Goodwill is not subject to amortization. Instead, companies must conduct periodic impairment testing. The amount of goodwill that a company maintains on its books as an asset must be tested at least annually to see if it has been impaired (though more frequent testing is needed if adverse events arise). If so, any impaired goodwill must be charged to expense in the current reporting period. How?
This post provides a simple and easy guideline on how to test goodwill impairment, determining gain/loss impairment and charging it to the company’s goodwill asset to expense in the current period. Enjoy!
Cash Generating Unit and Its Criterion
For the purpose of impairment testing, goodwill acquired in a business combination should, from the acquisition date, be allocated to each of the acquirer’s cash generating units, or groups of cash-generating units, that are expected to benefit from the synergies of the combination (irrespective of whether other assets or liabilities of the acquiree are assigned to those units).
A cash-generating unit is the smallest level of identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. Each cash-generating unit [or groups of cash-generating units], to which goodwill is allocated and tested for impairment should:
- Represent the lowest level within the entity at which the goodwill is monitored for internal management purposes; and
- Not be larger than an operating segment determined in accordance with IFRS
3 Steps For Goodwill Impairment Testing
Three steps are required for goodwill impairment testing:
Step-1. Determine the recoverable amount of a cash-generating unit which is the higher of the cash generating unit’s fair value less costs to sell (net selling price) and its value in use, which is the present value of the estimated future cash flows expected to be derived from the cash-generating unit.
Step-2. Compare the recoverable amount of the cash generating unit to its carrying value.
Note: If the recoverable value exceeds the carrying value, then there is no goodwill impairment, and the third testing step is not required.
Step-3. Allocate the recoverable value of the cash-generating unit as of the testing date to its assets (including intangible assets) and liabilities, with the remainder (if any) being assigned to goodwill. If the amount of goodwill resulting from this calculation is less than the carrying amount of goodwill, then the difference is impaired goodwill and must be charged to expense in the current period.
IAS 36 has imposed a requirement that reversals may not be recognized for previous write-downs in goodwill. Conversely, a later recovery in value of the cash generating unit will be allocated to assets other than goodwill.
Example Of Goodwill Impairment Testing
The Canadian Consulting Company acquired the Dharma Consulting Company (Dharma) and operates it as a cash-generating unit. For the most recent year of operations, Dharma had annual revenues of $900,000 and carrying values of assets and liabilities that are:
net of bad debts 250,000
Equipment, net of-
Intangible assets 135,000
Current liabilities (110,000)
Long-term debt (390,000)
In order to determine the fair (recoverable) value of Dharma, Canadian locates several companies whose operations are similar to those of Dharma. The management of Canadian believes that the recoverable value of Dharma is $720,000 (the greater of the net selling price of $720,000 and the present value of estimated future cash flows of $711,000) and so uses this amount in this assessment:
Recoverable value of the-
Dharma cash-generating unit $720,000
Carrying amount of cash-generating unit,
including goodwill 774,000
Recoverable value above or-
below carrying value $(54,000)
Dharma’s carrying amount exceeds its recoverable value, so additional testing is required to determine the extent of goodwill impairment.
To do so, Canadian Consulting’s accounting staff compares the carrying value of the cash-generating unit and fair value of Dharma’s assets and liabilities [note: excluding goodwill] in the next table to compute the implied value of goodwill and the extent of goodwill impairment.
Carrying value Fair value
Cash $32,000 $32,000
net of bad debts 250,000 230,000
Inventory 15,000 10,000
net of depreciation 190,000 200,000
Intangible assets 135,000 100,000
Goodwill 652,000 —-
Current liabilities (110,000) (110,000)
Long-term debt (390,000) (370,000)
Totals $774,000 $ 92,000
Recoverable value Of Dharma
cash-generating unit $720,000
Implied fair value of goodwill 628,000
Carrying value of goodwill 652,000
Impairment loss $(24,000)
Based on this analysis, goodwill impairment loss is $24,000 and Dharma must charge $24,000 of its goodwill asset to expense in the current period.
A company can select any date for impairment testing, but once selected, the same date must be used every year. The aggregate amount of goodwill impairment losses should be reported as a separate line item in the operating section of the income statement.