Understanding Goodwill Impairment: When and How to Test for Impairment under GAAP

When is a goodwill impairment loss recognized?

After only definitive quantitative assessments of the fair value of goodwill is completed.

A goodwill impairment loss is recognized when the carrying amount of a reporting unit’s goodwill exceeds its implied fair value. According to GAAP (Generally Accepted Accounting Principles), a reporting unit is the smallest identifiable segment of a company that generates revenue and in which separate, discrete financial information is prepared and regularly reviewed by management.

Goodwill impairment testing is typically done annually or when a triggering event occurs, such as a significant change in the business environment, legal or regulatory changes, macroeconomic conditions, industry-specific factors, or a decline in stock price.

The first step in the impairment analysis is to compare the carrying amount of the reporting unit’s net assets including goodwill to its fair value. If the fair value exceeds the carrying amount, goodwill is not impaired. However, if the carrying amount exceeds its fair value, an impairment loss must be recognized.

The second step is to determine the implied fair value of the goodwill, which is the fair value of the reporting unit’s net assets, excluding goodwill, compared to the fair value of the reporting unit as a whole. If the implied fair value of the goodwill is less than its carrying amount, an impairment loss must be recognized for the difference.

The impairment loss is recognized as an expense on the income statement and reduces the carrying amount of the goodwill. It cannot be reversed in subsequent periods. Goodwill is tested for impairment at the reporting unit level, and any impairment loss is attributed to the reporting unit’s goodwill.

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