How does goodwill impairment work under the acquisition method?

Goodwill impairment is a critical topic under the acquisition method. Here's a comprehensive breakdown:

How Goodwill Arises:

When Ridgemont Financial acquires 100% of Thornbury Wealth for $85 million, and the fair value of Thornbury's net identifiable assets is $62 million:

• Goodwill = $85M - $62M = $23 million

Impairment Testing (IFRS vs. US GAAP):

Under US GAAP (simplified one-step test):

1. Compare the fair value of the reporting unit to its carrying amount (including goodwill)
2. If fair value < carrying amount, recognize an impairment loss equal to the difference
3. The loss cannot exceed the carrying amount of goodwill allocated to that unit

Example:

Ridgemont's Thornbury reporting unit has:

• Carrying amount of net assets (excluding goodwill): $58M
• Goodwill: $23M
• Total carrying amount: $81M
• Fair value of reporting unit: $72M

Impairment loss = $81M - $72M = $9 million

Financial Statement Effects:

• Income statement: Impairment loss of $9M reduces operating income (typically shown as a separate line item)
• Balance sheet: Goodwill drops from $23M to $14M
• Cash flow statement: No cash impact — the impairment is added back in CFO under indirect method
• Ratios: Debt/equity increases (equity decreases), ROA may actually improve (lower asset base)

Under IFRS, the process allocates goodwill to CGUs and compares the recoverable amount (higher of value-in-use and fair value less costs of disposal) to the carrying amount.

Exam tip: Watch for questions asking how impairment affects return ratios. Since both the numerator (income) and denominator (assets) decrease, the long-term effect on ROA can be counterintuitive.

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