Impairment Testing: Goodwill (ASC 350), Long-Lived Assets (ASC 360), and How It Works

Why Impairment Testing Exists

GAAP records assets at historical cost and depreciated/amortised over time. But sometimes the economic value of an asset falls below its carrying value due to factors not reflected in scheduled depreciation — a business unit underperforms, competitive conditions deteriorate, or an acquisition turns out to be worth less than what was paid. Impairment testing ensures the balance sheet does not overstate asset values, preserving the qualitative characteristic of faithful representation in financial reporting.

Goodwill — the excess of acquisition price over fair value of net identifiable assets acquired — is particularly important because it is not amortised under US GAAP, making it vulnerable to accumulating overstatement over time. See the full background on goodwill and business combinations.

Goodwill Impairment: ASC 350

Goodwill must be tested for impairment at least annually, and more frequently if events or changes in circumstances indicate it might be impaired. Goodwill is assigned to reporting units — operating segments or one level below — which are the units being tested.

The current standard (simplified by ASU 2017-04) uses a single-step quantitative test: compare the fair value of the reporting unit to its carrying value (including goodwill). If fair value exceeds carrying value — no impairment. If carrying value exceeds fair value — impairment charge equals the difference, capped at the carrying amount of goodwill in that reporting unit. The old two-step test that required calculating implied goodwill was eliminated.

The Qualitative Assessment (Step Zero)

Before performing the quantitative test, companies may perform a qualitative assessment — also called the "Step Zero" evaluation. This asks: considering all relevant factors, is it more likely than not that the fair value of the reporting unit is less than its carrying amount? If the answer is no (i.e., fair value probably exceeds carrying value), the entity can skip the quantitative test for that year. This option reduces the cost of impairment testing for reporting units that are clearly not at risk.

Factors considered in the qualitative assessment include: macroeconomic conditions, industry and market conditions, overall financial performance of the reporting unit, changes in management or key personnel, changes in the company's share price, and relevant entity-specific events like restructurings or disposals.

The Quantitative Impairment Test

When the quantitative test is required (either because the qualitative threshold was not met or the entity chose to skip the qualitative step), the reporting unit's fair value must be estimated. Fair value is typically determined using discounted cash flow analysis, market multiples from comparable companies, or a combination. The inputs — discount rates, growth rates, terminal value assumptions — involve significant estimation and are the most heavily audited elements of the impairment analysis.

Long-Lived Asset Impairment: ASC 360

Long-lived assets held and used (property, plant and equipment, finite-lived intangibles) are tested for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable — this is a triggering event model, not an annual test. Common triggering events: significant decline in market value, major adverse changes in the business or legal environment, accumulation of costs significantly in excess of amounts originally expected, or a current period operating or cash flow loss combined with a history of losses.

The Two-Step ASC 360 Test

Step 1 — Recoverability test: Is the carrying amount recoverable? Compare carrying amount to the sum of the undiscounted expected future cash flows from the asset. If undiscounted cash flows exceed carrying amount — no impairment. If carrying amount exceeds undiscounted cash flows — proceed to step 2.

Step 2 — Measurement: Measure the impairment loss. Impairment = carrying amount minus fair value. Note the switch: step 1 uses undiscounted cash flows; step 2 uses fair value. This two-step structure means an asset can pass step 1 (undiscounted cash flows are positive) even while its fair value is below carrying value — impairment is only triggered when the cash flows are insufficient to recover the carrying amount.

Indefinite-Lived Intangibles

Intangible assets with indefinite useful lives (certain trade names, licences, in-process research) follow the same model as goodwill under ASC 350: tested annually or when triggering events occur, with a qualitative option (Step Zero) and quantitative measurement (fair value versus carrying amount). Unlike goodwill, indefinite-lived intangibles can be tested individually without assigning them to a reporting unit.

Why US GAAP Does Not Allow Reversals

Once an impairment charge is recognised under US GAAP, it establishes a new cost basis — it cannot be reversed even if the asset subsequently recovers value. This is a major difference from IFRS, which does allow impairment reversals (except for goodwill) when conditions improve. US GAAP's conservative one-way-door approach reflects the view that impairments represent a permanent loss of value, not a temporary fluctuation. This difference is explored in the IFRS vs GAAP comparison.