How do you test goodwill for impairment under current accounting standards?

Full Explanation

Goodwill impairment testing is required annually under both IFRS (IAS 36) and US GAAP (ASC 350), and whenever there are indicators that the carrying amount may not be recoverable. The process differs slightly between the two frameworks, but the objective is the same: ensure that goodwill on the balance sheet is not overstated.

Under IFRS, goodwill is allocated to cash-generating units (CGUs) or groups of CGUs that are expected to benefit from the acquisition synergies. The recoverable amount of each CGU is determined as the higher of its fair value less costs of disposal and its value-in-use (the present value of expected future cash flows from the CGU). If the carrying amount exceeds the recoverable amount, an impairment loss is recognised — first reducing goodwill, then reducing other assets of the CGU proportionally. Critically, goodwill impairment under IFRS cannot be reversed in subsequent periods.

Under US GAAP (post-ASU 2017-04, simplified), entities can optionally perform a qualitative assessment first — evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the qualitative assessment indicates potential impairment, or if the entity skips the qualitative step, a quantitative test compares the reporting unit's fair value to its carrying amount. Goodwill impairment equals the excess of carrying amount over fair value, capped at the amount of goodwill allocated to that reporting unit.

Key inputs requiring significant judgement include: discount rates (typically WACC adjusted for the CGU's specific risk), long-term growth rates (usually not exceeding the economy's long-term growth rate), and revenue and margin projections. Auditors pay close attention to these assumptions, and regulators have flagged goodwill impairment testing as a common area of financial reporting deficiency.

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