The goodwill impairment test is one of the most consequential, and historically burdensome, requirements in financial reporting. When the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2017-04, it eliminated the second step of the goodwill impairment test and replaced the old two-step process with a single, more straightforward calculation. For companies that carry goodwill on their balance sheet after an acquisition, this change reduces complexity, lowers compliance costs, and delivers the information investors actually want: whether an impairment exists and how large it is.
This article answers one central question: how does the one-step goodwill impairment test work, and what does it mean for your company? Along the way it explains what goodwill impairment is, how the test functioned before the update, and how companies should approach testing today.
What is goodwill and why does it appear on the balance sheet?
Goodwill is an intangible asset that appears on a company’s balance sheet when it acquires another business for a price that exceeds the fair value of the target’s identifiable net assets. The premium reflects factors such as the acquired company’s brand reputation, customer relationships, proprietary technology, and competitive positioning in its market. Because this premium cannot be tied to any single tangible item, accounting standards treat it as a residual recorded at the acquisition date.
Unlike tangible assets such as equipment or real estate, goodwill cannot be sold independently or measured with precision after the acquisition closes. Under U.S. Generally Accepted Accounting Principles (GAAP), companies must evaluate whether the recorded value of goodwill on the balance sheet still reflects economic reality. When the fair value of a reporting unit falls below its carrying amount, the company records a goodwill impairment: a non-cash write-down that reduces the reported value of the asset.
Goodwill impairment write-offs matter to stakeholders because they often signal that an acquired business is not performing as expected. A large impairment charge can reduce reported earnings, affect loan covenants, and draw scrutiny from investors, analysts, and regulators. For acquisitive companies, getting the goodwill impairment test right is therefore both a compliance requirement and a credibility issue.
How the old two-step goodwill impairment test worked
Before ASU 2017-04 took effect, companies followed a two-step process to test for goodwill impairment under ASC 350, _Intangibles, Goodwill and Other_. The process was designed to first detect a potential impairment and then measure its precise amount.
Step 1 required the company to compare the fair value of each reporting unit to its carrying amount, including goodwill. If the carrying amount exceeded the fair value, the company moved to Step 2.
Step 2 required the company to calculate the “implied fair value” of goodwill by performing a hypothetical purchase price allocation. This meant assigning fair values to every identifiable asset and liability within the reporting unit, essentially re-running the acquisition accounting, and treating the remainder as the implied fair value of goodwill. The impairment loss was then measured as the difference between the implied fair value and the carrying amount of goodwill.
Companies complained for years that Step 2 was expensive and time-consuming. It required detailed valuations of individual assets that had no bearing on the fundamental question of whether goodwill was impaired. The FASB heard consistent feedback that investors cared far more about the existence and magnitude of an impairment than about the precision of the Step 2 calculation.
What changed under the one-step goodwill impairment test
FASB’s updated standard eliminates Step 2 entirely. Under the simplified one-step goodwill impairment test, the impairment loss equals the amount by which the reporting unit’s carrying amount exceeds its fair value, capped at the total amount of goodwill allocated to that reporting unit. The text of ASU 2017-04:%20SIMPLIFYING%20THE%20TEST%20FOR%20GOODWILL%20IMPAIRMENT) describes the change as measuring impairment directly rather than through a second comparison.
The formula is straightforward:
Goodwill impairment = Carrying amount of reporting unit − Fair value of reporting unit
_(limited to the carrying amount of goodwill)_
This means companies no longer need to perform a hypothetical purchase price allocation. Instead, the goodwill impairment test compares two numbers: the fair value of the reporting unit and its carrying amount. If carrying amount exceeds fair value, the excess is the impairment charge, up to the amount of recorded goodwill.
The one-step approach also removes the requirement to calculate the implied fair value of goodwill as a separate exercise. That eliminates the most complex and costly element of the old process while still producing a reliable measure of impairment. The change also applies to reporting units with zero or negative carrying amounts, with related disclosures required so that financial statement users understand where goodwill resides.
How to test for goodwill impairment under current rules
Companies subject to annual goodwill impairment testing should follow this sequence under the current standard. The first stage is optional, the second is the quantitative test that produces any impairment charge.
Optional qualitative assessment (Step 0). Before performing a quantitative goodwill impairment test, a company may elect to conduct a qualitative assessment, sometimes called “Step 0,” to determine whether it is more likely than not (greater than 50% probability) that the fair value of a reporting unit is less than its carrying amount. Factors to consider include macroeconomic conditions, industry and market conditions, cost factors, overall financial performance, and entity-specific events such as leadership changes or litigation.
If the qualitative assessment indicates that impairment is not more likely than not, no further testing is required. If it suggests impairment may exist, or if the company skips the qualitative step, the company proceeds to the quantitative test.
Quantitative one-step test. The company determines the fair value of the reporting unit using accepted valuation approaches, which typically include the income approach (discounted cash flow analysis), the market approach (comparable company or transaction multiples), or a combination of both. It then compares that fair value to the reporting unit’s carrying amount.
If the carrying amount exceeds fair value, the company records an impairment loss equal to the difference, limited to the total goodwill allocated to the reporting unit. The goodwill impairment journal entry debits an impairment loss on the income statement and credits goodwill on the balance sheet. Because valuation judgments drive the result, many companies engage outside specialists or coordinate the work with their audit and assurance services team to support the figures.
Goodwill amortization vs. impairment: the private company alternative
Private companies and not-for-profit entities have an additional option under ASC 350. They can elect to amortize goodwill on a straight-line basis over a period of up to 10 years, or a shorter period if more appropriate, instead of performing annual impairment testing. This election was introduced for private companies through ASU 2014-02 and later extended to not-for-profit entities through ASU 2019-06. Both updates were designed to reduce the reporting burden for these organizations.
Companies that elect goodwill amortization still need to test for impairment, but only when a triggering event occurs, not annually. The triggering-event test also follows the simplified one-step model, so even companies using the amortization alternative benefit from the streamlined approach.
The choice between goodwill amortization and annual impairment testing depends on factors such as the expected useful life of the goodwill, the cost of performing annual valuations, and the preferences of the company’s financial statement users. Companies should consult their accounting advisors to determine which approach best fits their circumstances, particularly when an acquisition is on the horizon.
When the one-step test became effective
ASU 2017-04 went into effect for fiscal years beginning after December 15, 2019 for SEC-filing public companies. All other public companies had an additional year, and private companies that had not elected the amortization alternative had two additional years to adopt.
Because the one-step goodwill impairment test is simpler than the two-step version it replaced, early adoption was permitted for any interim or annual goodwill impairment test conducted after January 1, 2017. Many companies chose to adopt the standard early to realize immediate cost savings and reduce the complexity of their year-end close process.
As of today, all companies subject to goodwill impairment testing under U.S. GAAP use the one-step model. The two-step process is no longer applicable.
Key considerations for companies performing the goodwill impairment test
Several practical issues deserve attention when planning and executing a goodwill impairment test under the current standard. Each one influences both the reliability of the result and how auditors and regulators view it.
Reporting unit identification. The accuracy of the goodwill impairment test depends on correctly identifying reporting units. Under ASC 350, a reporting unit is an operating segment or one level below an operating segment. Companies that have restructured or reorganized since their last acquisition should confirm that their reporting units still align with how the business is managed.
Fair value measurement. Determining the fair value of a reporting unit remains the most judgment-intensive part of the process. Companies should document their valuation methodology, key assumptions such as discount rates, growth rates, and comparable transactions, and any changes from prior periods. Securities regulations such as Regulation S-X govern how these intangible balances are presented, and auditors continue to scrutinize fair value estimates closely.
Timing and frequency. Companies must test goodwill for impairment at least once per year at the same time each year. They must also test between annual dates whenever events or circumstances indicate that goodwill might be impaired, for example a significant decline in stock price, loss of a major customer, or adverse changes in the regulatory environment.
Tax considerations. Under the one-step model, the impairment loss is measured before considering the tax-deductible goodwill component. Companies should work with their tax advisory team to understand the deferred tax implications of any goodwill impairment charge, and should fold goodwill expectations into deal planning through transaction advisory support.
Frequently Asked Questions
What is a goodwill impairment test?
A goodwill impairment test is an evaluation that companies perform to determine whether the recorded value of goodwill on their balance sheet still reflects its economic value. Under current U.S. GAAP, the test compares the fair value of a reporting unit to its carrying amount. If carrying amount exceeds fair value, the company records an impairment loss up to the total goodwill allocated to that unit.
How does the one-step goodwill impairment test differ from the old two-step test?
The one-step test eliminates the need to calculate the “implied fair value” of goodwill through a hypothetical purchase price allocation. Under the old two-step process, companies had to assign fair values to every identifiable asset and liability within the reporting unit. The simplified test measures impairment directly as the excess of carrying amount over fair value, capped at the goodwill balance.
What is the goodwill impairment journal entry?
When a company recognizes goodwill impairment, it debits an impairment loss account, reported on the income statement and typically shown as a separate line item, and credits the goodwill account on the balance sheet. The entry reduces both reported earnings and the carrying amount of goodwill on the company’s books.
Can private companies amortize goodwill instead of testing for impairment annually?
Yes. Under ASU 2014-02 (extended to not-for-profit entities by ASU 2019-06), private companies and not-for-profit entities can elect to amortize goodwill over a period of up to 10 years on a straight-line basis. Companies that make this election only need to test for goodwill impairment when a triggering event occurs, rather than performing an annual test.
What qualitative factors should a company consider before performing a quantitative goodwill impairment test?
Companies can assess qualitative factors, known as a “Step 0” analysis, to determine whether a quantitative test is necessary. Relevant factors include deterioration in macroeconomic conditions, declining industry or market conditions, increased costs, negative changes in cash flows, management turnover, and sustained decreases in the company’s stock price.
How do you calculate fair value for goodwill impairment testing?
Fair value is typically estimated using the income approach (discounted cash flow analysis), the market approach (guideline public company multiples or comparable transaction multiples), or a weighted combination of both. The chosen methodology should reflect what a market participant would pay for the reporting unit, incorporating current market conditions and reasonable future expectations.
