The recent drop in equity markets has created goodwill impairment triggering events for companies in many industries. Public companies with quarterly filing requirements typically assess, measure and book impairments throughout the year, but most private companies deal with any impairments at fiscal year-end, which for many is the same as calendar year-end.
As you prepare your year-end accounting checklist and begin checking off boxes, you need to consider if a goodwill impairment test should be among those items. The following FAQs can help you better understand what goodwill impairment means and how it may impact the value of your business:
In an acquisition, more often than not, goodwill is booked on the acquiring company’s balance sheet. As part of the opening balance sheet calculation, goodwill is calculated as the excess purchase price that was paid by the acquirer over and above the value of the identifiable tangible and intangible assets acquired. Goodwill is usually paid for by a buyer, and it represents future expected intangible assets that are not yet identifiable as of the date of acquisition.
For example, let’s say a company is acquired for $100 million , and it owns $10 million in accounts receivable, $10 million in property plant and equipment, and $20 million of identifiable intangible assets such as patents and customer relationships. The remaining $60 million ($100M-$10M-$10M-$20M=$60M) is implied future value that is expected to be developed down the road . This $60 million value would be the goodwill that would be booked by the acquirer as part of the purchase.
Because goodwill goes on the acquirer’s balance sheet as an asset, it must be tested for impairment anytime there is a triggering event. This is any event that may lead to the value of the goodwill being less than its current value on the company’s balance sheet. Under the conservatism principle of accounting, if an asset’s fair value is worth less today in an exit scenario than it is currently listed for on a company’s balance sheet, the company must calculate an impairment of that asset, including goodwill.
A goodwill impairment is an indication that the company purchased an asset in the past, and that asset is now worth less than its value on the company’s balance sheet. Goodwill impairments generally are not a good thing and often indicate a series of events that did not go as originally planned. That said , these unplanned events are not necessarily the fault of management and may be completely outside of management’s control — for example, changes in the company’s industry, technological advances in the market, overall equity market downturns, global pandemics and supply chain shortages, to name a few.
If you have goodwill on your books and a triggering event has occurred that could potentially affect your company, you need to assess whether there is a goodwill impairment. The first step is to perform a preliminary qualitative assessment, which evaluates goodwill based on economic conditions, market fluctuations, regulatory developments, internal structural shifts or other relevant changes.
If this qualitative evaluation determines that the carrying value (book value) of the company’s goodwill more likely than not exceeds its fair value, you must move on to quantitative testing. This in-depth quantitative evaluation is a very manual process that involves metrics and detailed analysis to determine the current fair value of the goodwill versus the carrying value the goodwill is currently listed for on the balance sheet.
If the quantitative test confirms that the current fair value of the goodwill is less than its carrying value, the goodwill is impaired, and the difference between the carrying value and fair value must be booked as an impairment.
Goodwill impairment is calculated as the difference between the fair value and carrying value of the goodwill, however, it is important to note that the impairment cannot exceed the carrying value. The value of the impairment then flows through to the company’s income statement as a loss, and technically it ultimately results in lower earnings. While company management or analysts may view this charge as one-time, non-recurring or extraordinary, the impairment loss does decrease the net income of the company. These lower earnings then flow back into the equity section of the balance sheet to reflect a lower book value of equity.
The market downturn, supply chain issues, the inflationary environment, interest rate hikes, currency-related challenges (particularly for U.S. domiciled companies with significant non-U.S. revenues), the war in Ukraine, as well as various other macroeconomic and industry-specific factors have had significant impacts on corporate profitability and increased the likelihood of triggering events that could lead to goodwill impairment. The COVID-19 pandemic was also a triggering event for many companies and, even as we move forward, it continues to impact businesses. These conditions led many companies to recognize goodwill impairments in 2022, and they will require continued assessment by management and ownership through year-end and the financial statement preparation process.
Per U.S. generally accepted accounting principles (GAAP) rules, companies must test for goodwill impairment when triggering events take place. Business owners who bought a company recently should also keep goodwill impairment on their radar because market conditions changed during this past year. And if you’re looking to sell your business and you see a potential goodwill impairment on the horizon, it’s important to take the time to perform an accurate valuation and determine the significance of a goodwill impairment on the overall value of your company.
For companies that fail their qualitative test and need a quantitative assessment, the first step is to hire a reputable valuation provider who can calculate the extent of the impairment, as well as support the analysis with valuation best practices and discuss such intelligently with auditors and other reviewers to ensure compliance every step of the way.
Have this year’s events triggered potential goodwill impairment for your company? Contact our valuation team to help you understand what that potential impairment may mean for your business as you prepare your 2022 financial statements and for 2023.
