Goodwill is an intangible asset that arises when one entity acquires another entity and pays more than the fair value of the acquired entity’s net assets. Goodwill is typically assigned to a cash-generating unit (CGU), which is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.
Goodwill is required to be tested for impairment at least annually, or more frequently if there are indicators of impairment. The impairment test for goodwill involves comparing the carrying value of the goodwill to its recoverable amount. The recoverable amount is the higher of the goodwill’s fair value less costs to sell and its value in use.
The value in use of goodwill is the present value of the future cash flows expected to be generated by the CGU to which the goodwill is assigned. The future cash flows should be based on the entity’s best estimate of the CGU’s future cash flows, taking into account the entity’s plans and assumptions about future market conditions, competition, and other factors. The future cash flows should be discounted at a rate that reflects the risks associated with the cash flows.
If the carrying value of the goodwill exceeds its recoverable amount, the goodwill is impaired and the entity must recognize an impairment loss. The impairment loss is the difference between the carrying value of the goodwill and its recoverable amount. The impairment loss should be recognized in the income statement as an expense, and the carrying value of the goodwill should be reduced to its recoverable amount.
For example, if an entity has goodwill with a carrying value of £500,000 assigned to a CGU, and the recoverable amount of the goodwill is determined to be £450,000, the goodwill is impaired and the entity must recognize an impairment loss of £50,000. The impairment loss of £50,000 would be recognized as an expense in the income statement, and the carrying value of the goodwill would be reduced to £450,000.
Goodwill relating to a foreign subsidiary would need to be re-translated at each year end, with the exchange gain/loss recognised in an FX equity reserve relating to the subsidiary.