commission (SEC) filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019.

A public business entity that is not an SEC filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2020.

All other entities, including not-for-profit entities, that are adopting the amendments in this Update should do so for their annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2021.

Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.

What Organizations Are Affected by the New Guidance in The Update?

The amendments in this Update are required for public business entities and other entities that have goodwill reported in their financial statements and have not elected the private company alternative for the subsequent measurement of goodwill. Private companies that have adopted the private company alternative for goodwill but not the private company alternative to subsume certain intangible assets into goodwill are permitted, but not required, to adopt the amendments in this Update without having to justify preferability of the accounting change if it is adopted on or before the effective date. Private companies that have adopted the private company alternative to subsume certain intangible assets into goodwill, and, thus, also adopted the goodwill alternative, are not permitted to adopt this guidance upon issuance without following the guidance in Topic 250, Accounting Changes and Error Corrections, including justifying why it is preferable to change their accounting policies.

Additional Information

  • Download the Accounting Standards Update

Have A Question?

Submit questions about the new requirements using our Technical Inquiry System.

Accounting for goodwill is normally applicable for Group Company where the parent company has bought or acquired its subsidiaries’ shares. There is specific formula for goodwill calculation. Before understanding how to account for goodwill and the subsequent impairment recognition, let’s understand the key definition of goodwill first. So what is Goodwill?

Definition

We commonly call goodwill as value or reputation of a business or entity. The value of such kind of goodwill might be considerable. However, each entity does not usually value and record this goodwill in the accounts of a business at all and they normally shall not present such kind of goodwill in the Balance Sheet or Statement of Financial Position of a business.

Only the goodwill arising from the business combination or acquisition shall be accounted for in the Financial Statements.

In accordance with IFRS 3, Goodwill is defined as follow:

Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized”.

So from above definition, it is clear that the goodwill arises from the business combination. So what is business combination? And when we consider business combination incurred?

An entity considers an event or transaction as business combination when the assets acquired and liabilities assumed constitute a business. This means that such asset acquisition is for business purpose. For instance to gain market shares or to enter into a new market through such acquisition.

Calculation and Accounting for Goodwill

In order to account for goodwill, an entity shall first identify the business combination by applying the acquisition method. The identification of business combination through the acquisition method requires such entity to know the following information:

First, we need to identify the acquirer. Who acquires or purchase shares of a business and gain the control over such entity. Secondly, we need to identify the acquisition date. The date at which the parent company gain control as result of such acquisition.

Then, we shall need to recognize and measure the identifiable assets that they acquired and any liabilities that they assumed as well as any non-controlling interest where such acquisition or gaining control is not 100% of shares of targeted entity that they acquired.

Finally, we shall recognize and measure the goodwill or gain from such bargain purchase or acquisition.

So at this stage, if the consideration transferred exceed the fair value of the identified assets, we commonly call such difference as Goodwill. However, if it is less than the fair value of the identified assets, we consider such difference as Negative goodwill instead.

How to account for goodwill impairment

Below is the basic formula for Goodwill calculation as result of business combination:

The above formula is is for basic calculation of goodwill. In a complex group company where there are deferred consideration or contingent liability, such formula for goodwill calculation will change a little bit to include the deferred consideration or contingent liability.

Recognition of Goodwill

An entity recognizes as Goodwill as a result of business combination when the fair value of the assets acquired exceed the consideration transfer as mentioned above.

After a parent or a group of company have calculated Goodwill, the group shall initially measure and recognize such Goodwill at its cost. The cost at which the excessing of the cost or consideration transferred of the combination over the acquirer’s interest in the net fair value of the acquiree’s identifiable assets, liabilities and any contingent liabilities.

After the initial recognition, the Goodwill shall need to be subsequently recognized at its costs less any accumulated impairment losses. An entity shall not recognize any amortization of goodwill arising from the business combination. Instead, the group company shall perform test of impairment on annual basis on such goodwill and recognize the impairment accordingly in the income statement or profit and loss account as result of such impairment testing.

Example of Goodwill Calculation

ABC Co acquired the ordinary shares of D Co on 31 January 2019 for a consideration transferred of US$80,000. The financial statements at the date of the acquisition of each company are as follow:

Calculate the Goodwill as result of the acquisition

From the example above, we can summary as follow:

Consideration transferred = US$90,000

Net asset represented by:

Ordinary shares = US$50,000

Retained earnings = US$20,000

How to account for goodwill impairment

Thus, the goodwill will be as follow:

Therefore, the goodwill arising from the acquisition is US$20,000.

Suppose further that at the end of 31 December 2019, the goodwill has been tested for impairment. As result, the carrying value of goodwill as of 31 December 2019 is only US$18,000.

Therefore, ABC Co shall recognize the impairment of goodwill in the financial statement by reducing from US$20,000 at the date of acquisition to only US$18,000 subsequently as at 31 December 2019.

The journal entries of the impairment are as follow:

Dr. Group Retained earnings US$2,000

Cr. Goodwill US$2,000

Thus, the group shall record or show the impairment of US$2,000 as a reduction in group retained earning and the group shall record and present the reduction in goodwill as a reduction of carrying amount of goodwill. Therefore, the carrying amount of US$18,000 will be shown in the Consolidated Balance Sheet or Consolidated Statement of Financial Position.

Conclusion

Only goodwill arising from the business combination or acquisition shall be accounted for in the Financial Statements. At initial recognition, the goodwill shall be recognized at its cost and subsequently shall be recognized at the costs less accumulated impairment as per the annual impairment valuation or testing.