Learning Outcomes
After studying this article, you will be able to explain how goodwill arises under the acquisition method during business combinations, distinguish between full and partial goodwill approaches, calculate goodwill, and evaluate the procedures for impairment tests under both IFRS and US GAAP. You will also be able to identify the balance sheet and income statement impact of goodwill impairment adjustments and understand practical exam applications.
CFA Level 2 Syllabus
For CFA Level 2, you are required to understand the accounting and analytical implications of goodwill for business combinations. Specifically, you should focus your revision on:
- Calculating acquisition date goodwill using both full and partial goodwill approaches
- Explaining and comparing the IFRS and US GAAP impairment testing procedures for goodwill
- Determining the balance sheet and income statement impact of goodwill recognition and impairment
- Assessing how different goodwill methods affect reported equity, assets, ROE, and ROA ratios
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- Under the acquisition method, how is goodwill calculated when less than 100% of a subsidiary is acquired?
- Which impairment approach does US GAAP require for goodwill? a) One-step method b) Two-step method
- True or false? Partial goodwill results in lower reported assets and equity than the full goodwill method.
- Briefly state when a goodwill impairment loss is recognized under IFRS.
Introduction
Business combinations often result in the recognition of goodwill on the acquirer's balance sheet. For the CFA exam, you must understand how goodwill is calculated under both full and partial goodwill methods, as well as the procedures and implications of subsequent impairment testing. These details affect consolidated financial statements, ratios, and interpretation of acquisition performance. This article provides a concise guide to goodwill under the acquisition method, addressing both calculation and impairment.
Key Term: goodwill
The excess of the purchase price over the fair value of identifiable net assets acquired in a business combination, representing future economic benefits not individually identified or separately recognized.
GOODWILL UNDER THE ACQUISITION METHOD
Calculation of Goodwill
When acquiring control of a subsidiary (usually >50% ownership), the acquirer applies the acquisition method. Goodwill is recognized as the excess of the purchase consideration plus the value of non-controlling interests (NCI) over the fair value (FV) of the subsidiary’s identifiable net assets.
There are two permitted approaches to measuring goodwill when less than 100% of the subsidiary is acquired:
- Full goodwill method (required by US GAAP; permitted by IFRS)
- Partial goodwill method (permitted by IFRS only)
Key Term: full goodwill
The difference between the fair value of the subsidiary as a whole and the fair value of its identifiable net assets, resulting in the recognition of goodwill attributable to both the controlling and non-controlling interest.Key Term: partial goodwill
The difference between the purchase price paid and the acquirer's proportionate share of the fair value of the subsidiary’s identifiable net assets, resulting in goodwill only for the controlling interest.
Calculations
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Full goodwill: Where the fair value of the subsidiary as a whole is usually calculated as:
-
Partial goodwill:
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Non-controlling interest (NCI):
- Under full goodwill: measured at fair value (including goodwill)
- Under partial goodwill: measured as proportionate share of the FV of net identifiable assets (excluding goodwill)
Worked Example 1.1
A company acquires 75% of Target Co. for $900,000. The fair value of Target’s identifiable net assets is $1,000,000. The fair value of the NCI is $280,000. Calculate goodwill under (a) the full and (b) partial goodwill methods.
Answer:
(a) Full goodwill:
Full value of subsidiary = $900,000 ÷ 75% = $1,200,000
Goodwill = $1,200,000 − $1,000,000 = $200,000 (b) Partial goodwill:
Partial goodwill = $900,000 − (75% × $1,000,000) = $900,000 − $750,000 = $150,000
Impact on Financial Statements and Ratios
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Full goodwill method results in:
- Higher goodwill reported on balance sheet
- Higher NCI
- Higher total assets and equity
- Lower return on assets (ROA) and return on equity (ROE)
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Partial goodwill method results in:
- Lower goodwill and NCI
- Lower total assets and equity
- Higher ROA and ROE (due to smaller denominator)
GOODWILL IMPAIRMENT TESTING
Goodwill is not amortized; it must be tested for impairment annually and whenever indicators of impairment are present.
Impairment under IFRS
- Goodwill is allocated to cash-generating units (CGUs) expected to benefit from the combination.
- Impairment test (one-step approach):
- If the recoverable amount of the CGU is less than its carrying amount (including goodwill), an impairment loss is recognized.
- The loss is allocated first to reduce goodwill, then pro rata to other assets in the CGU.
Impairment under US GAAP
- Goodwill is allocated to reporting units.
- Impairment test (ASU 2017-04, current standard):
- One-step approach: If the carrying amount of the reporting unit exceeds its fair value, the difference is recognized as a goodwill impairment loss (limited to the amount of goodwill allocated to the reporting unit).
- Previously, GAAP used a two-step process, but this has been replaced by the simpler test above.
Key Term: impairment (goodwill)
The write-down of goodwill on the acquirer’s balance sheet when its recoverable amount (IFRS) or fair value (GAAP) falls below its carrying value.
Worked Example 1.2
ReMajor records $300,000 of goodwill from an acquisition. At year-end, the reporting unit’s carrying value (including goodwill) is $1,800,000; the recoverable amount (IFRS) or fair value (GAAP) is assessed at $1,730,000. What is the impairment loss recorded?
Answer:
Impairment loss = Carrying amount − recoverable (or fair) value
= $1,800,000 − $1,730,000 = $70,000
The carrying amount of goodwill is reduced by $70,000, loss recognized in the income statement.
Exam Warning
Under IFRS, the impairment test may apply to groups of assets (cash-generating units), whereas US GAAP tests are done at the reporting unit level. On the exam, pay attention to whether the question is referencing a CGU (IFRS) or reporting unit (GAAP).
SUMMARY
- Goodwill arises under the acquisition method when the purchase price and (for full goodwill) the fair value of NCI exceed the fair value of identifiable net assets.
- Full goodwill (GAAP, optional under IFRS) recognizes additional goodwill attributable to non-controlling interests, resulting in higher reported assets and equity, while partial goodwill (IFRS option) recognizes only the acquirer's share.
- Goodwill is not amortized but must be tested annually for impairment. Impairments reduce goodwill and affect net income.
- IFRS and US GAAP differ in the level and method for impairment testing.
Key Point Checklist
This article has covered the following key knowledge points:
- Differences between full and partial goodwill calculation under the acquisition method
- Impact of full vs partial goodwill on NCI, assets, and equity
- Goodwill impairment testing under IFRS (CGU, recoverable amount) vs US GAAP (reporting unit, fair value)
- Financial statement effects of goodwill recognition and impairment
- Importance of identifying which goodwill approach and impairment method is specified in exam questions
Key Terms and Concepts
- goodwill
- full goodwill
- partial goodwill
- impairment (goodwill)