Goodwill Impairment Testing under IFRS

8.4 Goodwill Impairment Testing under IFRS

Goodwill impairment testing is a critical component of financial reporting under the International Financial Reporting Standards (IFRS). This section provides a comprehensive overview of the goodwill impairment testing process, focusing on IFRS standards, particularly IAS 36 – Impairment of Assets. Understanding this process is essential for preparing consolidated financial statements and is a key area of focus for Canadian accounting exams.

Understanding Goodwill

Goodwill arises in business combinations when the purchase price exceeds the fair value of identifiable net assets acquired. It represents intangible assets such as brand reputation, customer relationships, and intellectual property that are not separately identifiable. Goodwill is not amortized but is subject to annual impairment testing to ensure its carrying value does not exceed its recoverable amount.

IFRS Standards for Goodwill Impairment

Under IFRS, goodwill impairment testing is governed by IAS 36, which outlines the procedures for identifying and measuring impairment losses. The standard requires entities to test goodwill for impairment at least annually and whenever there is an indication that goodwill may be impaired.

Key Concepts in Goodwill Impairment Testing

Cash-Generating Units (CGUs)

Goodwill must be allocated to one or more cash-generating units (CGUs) or groups of CGUs that are expected to benefit from the synergies of the business combination. A CGU is the smallest identifiable group of assets that generates cash inflows largely independent of other assets or groups of assets.

Recoverable Amount

The recoverable amount of a CGU is the higher of its fair value less costs of disposal and its value in use. Determining the recoverable amount is crucial in assessing whether an impairment loss has occurred.

Impairment Loss

An impairment loss is recognized if the carrying amount of the CGU, including goodwill, exceeds its recoverable amount. The impairment loss is allocated first to reduce the carrying amount of any goodwill allocated to the CGU, and then to the other assets of the CGU on a pro-rata basis.

Steps in Goodwill Impairment Testing

Step 1: Identify CGUs

Identify the CGUs to which goodwill has been allocated. This involves understanding the structure of the business and the cash flows generated by different segments.

Step 2: Determine the Recoverable Amount

Calculate the recoverable amount of each CGU. This involves estimating the fair value less costs of disposal and the value in use.

• Fair Value Less Costs of Disposal: This is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, minus the costs of disposal.

• Value in Use: This is the present value of the future cash flows expected to be derived from the asset or CGU. It involves estimating future cash flows and applying an appropriate discount rate.

Step 3: Compare Carrying Amount and Recoverable Amount

Compare the carrying amount of the CGU, including goodwill, with its recoverable amount. If the carrying amount exceeds the recoverable amount, an impairment loss is recognized.

Step 4: Recognize and Allocate Impairment Loss

If an impairment loss is identified, allocate it first to reduce the carrying amount of goodwill. Any remaining loss is allocated to other assets in the CGU on a pro-rata basis.

Step 5: Disclosures

Disclose information about the impairment testing process, including the assumptions used in determining the recoverable amount, the amount of impairment loss, and the impact on financial statements.

Practical Example of Goodwill Impairment Testing

Consider a company, ABC Corp, which acquired a subsidiary, XYZ Ltd, for $10 million. The fair value of XYZ Ltd’s identifiable net assets was $8 million, resulting in $2 million of goodwill. ABC Corp allocates this goodwill to a CGU that includes XYZ Ltd.

Step 1: Identify CGUs

ABC Corp identifies the CGU as the operations of XYZ Ltd, which generates cash inflows independent of other segments.

Step 2: Determine the Recoverable Amount

ABC Corp estimates the fair value less costs of disposal of the CGU at $9 million and the value in use at $9.5 million. The recoverable amount is the higher of these two values, which is $9.5 million.

Step 3: Compare Carrying Amount and Recoverable Amount

The carrying amount of the CGU, including goodwill, is $10 million. Since the recoverable amount ($9.5 million) is less than the carrying amount, an impairment loss is recognized.

Step 4: Recognize and Allocate Impairment Loss

The impairment loss is $0.5 million ($10 million - $9.5 million). This loss is allocated to reduce the carrying amount of goodwill from $2 million to $1.5 million.

Step 5: Disclosures

ABC Corp discloses the impairment loss of $0.5 million, the assumptions used in estimating the recoverable amount, and the impact on the financial statements.

Challenges in Goodwill Impairment Testing

1. Estimating Future Cash Flows: Accurate estimation of future cash flows is challenging due to uncertainties in market conditions and business performance.

2. Determining Discount Rates: Selecting an appropriate discount rate requires judgment and can significantly impact the value in use calculation.

3. Identifying CGUs: Determining the appropriate level at which goodwill is tested for impairment can be complex, especially in diversified businesses.

4. Market Volatility: Fluctuations in market conditions can affect the fair value less costs of disposal, leading to variability in impairment testing results.

Best Practices for Goodwill Impairment Testing

• Regular Review: Conduct regular reviews of assumptions and estimates used in impairment testing to ensure they remain relevant and accurate.

• Documentation: Maintain thorough documentation of the impairment testing process, including assumptions, calculations, and judgments made.

• Sensitivity Analysis: Perform sensitivity analysis to understand the impact of changes in key assumptions on the recoverable amount.

• Engage Experts: Consider engaging valuation experts to assist in complex impairment testing scenarios.

Regulatory Considerations

Under IFRS, entities must comply with the disclosure requirements outlined in IAS 36, including providing detailed information about the impairment testing process, assumptions used, and the impact on financial statements. Compliance with these requirements is essential for transparent and accurate financial reporting.

Conclusion

Goodwill impairment testing under IFRS is a critical process that ensures the carrying value of goodwill reflects its recoverable amount. By following the steps outlined in this section and adhering to best practices, you can effectively conduct impairment testing and ensure compliance with IFRS standards. Understanding this process is essential for preparing consolidated financial statements and is a key area of focus for Canadian accounting exams.

Ready to Test Your Knowledge?