What it calculates

Goodwill impairment testing asks whether the premium paid in an acquisition is still supported by the performance of the business acquired. Goodwill is not amortised, so this annual test is the only mechanism by which an overpayment eventually reaches the income statement.

How it is calculated

Goodwill is allocated to reporting units. Each unit's fair value, usually from a discounted cash flow or a market multiple, is compared with its carrying amount including goodwill. Under current United States GAAP the impairment is simply the excess of carrying amount over fair value, capped at the goodwill allocated to that unit. A qualitative assessment may be used first to determine whether the quantitative test is necessary at all.

How to read the result

The headroom - fair value less carrying amount - is what to monitor, not the impairment itself. A unit with thin headroom is one adverse assumption away from a charge, and the sensitivity disclosures in the notes tell you how thin. An impairment is non-cash and backward-looking, so the market usually knows before the write-down arrives, but it does confirm that the acquisition thesis has not held, and it often precedes a change in segment reporting or management.

Worked example

A reporting unit carries 500,000,000 of net assets including 180,000,000 of goodwill. A DCF puts its fair value at 430,000,000. The carrying amount exceeds fair value by 70,000,000, which is less than the goodwill balance, so a 70,000,000 impairment is recognised and goodwill falls to 110,000,000.

Common questions

Can goodwill impairment be reversed later?

No. Under both United States GAAP and IFRS, an impairment of goodwill is permanent even if the business recovers fully. That asymmetry is deliberate: it prevents management from writing value back up on the strength of its own forecasts.

How often must the test be performed?

At least annually, at the same point each year, and immediately whenever a triggering event occurs - a sustained share price decline, loss of a major customer, a significant adverse regulatory change, or a plan to dispose of part of the unit.

Why do some companies amortise goodwill instead?

Private companies in the United States may elect to amortise goodwill over ten years or less, which reduces the cost and volatility of annual testing. Public companies must apply the impairment-only model, which is why large one-off write-downs are a public-company phenomenon.