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Year-End Alert: Goodwill Impairment Testing is More Critical Than Ever

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As we approach the close of the fiscal year, businesses should be honing in on a crucial aspect of their financial reporting: the health and accuracy of their balance sheets. An active M&A market in the last few years means goodwill and intangible assets continued to grow in importance, becoming even more significant figures in company financial statements. Goodwill does not merely showcase potential from past acquisitions—it is the crystallization of future growth expectations embedded in your financial narratives and quantitative representations. Revisiting these prior measurements is paramount in volatile and changing macro-environments.

 

Understanding the Imperative for Impairment Testing

Goodwill is the financial articulation of your past acquisition successes and a compass for future expectations. However, market volatility can influence premises used to formulate expectations making it essential to scrutinize these values. Goodwill impairment testing goes beyond regulatory compliance; it is a strategic tool for accurate financial representation and forward-looking business planning. This year, it’s not enough to just evaluate; it’s best to align your financial reporting with real-time economic conditions by reviewing prior expectations. Re-evaluating past acquisitions is integral to year-end planning and may impact financial reporting for year-end.

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    The Hard Facts: How Economic Changes Affect Asset Valuations

    A 2021 study by Duff & Phelps [Kroll] revealed that Goodwill Impairment Events were up 45% in 2021, with the total dollar figure doubling from the prior year. While COVID and other external shocks may have been to blame, 2022 saw additional increases. In the first half of 2022, the top 10 aggregate impairments almost tripled, as noted in Kroll research. Now, with financial conditions shifting further, expectations for 2023 look even less promising. While these are all non-cash expenses, possibly even leading to substantial tax-shields, they still have an impact on the perceived financial health of a company and may lead to scrutiny in their future results. This should be a serious call for accounting officers and their finance counterparts to be wary over timing, size, and nature of impairments.

     

    Impairment Testing: A Strategic Imperative

    The process of impairment testing marries historical financial decisions with current market realities, asking if past growth rates and cash flow assumptions are still defendable under new economic strains. This is not merely theoretical. The tangible impact of getting it wrong can mean a stark difference in the perceived financial health of your company. In an era in which a tech company’s entire value can pivot on the perception of its intangible assets, realistic valuations are not just a formality; they’re a necessity. These are exercises that help business units make better decisions, rehash their budgets, and better prepare operationally for these revised projections.

     

    Actionable Steps for Goodwill Impairment Testing

    To ensure your business’s goodwill and intangible assets are fairly represented, consider the following:

    1. Update Your Assumptions: Considering today’s conditions, revisit the assumptions underpinning your goodwill valuations. Reflect on the latest market indices, economic forecasts, and sector-specific trends to reassess the value of acquired goodwill and intangible assets.
    2. Employ Realistic Discount Rates: Utilize a revised discount rate that mirrors today’s economic climate. Employ the most recent tools or methodologies, such as the CAPM, to adjust discount rates that accurately reflect your cost of capital in the current market. Be sure to also look at outside benchmarking as well as debt costs as a compass for revised equity costs.
    3. Engage in Scenario Planning: Conduct comprehensive scenario analyses to anticipate the potential impact of varying economic conditions on your valuations. Contrast a conservative scenario against your base case to ensure preparedness for any eventuality.
    4. Consult with Valuation Experts: Goodwill impairment is intricate, and expert consultation is invaluable. Collaborate with specialists who have a demonstrable impact on enhancing the impairment process, as evidenced by their work in your industry, or given their exposure to a wide array of businesses outside of your immediate periphery.

     

    The Bottom Line: Proactive Goodwill and Intangible Asset Valuation

    As the fiscal year-end approaches, taking a proactive stance on goodwill and intangible asset valuation is more than a regulatory gesture—it’s a strategic imperative. The financial statement is not just a ledger but a narrative that communicates your company’s true value to stakeholders. This year-end, ensure that your financial statements do not merely present numbers but tell a story that aligns with reality, boosting stakeholder confidence in your company’s future.

    Remember, at Objective, we are committed to helping you conduct the most effective audit possible. Our goal is to reduce the stress typically associated with defending financial analyses, ensuring your company’s value is transparently and accurately communicated. Further, our goals are not only operational, as we see compliance-based analysis as the window into better strategic planning.

     

    Jordi Pujol - Objective-Team-Headshots

    Jordi Pujol, CFA

    Director, Valuation

    Jordi has 10+ years of financial modeling experience and has worked on a vast number of financial reporting engagements, tax opinions, and intangible asset valuations. 

     

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