If a 100 Goodwill impairment is not deductible for cash taxes, which statement correctly describes the three financial statements?

If a 100 Goodwill impairment is not deductible for cash taxes, which statement correctly describes the three financial statements?

• A. Income Statement: Net Income down 60; Tax NI unchanged; Cash unchanged; Balance Sheet: Goodwill down 100; DTL down 40; RE down 60; Cash unchanged.
• B. Income Statement: Net Income down 100; Tax NI down 40; CFO down; Balance Sheet: Cash down.
• C. Income Statement: Net Income unchanged; Tax NI unchanged; CFO up; Balance Sheet: Cash up.
• D. Income Statement: Net Income down 60; Tax NI down 60; CFO up; Balance Sheet: Cash up.

Answer: (A)

When goodwill impairment is not deductible for cash taxes, it creates a permanent difference between book and tax accounting. The impairment reduces GAAP net income, but it does not reduce current taxes, so the tax expense on the income statement stays the same while the accounting charge remains 100. Compute the after-tax effect: the impairment lowers pre-tax book income by 100, but since there is no tax shield, taxes do not fall, so net income falls by 100 × (1 − 0.40) = 60. That aligns with a 60 decline in net income. On the balance sheet, the impairment directly reduces goodwill by 100. The retained earnings (part of shareholders’ equity) decrease by the after-tax amount 60 to reflect the drop in net income. The remaining 40 from the impairment’s tax effect is treated as a timing adjustment that reduces the deferred tax liability by 40, since there is no tax deduction to shelter that loss now. Cash is unaffected in the current period because the impairment is non-cash and cash taxes do not change. In summary, the impairment lowers net income by 60, reduces goodwill by 100, lowers retained earnings by 60, reduces the deferred tax liability by 40, and leaves cash unchanged.

When goodwill impairment is not deductible for cash taxes, it creates a permanent difference between book and tax accounting. The impairment reduces GAAP net income, but it does not reduce current taxes, so the tax expense on the income statement stays the same while the accounting charge remains 100.

Compute the after-tax effect: the impairment lowers pre-tax book income by 100, but since there is no tax shield, taxes do not fall, so net income falls by 100 × (1 − 0.40) = 60. That aligns with a 60 decline in net income.

On the balance sheet, the impairment directly reduces goodwill by 100. The retained earnings (part of shareholders’ equity) decrease by the after-tax amount 60 to reflect the drop in net income. The remaining 40 from the impairment’s tax effect is treated as a timing adjustment that reduces the deferred tax liability by 40, since there is no tax deduction to shelter that loss now. Cash is unaffected in the current period because the impairment is non-cash and cash taxes do not change.

In summary, the impairment lowers net income by 60, reduces goodwill by 100, lowers retained earnings by 60, reduces the deferred tax liability by 40, and leaves cash unchanged.