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 considerationsgoodwill 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 23u s generally accepted accounting principles gaap require companies to review their goodwill for impairment at least annually at a reporting unit level 1 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 1example of goodwill impairmentperhaps the most famous goodwill impairment charge was the 54 2 billion reported in 2002 for the aol time warner inc merger 4 this was at the time the largest goodwill impairment loss ever reported by a company 5