Goodwill Impairment (ASC 350): A Clear and Concise Guide

Goodwill is an intangible asset that arises when a company acquires another business for a price higher than the fair value of its net assets. While goodwill is not amortized, it must be tested for impairment to ensure it remains accurately reported on financial statements. This whitepaper provides an overview of goodwill impairment under ASC 350, making the topic accessible to those new to the subject.

What is Goodwill Impairment?

Goodwill impairment occurs when the carrying value of goodwill exceeds its fair value, meaning the asset is no longer worth what is recorded on the balance sheet. This reduction in value must be recognized as an expense on the income statement.

Key Concepts in Goodwill Impairment Testing

1. Impairment Indicators

ASC 350 requires companies to assess whether there are indicators of impairment, such as:

• A decline in the company’s stock price
• Deterioration in financial performance
• Significant adverse changes in the industry or economy
• Loss of key customers or contracts
• Changes in management or strategic direction

2. The Impairment Testing Process

Under ASC 350, goodwill impairment testing follows these steps:

Step 1: Identify the Reporting Unit

A reporting unit is the level at which goodwill is tested, typically a business segment or subsidiary that generates independent cash flows.

Step 2: Perform the Fair Value Test

Companies must compare the carrying value of the reporting unit (including goodwill) with its fair value. If the carrying value exceeds the fair value, an impairment loss is recognized for the difference.

• • Prior to ASU 2017-04, companies used a two-step test:
    1. Compare carrying value to fair value.
    2. If impaired, determine the implied fair value of goodwill by allocating fair value to assets and liabilities.

• • After ASU 2017-04, companies use a simplified one-step test:

• • 1. If the carrying amount exceeds fair value, record an impairment charge for the difference immediately.

Private Company Alternative

Private companies can elect an accounting alternative (ASU 2014-02) and only test for goodwill impairment when a triggering event occurs, rather than annually.

3. Recognizing and Reporting Impairment

If impairment is identified:

• The loss is recorded as an expense on the income statement, reducing net income.
• The balance sheet reflects the reduced goodwill amount, providing a more accurate representation of the company's financial health.

Practical Implications of Goodwill Impairment

Goodwill impairment can have significant financial and operational consequences, including:

• Lower reported earnings, which may impact investor perception and stock price.
• Potential breaches of loan covenants if financial ratios are affected.
• Tax implications, as impairment losses may affect deferred tax assets.
• Impact on executive compensation, especially if earnings-based performance metrics are used.
• Strategic considerations for M&A, as impairment charges could influence valuations.

How to Mitigate the Risk of Goodwill Impairment

• Conduct regular internal financial reviews to detect early warning signs.
• Maintain realistic projections for future cash flows.
• Reassess goodwill value when market conditions change significantly.
• Diversify revenue streams to reduce reliance on specific segments.

Conclusion

Understanding goodwill impairment under ASC 350 is essential for financial professionals and business leaders to ensure accurate financial reporting. By proactively monitoring impairment indicators and following a structured testing process, companies can maintain transparency and compliance with accounting standards.

For further guidance on goodwill impairment or valuation support contact info@houlihancapital.com