Discount Rate in Goodwill Impairment Testing: 2026 Practitioner Walkthrough

The discount rate is the single most consequential input in a goodwill impairment DCF, and in 2026 it carries more audit and regulatory risk than at any point since the financial crisis. With the 10-year US Treasury yield having risen more than 200 basis points above its 2012-2021 average, WACCs derived today are structurally higher than those baked into many companies' impairment models, and the consequences of a stale rate are both an accounting problem and an auditor problem. This guide walks through how to build the rate correctly, how US GAAP and IFRS differ in ways that matter, and what regulators actually challenge in practice.

For the mechanics of the one-step impairment model and reporting unit identification, see our ASC 350-20 practitioner guide and reporting unit identification walkthrough. This article focuses entirely on the discount rate.

Key takeaway: A 100 bps rise in WACC does not produce a linear decline in fair value. It compresses terminal value non-linearly via the Gordon Growth Model denominator, making the discount rate far more sensitive than most impairment models make obvious.

Why the Discount Rate Is the Most Sensitive Input

The discount rate drives the fair value of a reporting unit more than any other single assumption. Under FASB ASU 2017-04, the goodwill impairment test is a single comparison: if the carrying amount of the reporting unit exceeds its fair value, the excess is the impairment charge, capped at the carrying amount of goodwill. That makes the fair value estimate the only number that matters, and the discount rate is the most sensitive input in the DCF that produces it.

The sensitivity is non-linear. In a Gordon Growth Model terminal value, TV = FCF x (1+g) / (WACC - g), the denominator is the spread between WACC and the long-term growth rate. If WACC rises from 9% to 10% and the growth rate is 3%, the denominator widens from 6% to 7%, a 17% compression in terminal value, before you even touch the near-term cash flows. For businesses where terminal value represents 60-70% of total DCF value, a 100 bps rate increase can reduce fair value by 15-25%, easily flipping a unit from comfortable headroom to impairment.

The 10-year US Treasury yield averaged below 2% from 2012 to 2021. By 2023-2024 it exceeded 4%, a structural shift of more than 200 bps in the risk-free rate component of every WACC. Kroll's annual goodwill impairment study reported approximately $100 billion in goodwill impairment charges by S&P 500 companies in 2022, the highest level since 2008, driven in part by this rate shift. Companies that have not refreshed their discount rate assumptions since the low-rate era face both accounting risk and audit risk.

Step 1: Understand What Rate Each Framework Actually Requires

Before building the WACC, get the conceptual requirement right. The two frameworks differ in a way that has real dollar consequences.

The US GAAP distinction is subtle but auditor-tested. ASC 820-10-35 requires fair value inputs to reflect market participant assumptions, not the entity's own cost of capital. A highly-leveraged company's own WACC may be materially higher than a market-participant WACC built on an industry-typical capital structure. Using the entity's own rate in that scenario overstates the discount, depresses fair value, and can produce impairment that a market participant would not recognise. SEC staff have challenged exactly this.

Under IFRS, the same CGU can legitimately carry two different discount rates: a pre-tax asset-specific rate for VIU, and a post-tax market-participant rate for FVLCD. Since recoverable amount is the higher of the two, the choice of which measure to rely on affects which rate applies. This is a source of genuine confusion in practice that the top-ranking content largely glosses over.

Step 2: Build the WACC Component by Component

The standard WACC formula is: WACC = (E/V x Re) + (D/V x Rd x (1 - Tc))

Where E = market value of equity, D = market value of debt, V = E + D, Re = cost of equity, Rd = cost of debt, Tc = corporate tax rate. For impairment testing, the capital structure weights should reflect a market-participant (industry-typical) structure, not necessarily the entity's own leverage, per PwC's Business Combinations guide.

Here is how to build each component in 2026, with the current market context that most impairment models are missing.

Risk-Free Rate

Use the yield on long-dated government bonds matched to the currency of the cash flows: the 10-year or 20-year US Treasury for USD analyses, equivalent sovereign bonds for other currencies. As of mid-2026, the 10-year Treasury yield remains materially above the sub-2% levels that characterised 2012-2021. Any model that has not been refreshed since that era is using a stale risk-free rate.

Practical trap: some teams use a spot rate on the measurement date; others use a normalised or smoothed rate. Auditors will ask which approach you used and why. Document the rationale, because the choice can move the rate by 30-50 bps.

Equity Risk Premium

Two widely-used sources produce different answers, and the gap matters:

• Damodaran (NYU Stern) publishes an implied (forward-looking) ERP. His January 2026 estimate for the US market was approximately 4.60%.
• Kroll's Cost of Capital Navigator (formerly Duff & Phelps) recommends a normalised ERP of 5.5% for US valuations as of Q4 2025.

The spread between these two approaches is 90 bps, enough to swing a borderline impairment conclusion. Document which source you used, why it is appropriate for a market-participant analysis, and whether your auditors have a preference. Consistency across periods matters too: switching ERP sources between years without explanation invites a comment.

Beta

Beta measures systematic risk relative to the market. For impairment testing, the standard approach is:

1. Identify a peer group of publicly traded companies in the same industry as the reporting unit.
2. Calculate each peer's raw (levered) beta using 2-5 years of historical data.
3. Unlever each peer's beta using the Hamada equation to remove the effect of the peer's capital structure.
4. Re-lever the median unlevered beta using the market-participant (or entity's) capital structure.

The lookback period matters. A 2-year beta captures recent sector repricing; a 5-year beta smooths short-term volatility but may not reflect recently-priced risks, including climate-related risks in carbon-intensive sectors, per KPMG's January 2026 guidance. Auditors will scrutinise the peer set selection and the lookback period. Document both.

Size Premium

The size premium is an additional return required by investors in smaller companies, above what CAPM predicts. Kroll's Cost of Capital Navigator publishes annual size premium data by market cap decile and is the most widely cited source.

This is a contested input. Damodaran argues size premiums have largely disappeared in recent decades. Kroll data suggests they persist. Auditors frequently challenge the inclusion of a size premium, particularly if it is large. If you include one, document the specific decile data you relied on and why the reporting unit's size profile supports it. If you exclude it, document that decision too.

Company-Specific Risk Premium (Alpha)

The company-specific risk premium (CSRP), or alpha, is an upward adjustment for risks specific to the CGU or reporting unit that are not captured in the beta or size premium. Common justifications include customer concentration, key-person dependency, single-product risk, or regulatory uncertainty.

As KPMG notes, "an alpha factor reflects a CGU-specific risk premium that may need to be added to the cost of equity when a CGU is determined to carry additional risk - i.e. risk that cannot be attributed to market risk (unsystematic risk) that would affect a market participant's required rate of return."

CSRP is the most judgmental component and the most frequent source of auditor pushback. The critical constraint: use it only for risks not already reflected in the cash flow projections. Reflecting the same risk in both the cash flows and the rate is double-counting, and it will produce a spurious impairment charge.

Cost of Debt

Use the pre-tax cost of debt for the market-participant capital structure, then tax-effect it at the marginal corporate tax rate. For the capital structure weights, use market values, not book values. If the entity's own debt is not representative of a market participant (e.g., the company is unusually leveraged), use an industry-typical debt-to-equity ratio instead.

Step 3: The IAS 36 Pre-Tax Iteration Problem

This is the most technically demanding step for IFRS preparers, and the one most often handled incorrectly.

IAS 36 paragraph 55 requires a pre-tax discount rate for VIU calculations. But WACC is inherently a post-tax measure: the cost of debt is tax-effected, and CAPM-based cost of equity is derived from post-tax market returns. So IFRS preparers face a conversion problem.

Two approaches are used in practice:

Approach 1: Gross-up method (most common) Divide the post-tax WACC by (1 - effective tax rate). If post-tax WACC is 10% and the effective tax rate is 25%, the pre-tax rate is 10% / (1 - 0.25) = 13.3%.

This is simple and widely used. It is also often inaccurate. As Grant Thornton's IAS 36 series confirms, the gross-up method can be materially wrong when the effective tax rate differs significantly from the marginal rate, when deferred tax timing differences are large, or when the CGU has tax losses or tax credits. Academic research on FTSE 100 companies found that the gross-up method is generally not adequate, yet it remains the dominant practice.

Approach 2: IRR iteration method (more accurate) Build the DCF on a pre-tax cash flow basis (add back the tax charge to the cash flows), then solve for the internal rate of return (IRR) that equates the present value of pre-tax cash flows to the carrying amount. This IRR is the pre-tax rate that is consistent with the post-tax VIU.

This approach is more accurate but computationally heavier. It requires a pre-tax cash flow model, which many teams do not maintain separately from their post-tax model. If the difference between the two methods is material, the IRR approach is defensible; the gross-up is not.

Key takeaway: If your effective tax rate differs from your marginal rate by more than 5 percentage points, or if the CGU has significant deferred tax positions, the gross-up method will produce a materially different pre-tax rate than the IRR method. Document which approach you used and why.

Step 4: Avoid the Three Most Common Errors

Error 1: Nominal-Real Mismatch

IAS 36 paragraph 40 explicitly requires consistency between the basis of the cash flows and the discount rate. If cash flows are projected in nominal terms (including inflation), the rate must be nominal. If cash flows are in real terms (inflation-stripped), the rate must be real. Using a nominal WACC to discount real cash flows overstates the discount and can produce spurious impairment. This error is more common than it should be, particularly in models built during the low-inflation era when the distinction seemed academic.

Error 2: Double-Counting Risk

Reflecting the same risk in both the cash flow projections and the discount rate inflates the effective discount rate and produces an impairment charge that overstates the economic reality. The IAS 36 constraint is precise: the rate must reflect risks "specific to the asset for which the future cash flow estimates have NOT been adjusted." If you have already haircut the cash flows for customer concentration risk, do not also add a CSRP for customer concentration.

Error 3: Stale Rate in a Rising-Rate Environment

Many companies built their impairment models during 2015-2021, when the 10-year Treasury was often below 2%. Those models embedded a risk-free rate assumption that is now 200+ bps too low. The qualitative bypass under ASC 350-20-35-3A (the "Step 0" screen) becomes much harder to justify when macroeconomic conditions have changed this materially. Auditors and SEC staff expect documentation of why a higher rate environment does not require a quantitative test, or why the quantitative test conclusion still holds. Our ASC 350 triggering events guide covers the indicators that force a quantitative test; the rate environment is now one of them.

For the interaction between Treasury yield movements and ASC 820 fair value measurements more broadly, see our Q2 2026 ASC 820 guide.

Step 5: Climate Risk Adjustments to the Discount Rate

The general principle, confirmed by KPMG's January 2026 guidance: "the impact of climate-related matters is generally reflected in the cash flows rather than in the discount rate, whenever possible."

Adjustments to the discount rate are appropriate only when:

• Sufficient data is not available to quantify the cash flow impact, or
• The climate risk affects the range and uncertainty of outcomes rather than the expected value of cash flows.

For goodwill CGUs specifically, the long duration of cash flow projections makes climate risk harder to quantify in the cash flows, which means rate adjustments are more likely to be warranted than for short-lived assets. Two WACC components can legitimately absorb climate risk:

• Beta: Climate risks that are industry-wide and priced by the market will eventually show up in sector betas. But beta is typically estimated from 2-5 years of historical data, so recently-priced climate risks may not yet be fully reflected. If you are in a sector with significant transition risk (energy, heavy industry, real estate), consider whether your peer betas capture this.
• Alpha (CSRP): For CGU-specific climate risks not captured in the sector beta, an alpha adjustment may be warranted. The double-counting constraint applies here too: if you have already reduced cash flows for a carbon tax, do not also add an alpha for carbon regulation.

Step 6: What Regulators Actually Challenge

SEC Comment Letter Patterns (US GAAP)

The SEC's Division of Corporation Finance has been consistent in what it challenges on discount rate disclosures. The four most common staff comments:

1. Requesting the specific rate used and how it was derived. Disclosing a range (e.g., "8%-12%") without explaining which rate applies to which reporting unit, or why, is a recurring comment trigger.
2. Asking why the rate is consistent with market-participant assumptions. Staff specifically flag cases where the rate appears to reflect the entity's own cost of capital rather than a market-participant WACC.
3. Requesting a sensitivity analysis. Staff expect disclosure of the impact of a 100 bps change in the discount rate on the fair value of the reporting unit, particularly when headroom is thin.
4. Challenging consistency with the risk profile of the projected cash flows. If the cash flows are optimistic, a low discount rate is harder to defend; if the cash flows are conservative, a high rate may double-count the risk.

For a full treatment of how to structure SEC comment letter responses, see our SEC comment letter response guide.

ESMA and FRC Enforcement (IFRS)

ESMA's 2023 European Common Enforcement Priorities specifically called out goodwill impairment, including discount rate assumptions, as a priority area for financial statement review. The specific criticism: discount rates that appear inconsistent with observable market data, and sensitivity disclosures that are inadequate.

The FRC's 2022 thematic review found that many companies failed to explain how their discount rate was derived or why it was appropriate for the specific CGU. Boilerplate disclosure, the kind that reads identically across CGUs with different risk profiles, is what triggers enforcement attention.

PCAOB Auditor Scrutiny

The PCAOB's 2023 inspection brief cited auditors for failing to adequately test the reasonableness of discount rate assumptions, particularly the selection of comparable companies for beta estimation and the support for company-specific risk premiums. This has a downstream effect on preparers: auditors under PCAOB scrutiny will push harder on exactly these inputs. Expect detailed questions on peer set selection, lookback period, and CSRP justification.

Step 7: Disclosure Requirements and Best Practice

Under IAS 36 paragraph 134, disclosure of the discount rate for each CGU to which a significant amount of goodwill has been allocated is mandatory, not optional. This is a quantitative disclosure requirement. Providing only a range, without tying specific rates to specific CGUs, does not satisfy it, and both ESMA and the FRC have said so.

Under IAS 36 paragraph 134(f), sensitivity analysis is required when a reasonably possible change in a key assumption would cause the carrying amount to exceed recoverable amount. The discount rate almost always triggers this requirement. Best practice, and SEC staff expectation for US registrants, is to disclose the specific rate used and the impact of a defined change (typically 100 bps) on headroom or impairment amount.

For a complete ASC 350 disclosure checklist, see our goodwill impairment disclosure requirements guide.

Pre-filing disclosure checklist for the discount rate:

• Specific rate(s) disclosed for each material reporting unit or CGU (not just a range)
• Basis for the rate explained: WACC components, peer set, data sources
• Confirmation that the rate reflects market-participant assumptions (ASC 820) or pre-tax asset-specific risks (IAS 36 VIU)
• Pre-tax iteration documented for IAS 36 VIU (method used, why it is appropriate)
• Sensitivity analysis: impact of 100 bps increase in discount rate on fair value or headroom
• No double-counting: risks in cash flows not also in the rate
• Nominal-real consistency confirmed
• Rate refreshed to reflect current risk-free rate environment
• Climate risk treatment documented: cash flows, rate, or both, with double-counting avoidance explained
• CSRP (if any) supported by specific, non-duplicative risk factors

FAQ

How is goodwill tested for impairment under US GAAP? Under ASC 350-20-35, a company compares the fair value of each reporting unit to its carrying amount. If carrying amount exceeds fair value, the difference is the impairment charge, capped at the carrying amount of goodwill. Fair value is almost always estimated via a DCF, making the discount rate the pivotal input. A qualitative screen (Step 0) can bypass the quantitative test, but material changes in the rate environment make that bypass harder to justify.

How often do you test goodwill for impairment? At least annually under both ASC 350 and IAS 36, and more frequently when triggering events occur, such as a significant decline in market capitalisation, a deterioration in operating performance, or a material change in the discount rate environment. The 200+ bps rise in risk-free rates since 2021 is itself a triggering event indicator that warrants documentation.

Is goodwill amortised or tested for impairment? Under current US GAAP (ASC 350), goodwill for public companies is not amortised; it is tested for impairment annually. Under IFRS (IAS 36), the same applies. FASB has an active project exploring whether to reintroduce amortisation for public companies, but as of mid-2026 no change has been finalised. Private companies under US GAAP may elect to amortise goodwill under ASC 350-20.

What is an impairment charge on goodwill? A goodwill impairment charge is the write-down recognised when the carrying amount of a reporting unit (or CGU) exceeds its recoverable amount or fair value. Under FASB ASU 2017-04, the charge equals the excess of carrying amount over fair value, capped at the carrying amount of goodwill. It flows through the income statement and is not reversible under US GAAP or IFRS.

Should we use our own WACC or a market-participant WACC? For US GAAP, always a market-participant WACC, per ASC 820-10-35. For IAS 36 VIU, start with your WACC as a surrogate, then adjust to reflect a market-participant view of CGU-specific risks. If your entity is unusually leveraged or has an atypical capital structure, the two can differ materially, and using your own rate without adjustment is a common error.

What is the difference between a VIU discount rate and a FVLCD discount rate under IAS 36? VIU uses a pre-tax rate reflecting the time value of money and asset-specific risks not already in the cash flows, per IAS 36 paragraph 55. FVLCD uses a post-tax market-participant rate consistent with IFRS 13, since market participants think in post-tax terms. The same CGU can legitimately have two different discount rates depending on which recoverable amount measure is higher.