What CFOs Should Know When Preparing For Goodwill Impairment

May 15, 2023

Recession fears and Fed rate hikes continue to dominate business news headlines. CFOs are examining their companies’ financial positions and seeking to fortify their balance sheets. Acquisitive companies will need to take a closer look at goodwill this year for potential goodwill impairment. Here is what CFOs should know about goodwill impairment:

FASB Overview

In 2009, the Financial Accounting Standards Board (FASB) released the Accounting Standards Codification (ASC) as the single source of authoritative nongovernmental U.S. generally accepted accounting principles (GAAP). ASC 350, Intangibles – Goodwill and Other provides guidance on financial accounting and reporting related to goodwill and intangible assets acquired in a business combination or in an acquisition by a not-for-profit entity. 

What is Goodwill? How do I Get It?

What is goodwill and how does a company go about obtaining it? FASB states that goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized. In other words, goodwill is a premium paid above the identifiable assets, both visible and invisible, in an acquisition. 

Companies obtain goodwill via an acquisition at a premium to its identifiable assets. Goodwill is created over time through sustained profitable financial operations. Most financially healthy companies have internally generated goodwill; you just don’t see it on the balance sheet because it is not recognized under GAAP. Internally generated goodwill only comes to the surface during an acquisition when an acquirer proves it exists by paying for it. If it is not paid for, it does not exist in the world of GAAP. In summary, goodwill represents a future cash payment to the seller and a future cash generation stream to the buyer. 

Got Goodwill?

Let’s use an example. You’ve acquired Company ABC in 2022 and paid $1 million for the entire company. You’ve identified $500,000 in physical tangible assets and property. You’ve also hired a 3rd party specialist, like Adamy Valuation, to determine that there was approximately $400,000 in identifiable intangible assets. This leaves $100,000 in purchase consideration to be assigned. After further review, no other identifiable assets were noted and goodwill of $100,000 was booked on your balance sheet. 

The year has passed and now it is 2023 year-end. Company ABC has not performed to your expectations, interest rates have risen, and your investment isn’t looking very promising. Your auditor has requested you analyze the $100,000 goodwill asset for impairment due to a possible triggering event. Impairment is synonymous with loss of value. Effectively, it is now a question of whether the $100,000 goodwill asset is worth what you paid for it. 

Test Time

Accounting Alternatives

A private company/not-for-profit (NFP) entity may make an accounting policy election for the following accounting alternatives related to goodwill:

  • Amortize goodwill on a straight-line basis over ten years, or less than ten years if the company demonstrates that another useful life is more appropriate; and
  • Evaluate goodwill impairment triggering events as of the end of a reporting period (whether interim or annual) rather than throughout the reporting period.

Impairment Testing Procedures

  1. An entity may first assess qualitative factors to determine whether it is necessary to perform the quantitative goodwill impairment test. The qualitative test can be skipped any time.
  2. An entity then assesses qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of goodwill is less than its carrying amount (what you paid or $100,000 in the example).
  3. If the answer is “not more likely than not”, you are done! If the answer is “more likely than not”, proceed to the quantitative test.
  4. An entity should consult with a 3rd party specialist to determine the appropriate valuation method for the quantitative impairment test. This analysis to determine the fair value of goodwill can be complicated and requires extensive business valuation knowledge.

Why You Should Hire Adamy

Here are some of the top reasons you should hire a reputable 3rd party business valuation specialist:

  • Extensive knowledge of relevant FASB guidance which ensures compliance with GAAP
  • Experience and know-how regarding complex financial modeling techniques that would be difficult to perform internally
  • Creates a smooth and seamless audit experience for the most complicated accounting topics
  • Allows management to focus on day-to-day operations while specialist handles the specific financial reporting matters creating internal efficiencies
  • Knowledge and technical expertise to assist management in all audit support exercises such as responding to detailed and complex audit questions
  • Access to costly subscription databases such as Standard and Poor’s Capital IQ, Business Valuation Resources (BVR), Kroll Cost of Capital Navigator, Economic Research Institute, IBIS World Industry Reports, GF Data, Risk Management Associate Studies (RMA), Crystal Ball and more

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