Effect of Revenue Declines on Goodwill Impairment Testing

Revenue declines often signal a period of caution, causing organizations to prioritize agility and adaptability to quickly respond to evolving market conditions and capitalize on new channels for growth.

It is essential to consider the effects of these revenue declines and changing market conditions on goodwill.

What is goodwill?

Goodwill is defined as an intangible asset that represents the excess purchase price of a company over the fair value of its identifiable tangible and intangible assets.

It is essentially a premium paid by the acquiring company to the company being acquired and is listed as an intangible asset on a company’s balance sheet because it represents factors like reputation, workforce, and brand value.

How do declines in revenue affect goodwill?

When a company’s revenue declines, the fair value of the reporting unit may also decline and as a result, fall below its carrying value – and thus, organizations will have to conduct goodwill impairment testing to evaluate whether or not the goodwill will need to be adjusted.

Today’s macroeconomic environment may also indicate declining reporting unit fair values, especially if these revenue declines suggest a deterioration in business fundamentals.

Goodwill Impairment Testing: Tips & Key Considerations

Goodwill impairment testing is required annually by the FASB – however, companies should conduct these evaluations on an ongoing basis to identify any triggering events and put processes into place to mitigate their effects.

In addition, impacts to goodwill can cause significant delays during an audit, as the auditor will need to closely review all the inputs and assumptions used in the goodwill impairment testing and the company must ensure they properly adjust their balance sheet and financial reporting processes well ahead of an auditor’s review.

To establish goodwill impairment testing success, companies should:

• Monitor revenue trends and seek to understand the reasons behind the decline.
• Develop realistic forecasts for future cash flows that consider the impacts of revenue declines on profitability and long-term growth initiatives.
• Assess market conditions and consider factors such as changes in consumer behavior, market competition, emerging technologies, and laws and regulations.
• Conduct comparative analysis on the unit experiencing revenue declines to see if the decline is specific to that unit or signals a larger, industry-wide issue.
• Evaluate triggering events on an ongoing basis to see if there will be future impacts to goodwill impairment testing.

Final Thoughts on Revenue Declines & Goodwill Impairment Testing

If you have had revenue declines, it is important to address the non-cash impact of the decline as well as market conditions in an efficient and audit-friendly manner.