Goodwill impairment is goodwill that is now lower in value than at the time of purchase. Goodwill is an intangible asset that sellers are willing to pay for; brand, reputation, a large customer base, strong customer service, and important patents all increase a company’s goodwill. Many contrary factors contribute to impairment of goodwill such as negative publicity from high-ranking company officials, unpopular changes in product line, or a decrease in customer loyalty or brand recognition.
Let’s say there is a athletic clothing company called Freeform. Freeform has $20,000,000 in annual sales and a reported Goodwill value of $10,000,000 due to an exceptional product, consistent customer service, and a loyal fan base. The following year a larger athletic company called AltaCorp purchases Freeform for $30,000,000 (combining the sales and Goodwill values).
Unfortunately, after the purchase is complete, sales fall 50% the consecutive year. AltaCorp’s CEO was removed for disparaging comments made towards his female customers. Furthermore, Adidas unfolds a new campaign targeting young women and gains a cult following that competes with Freeform’s largest customer base. Because of the drop in sales and the AltaCorp’s reputation, as well as the increase of competition in the marketplace, Freeform’s fair market value drops to $15,000,000. Now, the company is worth less than AltaCorp paid for it. So the Goodwill must be reduced, which reduces the overall Total Assets. This is a significant hit to AltaCorp as Goodwill can represent a large portion of the company’s net worth.
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It is important to note that Goodwill Impairment is relative and can be difficult to calculate; in most cases, it’s in the eye of the buyer. Test Goodwill annually against the fair value to manage a buyer or seller’s expectations if the company is undergoing business valuation.
Goodwill impairment gained wider attention in the 21st century after many companies discovered they had unrealistically increased their goodwill. Thus creating an inaccurate valuation of their company. As a result, stricter accounting standards exist to monitor and calculate goodwill.