Understanding goodwill impairment is impossible without understanding goodwill. Goodwill is something that occurs when one business purchases another business for more than the fair market value of that business. In other words, accountants would determine what the business should be worth on the open market (or the fair market value), and if the business is purchased for more than this value, goodwill is created.For example, assume Company A has a fair market value of $1 million. Company B decides to pay $2 million to buy company A. In doing so, Company B pays $1 million more than the fair market value of Company A, and therefore, $1 million in goodwill is created (purchase price of $2 million minus fair market value of $1 million).
Why is company B willing to pay $1 million more than Company A is worth? There are a variety of reasons. Company A may have excellent growth prospects, strong profit margins, a competitive edge, or be an excellent fit with Company B's current business model.
After the purchase, Company B would show $1 million in goodwill on its balance sheet, and $1 million indicating the value of the business.;
, Recall that goodwill is created when you pay more than for a company than what the company's assets are actually worth. What the company's assets are actually worth is known as the carrying value. It is known as carrying value because this is the value of the business that is "carried" on the balance sheet.


The carrying value of a business is equal to the cost that was originally paid for the business's assets, minus its debts. For example, if a business originally paid $2 million for its assets, and it has debts of $1 million, its carrying value would be $1 million.
Sometimes the carrying value of a company will be worth less than its fair market value, or what the market is willing to pay for it. Recall that goodwill is equal to the purchase price of a business minus the fair market value. For example, assume the carrying value of a company is $1 million and accountants determine the fair market value is $1.5 million. If somebody is willing to pay $2 million, the goodwill created would be $500,000, or $2 million minus $1.5 million.
 Each year, it is required that you test Goodwill for something known as impairment. Over time, the value of your business may fluctuate with market conditions, or with the performance of your business. Sometimes, poor market conditions or performance could mean that the market value will decrease below the carrying value recorded on the balance sheet. If this happens, it is necessary to decrease, or impair, the goodwill on the balance sheet to reflect the decrease in value.For example, assume you purchased a business for $2 million. Both the carrying value and fair market value in this case are $1 million, but it was decided for various reasons that you would pay $2 million due to strong advantages the business has. In this case, $1 million in goodwill is created
If a new competitor appears in the market that strongly reduces the business's sales, your business would be worth less if you tried to sell it. If the value of your business falls so that it is worth less than the carrying value (in this case, $1 million), it is necessary to reduce the goodwill by the difference between what the business is now worth, and what it is recorded as being worth on your balance sheet.
For example, assume the balance sheet indicates a carrying value of $1 million, plus $1 million in Goodwill. If something bad happens to your business and it is now only worth $500,000 on the open market, you would need to reduce, or impair the goodwill by $500,000.
Learn the definition of goodwill.
Calculate carrying value (also known as book value) of a business.
Understand Goodwill Impairment.
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