Goodwill Impairment: Is Your Company at Risk?

Goodwill impairment is often a red flag, signaling that a business acquisition has failed to meet management’s expectations. It may reveal underlying challenges, from market volatility to operational inefficiencies, that can erode a company’s financial health. With uncertain economic landscapes, persistent inflation, and rising interest rates, goodwill impairments are steadily becoming a focal point for businesses and investors alike.

But how do you assess whether your business might be at risk? And what can you do to manage goodwill impairment effectively? This blog explores the trends, accounting nuances, and proactive steps every business owner, finance professional, and investor should know.

Evaluating Goodwill Impairment Trends

Goodwill impairments have become a significant issue over the past few years, reflecting shifting market dynamics. Take a look at the recent data:

• 2022: 400 U.S. public companies reported $136.2 billion in pretax goodwill impairments.
• 2023: 353 U.S. public companies reported an estimated $82.9 billion in impairment, down 39% from 2022 but still far above the historical average since 2006.

The trend seems to be holding in 2024. For example, Walgreens reported a staggering $12.4 billion pretax goodwill impairment in Q1 2024, partly due to its acquisition of VillageMD. Economic uncertainty suggests other companies may face similar write-downs as the year progresses.

It’s also important to note that these figures largely exclude private companies, whose financial reporting isn’t publicly available. Given the typical lag in financial reporting between public and private sectors, the actual scope of goodwill impairment may be even broader.

What is Goodwill, and Why Does it Matter?

Before unpacking goodwill impairment, it’s crucial to understand what goodwill represents on a company’s financial statements. Goodwill is an intangible asset recorded when a business is purchased for more than the fair value of its identifiable net assets (tangible assets, intangible assets, and liabilities). It reflects the premium paid for a company’s brand reputation, customer relationships, or other unquantifiable advantages.

Key Features of Goodwill:

1. Indefinite Life: Unlike tangible assets, goodwill doesn’t depreciate over time. However, its value can diminish if the business underperforms.
2. Financial Reporting: Management and stakeholders rely on goodwill figures to gauge the long-term success of acquisitions.
3. Vulnerability to Impairment: If the value of goodwill falls below its carrying amount, the company must recognize an impairment loss, which directly impacts earnings.

Goodwill is more than just a number on a balance sheet—it’s a lens through which you can evaluate the success of a business combination over time.

Accounting for Goodwill Impairment

Under U.S. Generally Accepted Accounting Principles (GAAP), companies must test goodwill annually for impairment. Additionally, businesses must assess goodwill whenever a “triggering event” occurs that could diminish its value.

For Public Companies:

• Goodwill must be tested for impairment in at least one annual cycle.
• The value of goodwill is written down if it falls below cost during the testing process.
• Impairment loss is recorded on the income statement, reducing reported profits.

For Private Companies:

Private entities can elect to simplify goodwill accounting under Accounting Standards Update No. 2014-02. The key differences include:

• Goodwill can be amortized over a period of up to 10 years.
• Impairment tests are only required following significant triggering events rather than annually.

Not all private businesses adopt these simplified practices. Larger private companies, especially those considering a public offering, often choose to follow public company regulations for consistency and credibility.

What Triggers Goodwill Impairment?

Both internal and external factors can diminish the value of goodwill. These include:

• Economic Pressures: Market downturns, inflation, or rising interest rates.
• Industry Disruptions: New competitors or changes in regulations.
• Operational Challenges: Leadership changes, lawsuits, or loss of major clients.
• Cash Flow Problems: Negative or declining operating cash flows.

For example, after an acquisition, if an economic downturn causes the parent company to lose substantial value, this could result in goodwill impairment.

Implications of Goodwill Gone Bad

For public companies, goodwill impairments can send shockwaves through the market. A single impairing event can affect earnings reports, shareholder confidence, and the company’s stock price. Meanwhile, private companies might experience funding challenges and strained relationships with lenders if goodwill impairment signals instability.

Proactively monitoring and reporting goodwill is key—especially for private businesses that often defer impairment evaluations until the end of their accounting periods.

Minimizing Your Risk of Goodwill Impairment

Goodwill impairment doesn’t have to be a ticking time bomb. Here are some steps your business can take to stay ahead:

Conduct Ongoing Impairment Tests

Impairment testing doesn’t have to feel like a burden. By staying vigilant and conducting periodic tests—even if not required—you minimize surprises. Align your testing process with your company’s strategic goals.

Perform Comprehensive Due Diligence

If you’re planning an acquisition, due diligence is non-negotiable. Analyze the target’s financial health, industry position, and growth potential. An overvalued purchase price is often at the heart of significant future write-downs.

Monitor External Factors

Pay close attention to market trends, competitor activity, and economic indicators that could impact goodwill values. Regularly assess potential triggering events within your industry.

Engage Financial Advisors

Goodwill impairment calculations often involve complex modeling and forecasts. Partnering with experienced advisors can help you interpret results and maintain transparent reporting for stakeholders.

Your Partner in Goodwill Management

Goodwill impairment is a critical financial metric that deserves your attention—not just during audits, but throughout your company’s growth trajectory. Whether you’re monitoring existing goodwill, preparing for acquisitions, or aiming for transparent reporting, SD Mayer & Associates is here to guide you.

With our expertise in financial strategy, risk management, and accounting standards, we help businesses like yours safeguard their financial health. Don’t leave goodwill impairment to chance. Contact us today to ensure your company stays ahead of the curve.