Table of Contents
Goodwill is the intangible value of the reputation of business, and is largely different from other intangible assets (Orpurt, 2016). Goodwill is termed intangible because it is not identifiable physically and can only be valued in the balance sheet. Moreover, it is stated that goodwill cannot be calculated as an independent entity and hence is calculated as a part of value of business. The value of goodwill is subject to constant fluctuations due to the external and internal factors. The non-purchased goodwill entails the amount of goodwill that is not purchased and can be either positive or negative in nature (Bryant, 2012). It also needs to be considered that the company that has purchased goodwill of another company must mention the non-written off value in the balance sheet (Alexander & Britton, 2004). The objective of the paper is to determine the accounting treatment of goodwill as mentioned by the US GAAP or IFRS.
Definition of Goodwill
Goodwill is defined as an intangible asset for an organization that is recorded on the asset side of the balance sheet. It can further be referred as the extra value of an organization that is assumed based on its good reputation in the market, possession of proficient employees, effective operations and good location among others. In case, an organization takes over another business then it needs to pay for goodwill in addition to the cost of the assets that is acquired (Orpurt, 2016). It can be calculated by deducting the value of liabilities from the value of assets. The importance of goodwill calculation takes place in case when a business is purchased by another entity (Bryant, 2012). Goodwill is also valued in case a new partner enters into the firm, a partner exits or some sort of changes occur in the profit sharing ratio. A separate goodwill account is prepared that generally begins with a debit balance and is considered as an asset of the business. The necessary entries in the ledger are completed by passing journal entries for goodwill on a timely basis. After, all the entries are made the closing amount of goodwill is entered as a credit balance. An increase in the value of goodwill is divided among the partners in the profit sharing ratio (AAT, 2017). In the similar manner, goodwill is calculated in case conversion or valuation of shares takes place at the time of business amalgamation and mostly during the formation of a holding company among others. The methods that can be used to ascertain the value of goodwill include annuity method, super profit method, capitalization method, average profit method and arbitrary assessment method (Accounting Solutions, n.d.).
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Definition as per International Financial Reporting Standards (IFRS)
The IFRS mentions goodwill as an intangible asset of the organization that has to be valued when an entity acquires another business. The international accounting standards (IAS) 36 as issued in 31 March 2004 mentions in details about the significance of goodwill (Deloitte, 2017a). Goodwill as per IFRS is defined as something different from other assets and mere purchases of assets do not indicate that goodwill of a particular business has been acquired. At the time of acquiring business, the acquirer needs to calculate the value of goodwill separately (European Commission, 2011). IFRS has always stressed on the concept of purchased goodwill and states about the use of fair value accounting while measuring it. It can thus be stated that the definition of goodwill is closely connected with the norms laid down by the fair value theory of accounting. In this regard, it can be stated that goodwill is the resultant value of the difference between the fair price of the assets of a company and its purchase price (Lhaopadchan, 2010).
Fair price is the present market price of the assets, at which they can be sold. The fair value theory states that after a particular business entity has been purchased, the managers are not entitled to make any changes in the value of goodwill. The use of fair value theory of accounting is now applied globally to calculate goodwill especially after the adoption of IAS prescribed by the IFRS (Lhaopadchan, 2010).For instance, since 2005, goodwill is measured at the fair value in Europe and is represented using financial statements. IAS 3 of IFRS states that goodwill impairment is permanent, which means that in the value of an asset gets reduced. Goodwill can also be said as an acquisition premium because it is paid as an extra charge over the fair value of the business due to its reputation. The impairment of goodwill takes place when the bonus plans are small and shorter tenures of CEOs or higher rate of earnings comes from the operations (Lhaopadchan, 2010). IFRS mentions that goodwill has to be recorded in the balance sheet. Purchased goodwill is considered the economic benefit of an acquirer, taking over another business. The value of goodwill can also be calculated by estimating the flow of profits in the future period (Dip IFR, 2009).
Definition as per US GAAP
The generally accepted accounting principles (GAAP) are followed in the USA and are hence known as US GAAP. This standard defines intangible asset, as something that do not have any physical existence but is of great benefit to an organization. One such intangible assets is goodwill as mentioned in the ASC 350, Intangibles — Goodwill and Other (Ernst & Young, 2011). Goodwill is recorded in the financial statements after the acquirer has purchased another business (Deloitte, 2017b). The value of goodwill is similar to other tangible assets, which can be impaired and can even lead to a huge loss for the organization. As per US GAAP, the allocation of goodwill is done to the reporting unit, which is regarded as an operating segment. Operating segments is a subsidiary business of the parent company and is capable of earning profit. The provisions mentioned in the GAAP states that impairment of goodwill creates loss when its fair value is less than the carried amount (RSM, 2012). It is thus necessary for business houses to maintain a good reputation so that the value of their goodwill remains high. This will give high earnings for the sale of a business.
The US GAAP mentions that the value of goodwill is subjected to be reviewed at least once a year to detect the value of impairment. It is also considered to have an indefinite life as per the GAAP standards. However, it is not possible to amortize goodwill due to its indefinite life as per the US GAAP. It further indicates that charges of depreciation cannot be applied on goodwill (Ernst & Young, 2011). Even US GAAP focuses on the concept of purchased goodwill and makes it necessary for reporting units to measure it. The method of calculating goodwill is generally a two step process as per the provisions laid down in the US GAAP. Goodwill is hence an intangible asset, for which impairment loss is not reversible (Jerman & Manzin, 2008).
Accounting Treatment of Goodwill
Treatment under IFRS
IFRS states that since goodwill has indefinite life so it is not possible to amortize its value. However, it is important to calculate the value of impairment of goodwill at least once in year (Ernst & Young, 2011). The allocations of the costs are done to the cash-generating unit (CGU). These are the smallest units, which can generate cash inflows but are even smaller than the operating segment. Loss of impairment of CGU takes place when its incurred value is lower than the recoverable amount. Thereafter the value of the loss is allocated to goodwill till its value diminishes to zero. The IAS 36 of IFRS restricts reversal of the loss that is caused to goodwill due to impairment (RSM, 2012). Unlike US GAAP, IFRS does not focus on use of a two step process for calculation of goodwill. IFRS hence makes it mandatory for the companies to transfer the discount on acquisition of goodwill to profit and loss account (Jerman & Manzin, 2008). CGU must be smaller in size than the operating segment as per the IAS 36 (Ernst & Young, 2011). Under the provisions laid down by IFRS, it is important to determine the fair value of the assets, contingent liability and liabilities before the calculation of goodwill (Jerman & Manzin, 2008).
Going into more details, it is found that the value of goodwill is calculated by subtracting the amount of net assets recognized from the sum of non-controlling interest, consideration transferred and fair value of previous equity interests. The IFRS 3 mentions that calculation of goodwill takes place at the date of acquisition of the business. It is necessary to calculate the amount of contingent consideration while determining the value of goodwill. Contingent consideration is the obligation of the acquirer towards the acquiree’s former owner. Moreover, the acquirer needs to disclose certain financial statements such as the total value of goodwill that can be used for tax deduction and the qualitative factors that have been considered with the estimation of goodwill (Deloitte, 2017c).
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Treatment under US GAAP
As mentioned in the characteristics, US GAAP restricts the amortization of goodwill without affecting its impairment. Even in this case, the discounts that have been received on acquisition are transferred to the profit and loss account, which is considered as the effect of existing liabilities while calculating the value of goodwill. As per US GAAP, a company has to mention about the losses that takes place while calculating the impairment value of goodwill. It takes place due to reduction in the number of customers, strict action taken by the regulatory bodies and sudden rise in competition. Other factors include inappropriate budget and loss of potential employees. Moreover, US GAAP also considers the need of calculating fair value of the reporting unit by using present value criteria or with the estimation of the market prices (Jerman & Manzin, 2008). The US GAAP makes it necessary for the companies to determine the value of impairment loss both quantitatively and qualitatively, to know about the difference between the reporting unit’s fair value and goodwill. It is therefore important to consider the expenses related to the restoration, maintenance and development of goodwill (Deloitte, 2017d).
Goodwill is defined as an intangible asset possessed by business that is calculated based on the reputation of the organization, its location, the customers, profitability, efficiency of operations and others. Its value is subjective to fluctuations of the factors that are external as well as internal to a business. The value of goodwill can be both positive as well as negative and needs to be calculated at the time of admission or retirement of a partner, amalgamation or sell of a business. IFRS mentions goodwill as different from other intangible assets and its value is calculated by using the fair value accounting theory. The theory states that all assets and liabilities are calculated at fair value or market price even before commencing the calculation of goodwill. IFRS mentions that allocation of costs while calculating goodwill is done to CGUs while in case of US GAAP it is the operating units. Both in case of US GAAP as well as IFRS, discount on acquisition is transferred to profit and loss account. Goodwill is considered non–amortized, but can possibly be impaired under both the standards. The calculation of goodwill in US GAAP is done in a two step process, whereas in case of IFRS the two step process is not viable.
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