Goodwill impairment is often a negative indicator. It potentially signals that a business combination failed to meet management’s expectations due to internal or external factors. In recent years, uncertain markets, lingering inflation and high interest rates have caused goodwill impairments to spike.
Evaluating impairment trends
In 2022, 400 U.S. public companies reported $136.2 billion of pretax goodwill impairments. In 2023, 353 U.S. public companies reported an estimated $82.9 billion of pretax goodwill impairments. While the estimated impairment losses fell by 39% from 2022 to 2023, the total is well above the historical average dating back to 2006.
The trend appears to be ongoing. In the first quarter of 2024, Walgreens reported a $12.4 billion pretax impairment loss related in part to its acquisition of VillageMD, a health care company. As market volatility continues, other companies may follow suit in fiscal year 2024.
This historical data excludes write-downs reported by private companies whose results aren’t publicly available. Plus, there’s often a lag in the effects of financial reporting on private businesses compared to their public counterparts.
Accounting for goodwill
Goodwill is reported on a company’s financial statements if it’s acquired through a merger or acquisition. The purchase price of a business is first allocated to the following items based on their fair values:
- Tangible assets,
- Identifiable intangible assets, and
- Liabilities obtained in the purchase.
What’s left over is reported as acquired goodwill (an indefinite-lived intangible asset). Goodwill must be monitored for impairment in accounting periods after the acquisition date. That happens when the fair value of goodwill falls below its cost. Impairment losses reduce the carrying value of goodwill on the balance sheet. They also lower profits reported on the income statement. Tracking the value of goodwill helps management and external stakeholders evaluate a business combination over the long run.
Estimating impairment losses
Under U.S. Generally Accepted Accounting Principles (GAAP), public companies that report goodwill on their balance sheets can’t amortize it. Instead, they must test goodwill at least annually for impairment. When impairment occurs, the company must write down the reported value of goodwill. Testing should also happen for all entities whenever a “triggering event” occurs that could lower the value of goodwill.
Private companies can elect certain practical expedients to simplify the subsequent accounting of goodwill and other intangibles. Specifically, Accounting Standards Update No. 2014-02, Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill, allows private companies that follow GAAP the option to amortize acquired goodwill over a useful life of up to 10 years. The test that private businesses must perform to determine goodwill impairment was also simplified in 2014. Instead of automatically testing every year, private companies must test for impairment only when there’s a triggering event.
However, not all private companies choose to adopt these expedients. For instance, large private companies that are considering a public offering may follow the rules for public companies. The decision depends on specific business circumstances.
Close-up on triggering events
All companies — whether publicly traded or closely held — must evaluate impairment when a triggering event happens. The source of these events may be internal or external. Examples include:
- An economic downturn,
- Unanticipated competition,
- A major cyberattack or lawsuit,
- Disruptive industry regulations,
- The loss of a key customer,
- Leadership changes, and
- Negative operating cash flows.
Goodwill impairment may also occur if, after an acquisition, an economic downturn causes the parent company to lose value.
Goodwill gone bad
Public companies must report financial results quarterly, so they’re continually monitoring for impairment. However, private businesses often postpone evaluating the effects of triggering events until the end of the accounting period. If your company reports goodwill on its balance sheet, contact us to evaluate your company’s current situation and ensure transparent reporting.
Additionally, if you’re contemplating a merger or acquisition, it’s important to determine whether the price is fair based on the target’s financial health, market position and potential for future growth. We can help you conduct comprehensive due diligence to reduce the risk of overpaying.
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