Definition of Goodwill Impairment Test
Goodwill is an intangible asset for a business organization which is recorded in balance sheet only in case it is acquired by paying the money where the value of the goodwill is to be verified on an annual basis in order to measure whether the organization is able to generate the required cash flows or not and this whole process of testing the value of goodwill is termed as goodwill impairment test.
Explanation
Goodwill is the benefit which the company is enjoying in the market over others. As per generally accepted accounting procedures, self-generated goodwill is not to be recognized in accounts; only the purchased goodwill is to be recognized in the accounts. The value of goodwill is to be tested so as to verify whether the company is enjoying the benefits and able to generate the cash flows from the goodwill and also to verify whether there is any decline in the valuation of goodwill and this testing procedure is called as goodwill impairment test which is to be done on a regular interval generally annually or at any time when the organization feels that there is a decline in the value of goodwill. Goodwill is said to be impaired when the carrying value of goodwill is greater than goodwill’s fair value.
Steps of Goodwill Impairment Test
Following are the steps which are required for goodwill impairment testing:
1. Identify the Factors Which Involves Testing
First of all, the organization needs to access the factors which enforce the testing like the decline in share price, unfavourable cash flows, continuous losses, unfavourable market conditions, availability of substitutes, the decline in sales, increment in cost, unfavourable suit which results in heavy loss etc. all these are the pre determinants for impairment testing. The organization also needs to assess whether all these factors affect the valuation of goodwill; if the answer is positive, the organization needs to conduct the goodwill impairment test immediately.
2. Revaluation of Goodwill
After accessing the potential factors, the organization should re-value the valuation of goodwill by comparing the organisation’s value with the fair value. If the value of goodwill is more than the carrying value, then no revaluation is required, and if there is a decline in value, then goodwill is to be re-valued by proper accounting policies and procedures. For calculation of fair value, the market value of assets and liabilities is to be deducted from the market value of share capital. The balancing figure, if positive, is goodwill, which is to be compared with the carrying value of goodwill. There are also other scientific methods through which goodwill is to be calculated.
3. Calculation of Impairment Loss
If the value of goodwill is less than the carrying amount in the balance sheet and the value is positive, then the impairment loss is to be debited to profit and loss account, an impairment loss is a difference between the fair value of goodwill and the carrying value of goodwill, and if the fair value of the organization is less than the carrying value of an organization that means there is no goodwill at all, the whole carrying value of goodwill is to be debited to profit and loss account as an impairment loss.
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Example of Goodwill Impairment Test
Following are the examples of the Goodwill Impairment Test:
XYZ Inc. purchased CMN Inc. for the value of $ 150 million when the net asset value of CMN Inc. was $ 120 Million, i.e., XYZ Inc. paid $ 30 Million for the goodwill and accordingly, XYZ Inc. recognized $ 30 Million as goodwill valuation in the balance sheet. After 1-year, XYZ Inc. conducted the Goodwill Impairment test as the company’s cash flows started to decline. XYZ Inc. found that the valuation of net assets acquired from CMN Inc. declined to $ 110 Million, and this resulted in an impairment of $ 10 Million. So the impairment is adjusted from the goodwill, and the goodwill is to be valued at $ 20 million and $ 10 Million is shown as an Impairment loss.
- Following is ABC Ltd’s Balance sheet
| Liabilities | Amount ($ in a million) | Assets | Amount ($ in a million) |
| Shareholders’ Funds | Fixed Assets | ||
| Share Capital | 1,500.00 | Plant and Machinery | 1,000.00 |
| Reserves and Surplus | 500 | Immovable Property | 800 |
| Loans and Borrowings | Intangible assets | ||
| Mortgage Loan | 140 | Goodwill | 200 |
| Unsecured Loan | 10 | ||
| Current Liabilities | Investments | ||
| Trade Payables | 15 | Investment in shares | 10 |
| Outstanding expenses | 5 | ||
| Current Assets | |||
| Trade Receivables | 130 | ||
| Advances | 30 | ||
| Total | 2,170.00 | Total | 2,170.00 |
The Market Value of Net Assets is as under:
| Particulars | (Amount $ in Million) Fair Value |
| Plant and Machinery | 750 |
| Immovable Property | 900 |
| Investment in Shares | 12 |
| All other Assets and Liabilities at Book Value |
Conduct the Goodwill Impairment Test and Find out the re-valuation of Goodwill and Impairment loss, if any?
Solution:
Calculation of Carrying Value of Net Assets
| Particulars | Amount ($ in Million) |
| Total Assets | 2,170.00 |
| Less: Liabilities | |
| Mortgage Loan | (140.00) |
| Unsecured Loan | (10.00) |
| Trade Payables | (15.00) |
| Outstanding Expenses | (5.00) |
| Net Assets | 2,000.00 |
Calculation of Fair Value of Net Assets
| Particulars | Amount ($ in Million) |
| Plant and Machinery | 750 |
| Immovable Property | 900 |
| Investment in shares | 12 |
| Trade Receivables | 130 |
| Advances | 30 |
| Goodwill | 200 |
| Less: Liabilities | |
| Mortgage Loan | -140 |
| Unsecured Loan | -10 |
| Trade Payables | -15 |
| Outstanding Exps | -5 |
| Net Assets | 1,852.00 |
Impairment of Assets is calculated as
- Impairment of Assets = $2000 Million – $1852 Million
- Impairment of Assets = $148 Million
Goodwill is said to be impaired.
- Revaluation of Goodwill = 200 – 148
- Revaluation of Goodwill = $ 52 Million
Impairment Loss is calculated as
- Impairment Loss = $200 Million – $52 Million
- Impairment Loss = $148 Million
Goodwill Impairment Test under US GAAP
According to US GAAP testing procedure of goodwill impairment is as under:
- If the Carrying Value of Assets, including goodwill, is more than the Fair value of assets, then there is impairment of Assets which is to be allocated to Goodwill, i.e. impairment of assets is to be reduced from carrying value of Goodwill.
- Under the second method, the fair value of tangible assets and identifiable intangibles must be determined and reduced from the carrying value of assets without goodwill. The fair value is to be reduced from the carrying value, and the carrying amount is the value of goodwill which is to be compared with the carrying value of goodwill, and if the value determined is less than the carrying value, then goodwill is said to be impaired and to be revalued accordingly.
Conclusion
The goodwill impairment test is one of the procedures to determine whether the value which reflects in the balance sheet as goodwill is carrying the fair value or not. There are many scientific and recognized methods to determine the fair value of goodwill, but the most commonly used method is to compare the carrying amount of assets, including goodwill, with the fair value of assets and if carrying value is more than the impairment of an asset is to be reduced from goodwill valuation and accordingly the impairment loss is to be debited to profit and loss account.
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