The Comprehensive Guide to

Passive Income Investing


Learn the secrets of how Paul Tracy generates over $XXX,XXX per month in passive income!

How to Become Financially Independent Through Passive Income Investing

What is Goodwill Impairment?

Generally, a goodwill impairment occurs when a company A) pays more than book value for a set of assets (the difference is the goodwill), and B) must later adjust the book value of that goodwill.

How Does Goodwill Impairment Work?

Goodwill is an asset, but it does not amortize or depreciate like other assets. Instead, GAAP rules require companies to 'test' goodwill every year for impairments.

For example, let's assume that Company XYZ purchases Company ABC. The book value of Company ABC's assets is $10 million, but for various good reasons, Company XYZ pays $15 million for Company ABC. Because Company XYZ paid $15 million for $10 million worth of assets, Company XYZ records $5 million of goodwill as an asset on its balance sheet.

After the acquisition, Company ABC's sales fall by 40% over the year because Company XYZ changed its product line, which proved unpopular. Also, a competitor introduced a newer, lighter, faster, and cheaper product. As a result, Company ABC's fair market value falls to $8 million.

A year has now passed, and for Company XYZ, this means comparing the fair value of Company ABC to the book value on XYZ's financial statements. If the fair value of Company ABC is less than the book value (that is, if Company XYZ were to sell Company ABC today, it wouldn't get a price equal to or greater than its recorded value), Company XYZ must make a goodwill impairment.

In this example, Company XYZ would compare Company ABC's current fair market value of $8 million plus the $5 million of goodwill (a total of $13 million) to the $15 million it has recorded as Company ABC's value on its books. The difference between the two is $2 million, and Company XYZ must therefore reduce the goodwill on its books by that amount. The goodwill entry on its balance sheet goes from $5 million to $3 million, and its total assets fall correspondingly.

Why Does Goodwill Impairment Matter?

When a company records a goodwill impairment, it is telling the market that the value of the acquired assets has fallen below what the company generally paid for them.

Goodwill can represent a large amount of a company's net worth, and acquisitions (especially in the age of technology) often involve the purchase of things that by and large are intangible. But overinflating goodwill can mislead investors, and simply amortizing goodwill (which used to be the procedure) can also create artificial values for the asset. To find a more accurate value and therefore provide more meaningful and accurate financial statements, companies must therefore test their goodwill by comparing the actual value of the assets in question to their recorded value and adjusting for the difference every year.

Ask an Expert about Goodwill Impairment

All of our content is verified for accuracy by Paul Tracy and our team of certified financial experts. We pride ourselves on quality, research, and transparency, and we value your feedback. Below you'll find answers to some of the most common reader questions about Goodwill Impairment.

Be the first to ask a question

If you have a question about Goodwill Impairment, then please ask Paul.

Ask a question
Paul Tracy
Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.