Goodwill Impairment — Defining Reporting Units & Qualitative Tests

Goodwill impairment testing begins by assigning acquired goodwill to reporting units and determining whether a triggering event or qualitative factors indicate potential impairment.

The “Step 0” qualitative assessment allows entities to bypass the quantitative fair-value test if it is more likely than not that no impairment exists.

1. Assigning goodwill to reporting units

Under US GAAP (ASC 350), goodwill must be tested at the reporting unit level, which is defined as an operating segment or one level below it (a component) that:

• Engages in business activities generating revenues and expenses.

• Has discrete financial information available.

• Is regularly reviewed by management.

IFRS (IAS 36) uses cash-generating units (CGUs), the smallest identifiable group of assets generating cash inflows largely independent from other assets.

Framework	Level of testing	Allocation method
US GAAP	Reporting unit	Allocate goodwill to reporting units expected to benefit from the business combination
IFRS	Cash-generating unit (CGU)	Allocate goodwill to CGUs or groups of CGUs expected to benefit from synergies

2. Aggregating or disaggregating components

Entities may combine components into a single reporting unit if they share similar economic characteristics. Factors include:

• Nature of products or services

• Production processes

• Types of customers and markets

• Regulatory environments

Disaggregation may be required if components are economically distinct or reviewed separately by the Chief Operating Decision Maker (CODM).

3. The qualitative assessment (Step 0 test)

The optional Step 0 assessment evaluates whether it is more likely than not (>50 %) that the fair value of a reporting unit exceeds its carrying amount. If so, no further testing is required.

This step requires evaluating relevant events or circumstances that could affect fair value or carrying amount, including:

• Macroeconomic conditions

• Industry and market trends

• Cost factors (e.g., increases in raw materials, labor)

• Financial performance of the reporting unit

• Entity-specific events (e.g., loss of key personnel, litigation)

• Changes in share price or market capitalization

4. Example of Step 0 evaluation process

Factor	Evaluation	Impact
Market decline in key product	Moderate and expected to rebound next year	Neutral
Drop in unit’s revenue growth	Temporary due to known supply constraints	Neutral/temporary
Impairment indicators in peers	Not present	Positive (no concern)
Overall cash flows	Slightly above budget	Positive
Conclusion	No evidence that FV < carrying amount	Step 1 not required

5. Documentation and auditor expectations

When performing a qualitative test, companies must document:

• Each factor considered and its relative weight

• Judgments made in evaluating potential adverse trends

• Support for concluding that it is more likely than not that fair value exceeds carrying amount

• Consideration of interactions between risk factors

Auditors will assess whether the evaluation was comprehensive and unbiased and whether there are any omitted material factors.

6. When to skip Step 0 and proceed directly to Step 1

Companies may elect to bypass Step 0 and proceed directly to the quantitative fair-value test if:

• The reporting unit’s performance has deteriorated significantly

• Management lacks confidence in qualitative conclusions

• Internal controls over judgmental factors are weak

• A prior Step 0 test led to Step 1 confirmation of impairment

This conservative approach is often preferred when market volatility is high or visibility into forecasts is low.

7. Interaction with interim and triggering-event tests

Goodwill must be tested:

• Annually — For all reporting units with goodwill

• Interim — Whenever a triggering event occurs (e.g., restructuring, economic downturn, major loss of customers)

Triggering-event assessments may be qualitative or quantitative. If impairment is indicated, Step 1 must be performed even between annual test dates.

Key take-aways

• Goodwill must be assigned to the appropriate reporting unit or CGU based on who benefits from the business combination.

• The optional Step 0 assessment can save time and cost but must be supported by rigorous qualitative analysis.

• A failed or inconclusive Step 0 assessment requires a full fair-value comparison under Step 1.

• Consistent documentation, professional skepticism, and cross-functional input are critical for supporting judgments made during the Step 0 test.