Goodwill impairment is the test where the inputs are all yours, the method is prescribed, and the answer is one nobody wants. It produces more audit difficulty per pound of balance sheet than almost anything else, and the difficulty is usually avoidable.
What you are actually comparing
You compare the carrying amount of a cash generating unit, including its allocated goodwill, with its recoverable amount. Recoverable amount is the higher of fair value less costs of disposal and value in use.
In practice, most companies calculate value in use, because an observable market price for a business unit rarely exists. Value in use is the present value of the future cash flows the unit will generate.
So the test comes down to a forecast and a discount rate, which is why it is contentious. Both are judgements, both are yours, and small movements in either swing the answer.
Framework matters more than people expect
Under IFRS goodwill is not amortised, so the test is annual and unavoidable, regardless of indicators.
Under FRS 102 goodwill is amortised over its useful life, and the test is only triggered where there is an indicator of impairment, such as a lost major customer, a downgraded forecast, a restructuring or a market downturn.
Groups moving from FRS 102 to IFRS, or reporting into an IFRS parent, acquire an annual obligation they did not previously have. It is a common gap in a first group reporting cycle.
The cash generating unit decides the answer
Before any arithmetic, the boundary question. A cash generating unit is the smallest identifiable group of assets producing cash inflows largely independent of those from other assets.
This is where the outcome is effectively determined. Draw the unit widely and a strong business absorbs a struggling one, producing comfortable headroom and no impairment. Draw it narrowly and the struggling business stands alone and fails.
Which is why the boundary is scrutinised. The constraint is that goodwill cannot be monitored at a level higher than management actually monitors it internally. If your board reviews three divisions separately, arguing for one combined unit will not hold, and your own management pack is the evidence against you.
Allocate acquired goodwill to units at acquisition and document the basis then, not three years later when the test gets difficult.
Where the forecast gets challenged
The cash flows should be based on the most recent budget approved by the board, generally covering up to five years, with a terminal growth rate beyond that which does not exceed the long-term growth rate of the market.
Four things get examined.
Whether the forecast matches the one the board actually approved, or a more optimistic variant prepared for this purpose. A difference here is damaging beyond the impairment test itself.
Your track record. Prior year forecasts compared against actual outcomes is a standard procedure. Persistent optimism undermines the current forecast entirely, and no amount of explanation recovers it.
Exclusions. Value in use measures the asset in its current condition, so cash flows from future restructuring you are not yet committed to, or from enhancing performance beyond the asset’s current standard, come out.
Consistency between the cash flows and the discount rate. Pre-tax rate with pre-tax flows, and if the cash flows are real rather than nominal the rate must match. Mixing them is a common and material error.
The disclosure is half the work
Where there is reasonable headroom, say what the key assumptions are and how they were determined.
Where headroom is sensitive, which means a reasonably possible change in an assumption would eliminate it, disclose that: the assumption, the headroom, and the change that would use it up. This disclosure is frequently missed, and it is the one most useful to a reader.
Where an impairment is recognised, give the amount, the unit, the events behind it and the assumptions used.
Do it early
The common failure is running the test in the final week of the audit, using a forecast prepared for the purpose rather than approved by the board, with a discount rate someone estimated. That gets challenged, a revised forecast appears, and the argument runs into the reporting deadline.
Run it on draft figures two months before the year end. If the headroom is thin, you will know in time to prepare the sensitivity disclosure properly, brief the board, and have the conversation with your auditor while it is still a discussion rather than a deadline.