Goodwill is the premium an acquirer pays above the fair value of an acquired company’s net assets. It is tested for impairment at least annually, and written down when a reporting unit’s fair value falls below its carrying value.

Goodwill is the accounting residue of acquisitions. When one company buys another for more than the fair value of the target’s identifiable assets and liabilities—which is almost always, because buyers pay for brand, customer relationships, workforce, and expected synergies—the excess is recorded on the balance sheet as goodwill. It represents the premium over net asset value, and for acquisitive technology companies it can be one of the largest assets on the books.

Unlike most assets, goodwill is not amortized over time. Instead, accounting standards require it to be tested for impairment, and written down if it has lost value. Microsoft’s fiscal 2025 annual report describes the test it applies, including the level at which goodwill is evaluated and what can trigger an interim test.

"Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value."— Microsoft Corp. Form 10-K (FY2025), source

How the impairment test works

The test operates at the reporting-unit level—an operating segment or one level below it—rather than company-wide. A filer estimates the fair value of each reporting unit, commonly using a discounted-cash-flow approach, and compares it to the unit’s carrying value, including its allocated goodwill. If carrying value exceeds fair value, the company records an impairment charge for the difference, up to the amount of goodwill assigned to that unit. The standard requires at least an annual test and additional interim tests whenever events or changed circumstances make it more likely than not that a unit’s fair value has fallen below its carrying amount.

The accounting was simplified in recent years. Under the prior framework, an impairment required a complex two-step calculation; the Financial Accounting Standards Board’s update eliminated the second step, so an impairment is now measured directly as the amount by which carrying value exceeds fair value, capped at the unit’s goodwill. That change made charges easier to compute but did not change what they signal: a write-down means the cash-flow expectations that justified the acquisition premium have deteriorated.

A goodwill impairment is a non-cash charge—no money leaves the company when it is recorded—and it is typically excluded from non-GAAP earnings. But it is informationally loud. Because the charge is driven by a decline in a reporting unit’s expected fair value, an impairment is management’s own accounting acknowledgment that an acquired business is worth less than what was paid. For readers tracking acquisitive tech companies, the size and timing of goodwill write-downs are a direct, audited read on which deals are underperforming the thesis that justified them.

The optional qualitative screen

Before running a full quantitative test, a company is permitted to perform a qualitative assessment—often called "step zero"—to decide whether it is more likely than not that a reporting unit’s fair value is below its carrying value. If that screen finds impairment unlikely, the company can skip the quantitative test for that unit and period. This is why some filers disclose that they assessed goodwill qualitatively and concluded no test was required, while others go straight to a discounted-cash-flow valuation. The choice affects how much detail a reader sees, but not the underlying standard: an impairment must still be recognized whenever carrying value exceeds fair value.

Impairment risk concentrates where deals were richest and expectations have since cooled. A reporting unit acquired at a high multiple during an optimistic period carries a large goodwill balance, and a subsequent rise in discount rates, a slowdown in the unit’s growth, or a sustained decline in the acquirer’s market capitalization can all push estimated fair value below carrying value. Because the test uses a discounted-cash-flow approach, it is sensitive to the weighted-average cost of capital; rising interest rates alone can trigger impairments without any change in a business’s operations, which is one reason write-downs sometimes cluster across companies in the same period.

For readers, the analytical move is to size goodwill relative to total assets and equity, identify which reporting units carry it, and watch the assumptions disclosed in the critical-accounting-estimates section of the MD&A. A company that flags a reporting unit whose fair value only narrowly exceeds its carrying value is signaling impairment exposure if conditions deteriorate. The charge, when it comes, is non-cash and backward-looking—but it is the audited record of which acquisition premiums the market and management no longer expect to recover.

It is also worth distinguishing goodwill impairment from the related write-downs of acquired intangible assets such as customer relationships, developed technology, and trade names. Those finite-lived intangibles are amortized on a schedule and tested for impairment under a different model than goodwill, while indefinite-lived intangibles are tested annually like goodwill but at the asset rather than reporting-unit level. A large acquisition therefore seeds the balance sheet with both goodwill and identifiable intangibles, and a deteriorating deal can produce charges against either or both. When reading an acquisitive technology company’s filings, the sequence to watch is the acquisition that created the goodwill, the reporting unit it was assigned to, the annual-test disclosures in the years that follow, and finally any impairment charge—which closes the loop by recording, in audited form, that the premium paid for that business is no longer supported by its expected cash flows.