How does goodwill impairment work for an equity-method investment?

Under the equity method, goodwill is NOT impairment-tested separately. Instead, the entire investment carrying value is tested for impairment whenever there is a triggering event suggesting the carrying value may not be recoverable. This is sometimes called the "other-than-temporary impairment" or OTTI framework.

The test:

The investor compares:

• Carrying value of the investment (which includes the embedded goodwill, fair-value step-ups, and share of investee earnings)

versus

• Fair value of the investment (estimated from market price if available, or DCF / multiples if not)

If carrying value > fair value AND the impairment is judged "other than temporary," the investor writes down the investment to fair value and recognises the loss in earnings.

Triggering events:

• Significant decline in investee's share price (if publicly traded)
• Adverse changes in investee's industry or legal environment
• Investee operating losses or negative cash flows
• Investee creditworthiness deterioration
• Inability of investee to continue as a going concern
• Litigation against investee

"Other than temporary" judgment:

This is the controversial part. A short-term market dip is "temporary" and not impaired. A sustained decline due to deteriorating fundamentals is "other than temporary" and IS impaired.

The judgment is investor-management's — guided by:

• Severity: how big is the gap? 10% may be temporary; 50% may not be.
• Duration: how long has the gap persisted? 1 quarter may be temporary; 4 quarters less so.
• Cause: market-wide selloff vs. company-specific bad news.
• Recovery prospect: management's ability and intent to hold until recovery.

Compare to full-consolidation goodwill:

Under full consolidation (ASC 350), goodwill is allocated to a reporting unit and tested for impairment annually, regardless of whether there's a triggering event. The test:

• Step 0: qualitative assessment (optional). Is it "more likely than not" that the goodwill is impaired?
• Step 1: compare reporting-unit carrying value to fair value
• Step 2: if step 1 indicates impairment, write down goodwill to its implied fair value (US GAAP simplified test removed step 2 in 2017)

This is much more frequent than the equity-method's "only when triggered" test.

No reversal:

Once you write down an equity-method investment for OTTI, you CANNOT reverse the impairment later if the investee recovers. This is asymmetric — losses go through earnings, but gains are not recognised until you sell.

(Under IFRS, equity-method impairment CAN be reversed under certain conditions, which creates a US GAAP vs IFRS difference that occasionally appears on CFA exams.)

Real-world example:

In 2008, Berkshire Hathaway held a large equity-method investment in Burlington Northern. The investment carrying value was higher than fair value during the financial crisis. Berkshire did not recognise impairment because management judged the decline temporary and intended to hold. By 2010, Berkshire had moved to full consolidation by buying out the remainder. Had Berkshire been required to mark to fair value mid-crisis, billions of paper losses would have hit earnings.

Exam framing:

CFA Level II tests this in a vignette where the question gives you the investment carrying value, the fair value, and management's assessment of permanence. You decide whether to write down and by how much. Show your work — partial credit is available.