Goodwill impairment

As you probably know, Goodwill is typically established on your balance sheet as a result of paying above fair market value for an asset, whether it be the acquisition of stock, or even an asset acquisition from a competitor for example.

If you paid $3 million for assets from a competitor (to essentially buy them out of the business, for example), and the FMV of those assets were $2 million, then the entry (simplified of course) to book the purchase, assuming a cash purchase, would be as follows:

DR Fixed Assets 2,000,000
DR Goodwill 1,000,000
CR Cash 3,000,000

The key piece of information to know -- and retain -- at the time of purchase is this: how did you determine that these assets, only worth $2,000,000 on the open market, were worth more than that to you? Undoubtedly you all had a reason for paying more, likely due to synergies you believed would occur as a result of the purchase. If you have documentation that explains the rationale of the purchase price, then use of that same model or rationale, plugging in ACTUAL financial outcomes so far resulting from the acquisition in place of the expected financial outcomes should result in a higher or lower implied purchase price for the assets. If now, by plugging in actual results and updating future expected results, the purchase price should have been lower, then you must impair Goodwill by that difference (entry would be DR Impairment Expense, CR Goodwill). If, when you plug in actual results so far along with updating your new future expectations of asset performance, you find the purchase price could have even been higher and still achieved the return you were expecting, then no goodwill impairment should occur.

As another commenter (Scott Lane) mentioned, the most common model used to value such a purchase would be a discounted cash flow approach, such as an NPV model. If such a model was created to determine/justify the purchase price originally, then that same model should be used, with updated figures/assumptions, to determine whether the value of the assets has decreased, or has increased.

Often times, the issue of impairment is tied to the IP of the target. I don't advocate methods of making the testing more complex than necessary. The more visability the value associated with the goodwill is shown, the easier it is too provide the basis for analysis. For example, software is a common enough acquisition target and often is integrated into a hardware solution (as in robotics or GPS units) or as part of an existing software package (Oracle and Hyperion). Using Oracle above, as long as sales of the Hyperion product can be traced through the financials and explained to the ABV firm the shorter and less cost intensive the impairment study will be. I have dealt with this issue specifically and the approach is sound reasonable judgement by the harshest of standards.

The reality to the user is that the audit firm and ABV firm specializing in valuation studies will square off and duke out their assumptions.