Goodwill
When a company buys another business, the amount it pays above the fair value of the identifiable net assets acquired is recorded as goodwill on the balance sheet. If the acquired business underperforms, goodwill is written down and the loss hits earnings.
How to calculate it
Goodwill = purchase price − fair value of identifiable net assets acquiredGoodwill to equity = goodwill ÷ total shareholders' equityImpairment (U.S. GAAP, ASC 350) = carrying amount of the reporting unit − its fair value, capped at the goodwill assigned to itHow to read it
- Public companies do not amortize goodwill under U.S. GAAP. It is tested for impairment at least once a year and stays on the books until written down, and write-downs tend to arrive as large one-time charges.
- Compare goodwill with equity. The larger the share, the bigger the hit to equity and earnings from any impairment.
- The goodwill note shows goodwill by reporting unit. A unit whose fair value only narrowly exceeds its carrying amount is the one to watch, and some companies disclose that headroom.
Common pitfalls
- Goodwill is not a problem in itself. Successful acquisitions leave goodwill too; what matters is how the acquired businesses are doing now.
- Impairments often come late, after a sustained fall in the share price or in a year when the company is already reporting a loss.
- Goodwill impairment is a non-cash charge, and companies usually exclude it from adjusted earnings, so it may barely appear in the numbers management emphasizes.
- Goodwill is excluded from tangible book value. For banks and acquisitive companies, tangible measures can look very different from reported equity.
Where to find it in a 10-K
Balance sheet line 'Goodwill', and the goodwill and intangible assets note in the 10-K, which shows changes by segment or reporting unit and any impairment. Critical audit matters in the auditor's report often cover goodwill impairment testing.
U.S. vs. China reporting
China's accounting standards also prohibit goodwill amortization and require annual impairment tests, but A-share deals frequently come with performance guarantees from the sellers, and impairments cluster right after the guarantee period ends. U.S. deals rarely have such guarantees, and earn-outs are recorded as liabilities at fair value instead.