What is Impairment Testing for Goodwill?
Goodwill impairment of a company happens when the recognised goodwill, which is related to certain acquisition exceeds the implied fair value. In business combinations, where the acquirer obtains control of another organisation (the acquiree), it is common to see goodwill as a by-product. If the acquirer pays the acquiree a higher purchase price when compared to the fair value of the acquiree’s identifiable assets, then there is goodwill. After the acquirer has recorded the goodwill as its asset initially, it must conduct impairment testing on the goodwill regularly.
If you are confused by the concept of goodwill impairment testing, you should consider hiring an accounting firm in Johor Bahru to help you in acquisition if necessary.
Goodwill Impairment Testing
To test the goodwill of a company to see whether there is any possible impairment, you should follow the steps below:
Evaluate qualitative elements
You should assess the condition of the company and determine whether you need to perform impairment testing. However, according to the research of related situations and events, the probability that an impairment has happened is more than 50%. Those situations and events that have caused impairment include possible bankruptcy, reducing cash flow, higher costs, a continuous decline in the price of the company’s share, an adjustment in the management, as well as the deterioration of macroeconomics conditions. If the chance of impairment (Also see Impairment versus Depreciation of Fixed Assets) to occur is high, you should keep performing impairment testings. Otherwise, you may skip this procedure and conduct the next procedure straight away.
Determine potential impairment
You should compare the carrying amount of a acquiree’s assets and its fair value. Keep in mind that you must consider goodwill in the acquiree’s assets’ carrying amount and include any significant intangible assets that the company has not recognised. If the carrying amount is lower than the fair value of a acquiree’s assets, goodwill impairment did not take place, and therefore, you do not have to take the succeeding step. However, if the acquiree’s assets’ carrying amount is higher than its fair value, then you should move to the succeeding procedure for the calculation of impairment loss.
Calculate impairment loss
In this process, you need to make comparisons between the carrying amount of goodwill related to that acquiree’s assets and its implied fair value. If the former has a higher value than that of the latter, you should recognise that impairment loss by using the sum of the difference and record in the general ledgers using double entry posting. The maximum impairment loss can only be the whole carrying amount.
If you want to work out the fair value of the company’s goodwill, you should allocate the acquiree’s assets’ fair value to all relevant liabilities and assets. If there is any excess amount, that sum is the implied fair value of goodwill. We may assume that the acquiree’s assets’ fair value is the price that the company will obtain if it sells the acquiree’s assets in an orderly transaction in the market. To quote a acquiree’s assets’ market price, you may use other acceptable methods, for example, valuation according to multiples of revenue.
A company should perform impairment testing once a year. You may do so at any point of a year, given that you will conduct the test at the same time as the following year. If your company has different acquirees, you don’t need to do impairment testing on them simultaneously. If an event which may cause the acquiree’s assets’ fair value to fall lower than its carrying amount happens, then you may need to perform the tests more frequently. Some of the events that trigger this to happen include the loss of crucial staff, regulatory changes, a lawsuit, or the company is expected to sell a acquiree’s assets (Also see Liquidation Value).
To carry out impairment testing, the information you need may be rather comprehensive. If you want to improve the effectiveness of the process of impairment testings, bringing this information forward to the following year is acceptable if you meet the requirements below:
– The liabilities and assets that make up a acquiree’s assets have not experienced any substantial change.
– In the previous impairment test, the fair value exceeds the carrying amount greatly.
– There is a low possibility for the fair value to fall below the carrying amount.