How often must a cash-generating unit containing goodwill be tested for impairment, and how is the CGU defined in practice?

Question

AcadiFi · Accepted Answer

Under IAS 36, a **cash-generating unit (CGU)** is the smallest identifiable group of assets that generates cash inflows largely independent of other assets. Goodwill must be allocated to CGUs and tested for impairment with specific frequency rules.

**CGU Definition in Practice**

The identification depends on how management monitors operations and makes decisions about continuing or disposing of assets. Common CGU boundaries include:

- A **geographic region** (e.g., North American retail operations)
- A **product line** with independent revenue streams
- A **business segment** as reported internally

The key test: Could this group of assets be sold or shut down without affecting cash flows from other groups?

**Worked Example — Whitmore Consumer Products:**

Whitmore operates three divisions: Household Cleaning, Personal Care, and Pet Nutrition. Each division has its own manufacturing, distribution, and customer base. Management monitors profitability at the divisional level.

| Division (CGU) | Allocated Goodwill | Testing Date |
|---|---|---|
| Household Cleaning | $85M | October 31 |
| Personal Care | $120M | October 31 |
| Pet Nutrition | $45M | October 31 |

**Testing Frequency Rules:**

1. CGUs with goodwill must be tested **at least annually**. The test can occur at **any time during the annual period**, provided it occurs at the **same time each year**.
2. Different CGUs can be tested at different dates — Household Cleaning could test on June 30 while Personal Care tests on October 31.
3. If a **triggering event** occurs between annual tests (see IAS 36 indicators), the CGU must be tested immediately — regardless of when the last annual test was performed.
4. Newly acquired goodwill must be allocated to CGUs and tested **before the end of the annual period** in which the acquisition occurred.

**Testing Mechanics:**

Compare the CGU's **carrying amount** (including allocated goodwill) to its **recoverable amount** (higher of fair value less costs of disposal and value in use).

If carrying > recoverable → impairment loss is recognized:
- First, reduce **goodwill** allocated to the CGU to zero.
- Then, reduce other assets of the CGU **pro rata** (but not below individual fair value or zero).

**Analyst Red Flags:**

- Testing at period-end when results are already known (potential for timing manipulation).
- CGUs defined too broadly, masking underperformance of specific asset groups.
- Significant goodwill concentrated in a single CGU with declining margins.

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How often must a cash-generating unit containing goodwill be tested for impairment, and how is the CGU defined in practice?

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