Goodwill Impairment Test

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.

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.

Recommended Articles

This is a guide to Goodwill Impairment Test. Here we also discuss the definition and Goodwill Impairment Test under US GAAP along with an example. You may also have a look at the following articles to learn more –

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