How to account for goodwill

Assessments and tests for goodwill impairment can be left until the end of the reporting period.
Vincent Ryan

Private companies and nonprofit organizations got some breathing room on goodwill accounting this week. The Financial Accounting Standards Board published an update to U.S. accounting rules that allows private companies and nonprofits to only test for goodwill impairments at the time they are closing their books, instead of when triggering events occur.

The accounting standards update (ASU) provides an accounting alternative that allows private companies and not-for-profit organizations to perform a goodwill triggering event assessment, and any resulting test for goodwill impairment, as of the end of the reporting period, whether the reporting period is an interim or annual period.

Under current generally accepted accounting principles (GAAP), goodwill must be tested for impairment when a triggering event occurs that indicates that it is more likely than not that the fair value of the reporting unit is below its carrying value. Companies and organizations are required to monitor for and evaluate goodwill triggering events when they occur throughout the year.

But some stakeholders raised questions about the value of evaluating a triggering event at an interim date when certain private companies and not-for-profit organizations only issue GAAP-compliant financial statements on an annual basis, FASB said.

“They noted the cost and complexity of preparing interim balance sheets and projecting cash flows that, according to those stakeholders, may not be relevant at the annual reporting date when financial statements are issued,” added FASB.

The amendments in the ASU are effective on a prospective basis for fiscal years beginning after December 15, 2019. Early adoption is permitted for both interim and annual financial statements that have not yet been issued or made available for issuance as of March 30, 2021.

FASB is in the middle of a project that would change how all entities account for goodwill and identifiable intangible assets. The majority of the board, FASB chair Richard Jones told CFO this month, is interested in pursuing an amortization with impairments model. If the standard moves in that direction, FASB could also change how issuers test for impairments, Jones said.

Many comments on FASB’s proposal have noted the important signals the current impairment testing model provides to investors, in particular the insight it may give into management’s skill and ability.

“One user noted that the initial valuation and subsequent stewardship of goodwill is one of the most useful ways to assess strategic judgment and management skill, including whether management overpaid or failed to realize predicted synergies,” said FASB in a document summarizing comments it received.

Accounting for Goodwill in a Merger or Acquisition

With the economy slowly but surely improving, merger and acquisition activity has been on the rise the past couple of years. Many Los Angeles and Southern California business owners and entrepreneurs have taken advantage of this favorable M&A environment to acquire other companies in an effort to increase their sales volume and boost market share.

Businesses face many different challenges when acquiring other companies — everything from performing adequate due diligence on the target company to merging sometimes divergent corporate cultures. One challenge that many acquirers aren’t familiar with is how to handle the accounting associated with the goodwill a business acquires when it mergers with another business.

What Exactly is Goodwill?

From an accounting perspective, goodwill is an intangible asset that arises when a business buys another firm for more than the fair market value of its net assets — or in other words, for more than total assets minus total liabilities. The excess of the purchase consideration (or money paid to buy the business) over the business’ assets and liabilities is considered to be goodwill.

Goodwill typically includes such things as the value of a business’ brand name in the marketplace, patents and proprietary technology owned by the company, an established customer base, solid customer relations, and an experienced and stable workforce. Unlike plant, buildings and equipment, goodwill can’t be seen or touched — this is why it’s considered to be an intangible asset and categorized as such on the balance sheet.

The issue of accounting for goodwill in a business acquisition has undergone many changes over the years. In particular, changes in accounting rules in 2001 gave acquirers more discretion to include the value of intangible assets like goodwill in the book value of companies they are acquiring. These changes also required businesses to revalue acquired companies at regular intervals. If the company has declined in value, the acquirer must impair (or write down) the acquired goodwill.

At the time of a business merger, goodwill accounting might not seem like it’s that important. However, it’s critical that goodwill accounting be done properly in a business acquisition. Otherwise, a number of different problems can arise, including:

§ Disputes between the owners of the acquiring and acquired businesses. These disputes can lead to potential litigation down the road.

§ Decreased efficiency, lower profits and lost opportunities. These are a result of the business not running at peak capacity while disputes are being resolved.

§ Lower worker productivity as employees inevitably get drawn into the disputes.

§ Inequitable and unexpected liability assumed by one party. Both sides must be specific about the assets and liabilities to be transferred — for example, by spelling them out, assigning a proper cut-off date, and not adding additional items after the fact.

§ Wasted legal and valuation resources along with legal problems and issues. A valuation of the target company should be obtained upfront as part of the acquisition accounting, not after the fact to justify the accounting.

How an Outsourced CFO Can Help

An outsourced CFO services provider can help with accounting for goodwill as part of an acquisition. Such a provider has experience in mergers and acquisitions and knows what the acquisition agreement should look like and what needs to be done from an accounting perspective. An outsourced CFO will make sure everything is clearly spelled out, documented and properly archived so there are no outstanding issues left to chance. He or she will understand the more complex issues involved in the merger and thus can help ensure that acquirers negotiate the most favorable deal possible.

Engaging the services of an outsourced CFO for help in goodwill acquisition accounting can result in a number of positive outcomes. For example:

§ Management can focus on running the newly acquired business and integrating it into existing operations, not rehashing the acquisition.

§ Ownership and shareholder disputes are minimized or eliminated, thus eliminating distractions for both management and employees.

§ Unnecessary legal and other professional expenses down the road may be reduced or eliminated with the proper acquisition agreement, backed up by the proper accounting, in place from the beginning.

§ Equity fundraising or even a potential future sale of the company are not encumbered due to legal actions (or the threat of them).

Concluding Thoughts

Businesses face many different challenges when acquiring other companies, including how to handle the accounting associated with goodwill. At the time of a business merger, goodwill accounting might not seem like it’s that important, but it’s critical that goodwill accounting be done properly in a business acquisition. An outsourced CFO services provider can help with accounting for goodwill as part of an acquisition by making sure everything is clearly spelled out, documented and properly archived so no outstanding issues are left to chance.

© 2011-2021 CFO Edge, LLC – This article is only for general information and should not be used in lieu of professional advice.

Assessments and tests for goodwill impairment can be left until the end of the reporting period.
Vincent Ryan

Private companies and nonprofit organizations got some breathing room on goodwill accounting this week. The Financial Accounting Standards Board published an update to U.S. accounting rules that allows private companies and nonprofits to only test for goodwill impairments at the time they are closing their books, instead of when triggering events occur.

The accounting standards update (ASU) provides an accounting alternative that allows private companies and not-for-profit organizations to perform a goodwill triggering event assessment, and any resulting test for goodwill impairment, as of the end of the reporting period, whether the reporting period is an interim or annual period.

Under current generally accepted accounting principles (GAAP), goodwill must be tested for impairment when a triggering event occurs that indicates that it is more likely than not that the fair value of the reporting unit is below its carrying value. Companies and organizations are required to monitor for and evaluate goodwill triggering events when they occur throughout the year.

But some stakeholders raised questions about the value of evaluating a triggering event at an interim date when certain private companies and not-for-profit organizations only issue GAAP-compliant financial statements on an annual basis, FASB said.

“They noted the cost and complexity of preparing interim balance sheets and projecting cash flows that, according to those stakeholders, may not be relevant at the annual reporting date when financial statements are issued,” added FASB.

The amendments in the ASU are effective on a prospective basis for fiscal years beginning after December 15, 2019. Early adoption is permitted for both interim and annual financial statements that have not yet been issued or made available for issuance as of March 30, 2021.

FASB is in the middle of a project that would change how all entities account for goodwill and identifiable intangible assets. The majority of the board, FASB chair Richard Jones told CFO this month, is interested in pursuing an amortization with impairments model. If the standard moves in that direction, FASB could also change how issuers test for impairments, Jones said.

Many comments on FASB’s proposal have noted the important signals the current impairment testing model provides to investors, in particular the insight it may give into management’s skill and ability.

“One user noted that the initial valuation and subsequent stewardship of goodwill is one of the most useful ways to assess strategic judgment and management skill, including whether management overpaid or failed to realize predicted synergies,” said FASB in a document summarizing comments it received.

Brian Beers is a digital editor, writer, Emmy-nominated producer, and content expert with 15+ years of experience writing about corporate finance & accounting, fundamental analysis, and investing.

What Is Goodwill and How Does It Increase Corporate Value?

Business goodwill is an intangible asset owned by and associated with the operation of a company. Goodwill is the premium that is paid when a business is acquired. If a business is acquired for more than its book value, the acquiring business is paying for intangible items such as intellectual property, brand recognition, skilled labor, and customer loyalty.

Key Takeaways:

  • Business goodwill is an intangible asset that adds value to a company.
  • Factors such as proprietary or intellectual property and brand recognition are reflected in goodwill.
  • While goodwill is not easily quantifiable, it is calculated by subtracting the difference between the fair market value of a company’s assets and liabilities from its purchase price.
  • Companies must record the value of goodwill on their financial statements and record any impairments.

Understanding Goodwill and Its Effects on Corporate Value

Factors such as proprietary or intellectual property and brand recognition are reflected in goodwill. While goodwill is not easily quantifiable, it can be calculated by taking the purchase price of a company and subtracting the difference between the fair market value of the assets and liabilities. In fact, companies are required to record the value of goodwill on their financial statements and record any impairments. While intangible assets typically have a finite useful life, goodwill is considered indefinite.

The presence of goodwill implies that a company’s value is greater than its combined raw assets. The effect of goodwill on a company’s value is better understood by learning the factors that create business goodwill. The three factors in the creation of a company’s goodwill include its going concern value, excess business income, and the expectation of future economic benefits.

  1. The going concern value indicates that the company can produce income by applying existing capital (equipment, employees, management, and resources) effectively.
  2. The excess business income implies that a company is earning additional income due to the presence of its goodwill.
  3. The overall value further increases when expectations for economic growth are added to the equation. A company is expected to attract new customers and create more products, resulting in combined wealth.

How Business Goodwill Is Determined

A business’s goodwill is caluculated by subtracting the fair market value of the tangible assets from the total business value. Business goodwill is also determined by the capital surplus earnings method, which calculates the fair market value of the business assets, determines the fair rate of return on said assets, and subtracts the return from the company’s total earnings. The resulting excess earnings are considered the goodwill of the company.

Example of a Goodwill Calculation

Company A acquires company B for $4 million. Company B has assets equaling $2.8 million and liabilities equaling $400,000. The net assets of Company B are $2.8 million minus $400,000, which equals $2.4 million.

Goodwill equals $1,600,000, or $4 million minus $2.4 million.

Thus, company A paid $1,600,000 premium above the company’s net assets to acquire its assets, which add to its earning power. The goodwill account is located in the assets section of the balance sheet.

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What is Goodwill Amortization?

Goodwill amortization refers to the gradual and systematic reduction in the amount of the goodwill asset by recording a periodic amortization charge. The accounting standards allow for this amortization to be conducted on a straight-line basis over a ten-year period. Or, if one can prove that a different useful life is more appropriate, the amortization can be over a smaller number of years. The goodwill amortization alternative only applies to privately held entities.

If a business elects to amortize goodwill, it has to keep doing so for all existing goodwill, and also for any new goodwill related to future transactions. That means an organization cannot selectively apply amortization to the goodwill arising from just specific acquisitions. Thus, company management needs to commit to the amortization concept entirely, which many organizations may be reluctant to do.

If this option is chosen, there will be a large amortization charge that offsets profits for a long time. This means that the users of a company’s financial statements should be educated about the impact of amortization on reported results. Otherwise, the company will appear to be reporting worse results than its competitors.

Problems with Goodwill Amortization

The one catch to using amortization is that a business must also conduct impairment testing, but only if there’s a triggering event indicating that the fair value of the entity has dropped below its carrying amount. And, you can choose to test for impairment only at the entity level, not for individual reporting units. Since the ongoing amortization of goodwill is going to keep dropping the carrying amount of the entity over time, this means the likelihood of an impairment test is going to decline as time goes by. And since impairment testing is only at the entity level, there’s even less work involved in whatever amount of residual impairment testing there might be.

Reporting of Goodwill Amortization

There are reporting requirements associated with goodwill amortization. On the balance sheet, the amount of goodwill net of any accumulated amortization and impairment charges must be presented. This is the same logic we use in presenting fixed assets. And in the income statement, goodwill amortization is presented within continuing operations, unless it is associated with a discontinued operation – and in that case, it is presented with the results of the discontinued operation.

Prableen Bajpai is the founder of FinFix and Analytics Private Limited. She has 10+ years of experience as a finance, cryptocurrency, and trading strategy expert.

Goodwill vs. Other Intangible Assets: An Overview

One of the concepts that can give non-accounting (and even some accounting) business folk a fit is the distinction between goodwill and other intangible assets in a company’s financial statements.

Perhaps the confusion is to be expected. After all, goodwill denotes the value of certain non-monetary, non-physical resources of the business, and that sounds like exactly what an intangible asset is.

However, many factors separate goodwill from other intangible assets, and the two terms represent separate line items on a balance sheet.

Key Takeaways

  • Customer loyalty, brand reputation, and other non-quantifiable assets count as goodwill.
  • Intangible assets are those that are non-physical, but identifiable, such as a company’s proprietary technology (computer software, etc.), copyrights, patents, licensing agreements, and website domain names.
  • While “goodwill” and “intangible assets” are sometimes used interchangeably, there are significant differences between the two in the accounting world.

Goodwill

Goodwill is a miscellaneous category for intangible assets that are harder to parse out individually or measured directly. Customer loyalty, brand reputation, and other non-quantifiable assets count as goodwill.

A company’s record of innovation and research and development and the experience of its management team are often included, too. Goodwill cannot exist independently of the business, nor can it be sold, purchased, or transferred separately. As a result, goodwill has a useful life which is indefinite, unlike most of the other intangible assets.

Goodwill only shows up on a balance sheet when two companies complete a merger or acquisition. When a company buys another firm, anything it pays above and beyond the net value of the target’s identifiable assets becomes goodwill on the balance sheet.

Say a soft drink company was sold for $120 million; it had assets worth $100 million and liabilities of $20 million. The sum of $40 million that was paid over and above $80 million (the value of the assets minus the liabilities) is the worth of goodwill and is recorded in the books as such.

Look at this example of an assets section of a balance sheet. Goodwill is a separate line item from intangible assets.

Current Assets
Cash $300,000
Investments $200,000
Inventory $150,000
Non-current Assets
Property, plant, and equipment $600,000
Goodwill $200,000
Intangible Assets $150,000

Other Intangible Assets

There’s also a key distinction in how the two asset classes are amended once they’re on the books. Because assets tend to lose some of their value over time, companies sometimes have to make periodic write-downs.

Intangible assets are amortized, which means a fixed amount is marked down every year, resulting in a simultaneous charge against earnings. The amortization amount is adjusted if the asset’s value is impaired at some point after its acquisition or development.

Key Differences

While “goodwill” and “intangible assets” are sometimes used interchangeably, there are significant differences between the two in the accounting world.

Goodwill is a premium paid over the fair value of assets during the purchase of a company. Hence, it is tagged to a company or business and cannot be sold or purchased independently, whereas other intangible assets like licenses, patents, etc. can be sold and purchased independently.

Goodwill is perceived to have an indefinite life (as long as the company operates), while other intangible assets have a definite useful life.

Special Considerations

The Financial Accounting Standards Board (FASB) recently came up with a new alternative rule for the accounting of goodwill. For a long time, it could be amortized over a period of 40 years. A 2001 ruling decreed that goodwill could not be amortized, but must be evaluated annually to determine impairment loss; this annual valuation process was expensive as well as time-consuming.

Now, as per the alternative FASB rule for private companies (2014) (expanded in 2017 for public companies), goodwill can be amortized on a straight-line basis over a period not to exceed 10 years. The need to test for impairment has decreased; instead, an impairment charge is recorded when some event occurs that signals that the fair value may have gone below the carrying amount.

These rules apply to businesses conforming to generally accepted accounting principles (GAAP) using a full accrual accounting method. If conditions indicate that the carrying value may not be recoverable, then tests for impairment are performed.

If there is no impairment, goodwill can remain on a company’s balance sheet indefinitely.

Small businesses using cash-basis accounting or modified cash-basis accounting can use the statutory rates set by the Internal Revenue Service (IRS). The IRS allows for a 15-year write-off period for the intangibles that have been purchased. There is a lot of overlap as well as the contrast between the IRS and GAAP reporting.

Assessments and tests for goodwill impairment can be left until the end of the reporting period.
Vincent Ryan

Private companies and nonprofit organizations got some breathing room on goodwill accounting this week. The Financial Accounting Standards Board published an update to U.S. accounting rules that allows private companies and nonprofits to only test for goodwill impairments at the time they are closing their books, instead of when triggering events occur.

The accounting standards update (ASU) provides an accounting alternative that allows private companies and not-for-profit organizations to perform a goodwill triggering event assessment, and any resulting test for goodwill impairment, as of the end of the reporting period, whether the reporting period is an interim or annual period.

Under current generally accepted accounting principles (GAAP), goodwill must be tested for impairment when a triggering event occurs that indicates that it is more likely than not that the fair value of the reporting unit is below its carrying value. Companies and organizations are required to monitor for and evaluate goodwill triggering events when they occur throughout the year.

But some stakeholders raised questions about the value of evaluating a triggering event at an interim date when certain private companies and not-for-profit organizations only issue GAAP-compliant financial statements on an annual basis, FASB said.

“They noted the cost and complexity of preparing interim balance sheets and projecting cash flows that, according to those stakeholders, may not be relevant at the annual reporting date when financial statements are issued,” added FASB.

The amendments in the ASU are effective on a prospective basis for fiscal years beginning after December 15, 2019. Early adoption is permitted for both interim and annual financial statements that have not yet been issued or made available for issuance as of March 30, 2021.

FASB is in the middle of a project that would change how all entities account for goodwill and identifiable intangible assets. The majority of the board, FASB chair Richard Jones told CFO this month, is interested in pursuing an amortization with impairments model. If the standard moves in that direction, FASB could also change how issuers test for impairments, Jones said.

Many comments on FASB’s proposal have noted the important signals the current impairment testing model provides to investors, in particular the insight it may give into management’s skill and ability.

“One user noted that the initial valuation and subsequent stewardship of goodwill is one of the most useful ways to assess strategic judgment and management skill, including whether management overpaid or failed to realize predicted synergies,” said FASB in a document summarizing comments it received.

Accounting CPE Courses & Books

What is Goodwill Amortization?

Goodwill amortization refers to the gradual and systematic reduction in the amount of the goodwill asset by recording a periodic amortization charge. The accounting standards allow for this amortization to be conducted on a straight-line basis over a ten-year period. Or, if one can prove that a different useful life is more appropriate, the amortization can be over a smaller number of years. The goodwill amortization alternative only applies to privately held entities.

If a business elects to amortize goodwill, it has to keep doing so for all existing goodwill, and also for any new goodwill related to future transactions. That means an organization cannot selectively apply amortization to the goodwill arising from just specific acquisitions. Thus, company management needs to commit to the amortization concept entirely, which many organizations may be reluctant to do.

If this option is chosen, there will be a large amortization charge that offsets profits for a long time. This means that the users of a company’s financial statements should be educated about the impact of amortization on reported results. Otherwise, the company will appear to be reporting worse results than its competitors.

Problems with Goodwill Amortization

The one catch to using amortization is that a business must also conduct impairment testing, but only if there’s a triggering event indicating that the fair value of the entity has dropped below its carrying amount. And, you can choose to test for impairment only at the entity level, not for individual reporting units. Since the ongoing amortization of goodwill is going to keep dropping the carrying amount of the entity over time, this means the likelihood of an impairment test is going to decline as time goes by. And since impairment testing is only at the entity level, there’s even less work involved in whatever amount of residual impairment testing there might be.

Reporting of Goodwill Amortization

There are reporting requirements associated with goodwill amortization. On the balance sheet, the amount of goodwill net of any accumulated amortization and impairment charges must be presented. This is the same logic we use in presenting fixed assets. And in the income statement, goodwill amortization is presented within continuing operations, unless it is associated with a discontinued operation – and in that case, it is presented with the results of the discontinued operation.