Determining how to account for goodwill found in business combinations has been a hotly debated topic for decades. Standard setters have published many different approaches over time, and over the past decade the FASB has issued several guidance aimed at streamlining the current impairment model. The authors explain how a new proposal has brought the issue back into the limelight and analyze the potential impact of a return to the amortization method on financial reporting.
Finding an optimal solution for accounting for business combinations, particularly the treatment of goodwill, continues to pose challenges for accounting standard setters. In 2001, the FASB issued Statement of Financial Accounting Standards (SFAS) 141,business combinations,which, among other things, abolished the method of pooling of interests. Simultaneously SFAS 142,goodwill and other intangible assets,replaced the requirement to amortize goodwill with a periodic impairment test. Over the past eight years, multiple Accounting Standards Updates (ASU) have modified and relaxed the original requirements of SFAS 141 and 142.
In a new Request for Comment (ITC), "Identifiable Assets and Subsequent Accounting for Goodwill," the FASB asked for additional comment and input on whether the benefits of the current goodwill impairment accounting model outweigh the cost of preparing and auditing the information for public Companies justify companies, and if not, whether some form of goodwill amortization should be considered. While the ITC raises questions about the current goodwill impairment model, it does not mean that the FASB has made a final decision to revert to the amortization approach; rather, the FASB has received mixed feedback from constituents, preparers and assessors on the current impairment approach and is seeking comment on whether it should address changes to the current model. This article provides background on GAAP goodwill accounting, the current issues being discussed at the ITC, and the potential financial statement implications of a return to the public company depreciation model.
The further development of goodwill accounting
The treatment of goodwill has been a contentious and much-debated topic in accounting for well over a century. (For a detailed history see Hugh P. Hughes,Goodwill in Accounting: A History of the Issues and ProblemsGeorgia State University, 1982.) Historians have noted cycles in US history in which the nation swings in one political direction and then swings back in the opposite direction over time. As a political process, the setting of accounting standards is not free from these cycles. Not unexpectedly, the FASB and its predecessors in establishing GAAP, the Committee on Accounting Procedure (CAP) and the Accounting Principles Board (APB), have all grappled with the initial and subsequent treatment of goodwill and have come to slightly different conclusions. (For more information, see David A. Rees and Troy D. Janes, "The Continuing Evolution of Accounting for Goodwill,"Das CPA-Journal,January 2012,http://bit.ly/2OIZnfj.) Although there have been minor differences in initial measurement as GAAP has evolved into goodwill, the basic concept has remained the same: goodwill is the difference between the price paid for an acquired business and the total fair value Fair value of identifiable net assets . However, post-accounting for goodwill remains a hotly debated topic, as evidenced by the recent ITC.
The treatment of goodwill has changed between the issuance of Accounting Research Bulletin 24 (ARB 24),accounting for intangible assets,in 1944 and the publication of SFAS 142 in 2001. ARB 24 essentially permitted the following procedures for the subsequent accounting of goodwill:
- Perpetual preservation as an asset
- Systematic amortization of profit, retained earnings or capital reserves
- An immediate charge to retained earnings or capital reserves.
While ARB 24 discouraged the practice of discretionary goodwill amortization, it did not prohibit such amortization.
In Chapter 5 of ARB 43,restatement and revision of accounting research bulletins,Published in 1953, CAP prohibited the arbitrary amortization of goodwill and the immediate charging of goodwill against equity. Although ARB 43 still permitted the permanent preservation of goodwill, this approach was not favoured; instead, the systematic amortization affecting net income was the emphasized approach for subsequent goodwill accounting. In 1970, CAP's successor, the APB, issued Opinion 17,intangible assets,This eliminated the retention (asset) approach and the goodwill had to be amortized through profit or loss on a straight-line basis over a maximum period of 40 years unless another method was shown to be more appropriate. APB Opinion 17 also required an ex post write-off review. In choosing to amortize goodwill, the APB noted: “Amortization of the cost of goodwill and similar intangible assets on an arbitrary basis without evidence of finite useful life or reduced value may recognize expenses and depreciation early, but amortization of cost up to a Losses are obvious, the declines can be seen retrospectively.”
In 2001, the successor to the APB, FASB, issued SFAS 142, which replaced APB Opinion 17's requirement for amortization of goodwill with a periodic impairment testing approach. According to SFAS 142, there are two steps in the impairment test:
- First, the entity compares the fair value of the reporting unit to its book value (Step 1).
- Second, if the fair value is lower, the entity must calculate an impairment of goodwill by comparing the implied fair value of goodwill to its carrying amount (Step 2).
If the calculated implied fair value of goodwill is less than its carrying amount, the entity recognizes an impairment loss for the difference. In arriving at this approach, the FASB noted that "amortizing goodwill on a straight-line basis over any period of time does not reflect economic reality and therefore does not provide useful information."
After the issuance of FASB 142, the FASB received feedback from stakeholders indicating that the cost of performing the impairment test outweighed the benefits. The FASB responded by issuing several ASUs to alleviate the burden. In 2011, it issued ASU 2011-08,Intangible Assets – Goodwill and Other (Item 350): Testing of Goodwill for Impairment,which provides an option where an entity can choose to assess impairment based on qualitative factors (Step 0). The entity is not required to perform the two-stage impairment and calculate the fair value of the reporting unit and thus bear the associated costs unless it determines that its fair value is more likely to be less than its carrying amount. To further reduce the cost and complexity of goodwill impairment testing, the FASB issued 2017 ASU 2017-04,Intangible Assets – Goodwill and Other (Item 350): Simplifying the Goodwill Impairment Test,thereby eliminating step 2 of the quantitative two-step impairment test, the calculation of implied goodwill. Instead, entities recognize an impairment based on the excess of the carrying amount of a reporting unit's goodwill over its fair value.
The amendments in ASU 2011-08 and ASU 2017-04 both fall within the scope of the non-amortization approach originally advocated by the FASB in SFAS 142; however ASU 2014-02,Intangible Assets – Goodwill and Other (Item 350): Accounting for Goodwill (A Private Company Council Consensus), contains significant changes in the subsequent accounting of goodwill. Specifically, ASU 2014-02 allows private companies the option to amortize goodwill over 10 years.
In summary, over the past eight years, in response to concerns about the costs and benefits of the non-amortization approach, the FASB has modified and relaxed the original requirements of its non-amortization approach, allowing private companies the option of using the non-amortization approach to be used instead of the impairment test. The pendulum seems to be swinging back towards amortization.
The invitation to comment
In July 2019, due to mixed feedback on the costs and benefits of the current goodwill accounting model, the FASB issued an invitation to comment on Identifiable Assets and Subsequent Accounting for Goodwill. The ITC is seeking input on the costs and benefits of the current goodwill accounting model and whether the FASB -
- change the subsequent accounting for goodwill;
- change the recognition of intangible assets in a business combination; or
- Change information on goodwill and intangible assets.
The ITC makes it clear that the FASB does not seek input on the conceptual basis for the recognition of goodwill or the immediate amortization of goodwill.
With respect to post-accounting for goodwill, the FASB notes that there are two non-mutually exclusive approaches that can resolve the cost-benefit issue: amortizing goodwill or simplifying the goodwill impairment test goodwill. In the ITC, the FASB states: "Assuming that there is a cost-benefit issue in subsequently accounting for goodwill, one approach to solving the issue would be to amortize goodwill for PBEs [Public Business Entities ] to be reintroduced.” In addition, the ITC is asking for feedback on the appropriate payback period. The ITC notes that goodwill amortization methods generally have at least one of the following characteristics, and these characteristics affect the costs and benefits of alternative depreciation approaches:
- A default period
- A cap (or maximum) on the payback period
- A reasonable estimate
- Justification for the period.
The ITC also seeks information on the length of any downtime that the FASB may require, noting that some stakeholders support amortizing goodwill over a 10-year downtime. While the ITC notes that the FASB is only soliciting input and has made no decisions, the extensive focus on amortization, the filing of other issues, and the discussion of the pros and cons of various amortization approaches seem to indicate that the FASB is on the way the directive to require or allow the possibility of depreciation for public companies.
As this article went to press, the FASB had received 89 comments on the ITC, with 48 letters supporting the goodwill amortization, 37 opposed, and four with mixed views. Most respondents in favor of depreciation were accountants and preparers, while most users, academics, and rating firms were mainly opposed.
Potential impact of depreciation on the financial statements
The FASB's decision to reconsider the accounting for subsequent measurement of goodwill comes as goodwill balances on public company balance sheets are at record levels. Recent studies have found that more than $1 trillion in goodwill was included on the balance sheets of publicly traded companies in calendar years 2015-2017, a significant increase compared to previous years (for more details see the2016,2017, and2018 U.S. Goodwill Impairment-Studienvon Duff & Phelps,http://bit.ly/2Bdm3wm). In addition, another recent study found that the amount of purchase price allocated to goodwill has increased in recent years, from an average allocation of 36% in 2016 to 40% in 2017 (for more details see thePurchase price allocation study 2017von Houlihan Lokey, 2018,http://bit.ly/33wZGhr). If the FASB were to revert to a model that systematically amortizes goodwill, the analysis below shows that the impact would likely be material on many companies' financial statements and key financial measures.
exhibition 1presents an industry-wide summary of goodwill as a percentage of a company's total assets for S&P 500 members reporting a non-zero goodwill balance for 2018. Overall, goodwill amounts to 20.3% (18.1%) of total assets on average (median). In the services and manufacturing sectors, goodwill accounts for the largest share of total assets (median 33.9% and 23.7% respectively). In the finance, insurance and real estate group, on the other hand, goodwill makes up a median of less than 4% of total assets.
Goodwill as a Percentage of Total Assets, by Industry, 2018
exhibition 2presents a list of the S&P 500 companies with the largest goodwill balances. Historically, these are very acquisition-heavy companies with goodwill balances ranging from $31.3 billion to $146.4 billion and total goodwill balances in excess of $1.1 trillion. For example, the largest goodwill balance in the sample belongs to AT&T, which acquired Time Warner and Direct TV in recent years, each at a significant premium to the total fair value of identifiable net assets ($38.6 billion and 34. allocated US$4 billion). to goodwill). While the companies listed inexhibition 2have the largest dollar-sized goodwill balances, however, their goodwill balances vary widely as a percentage of total assets, ranging from 1.8% to 45.0%.
The 20 Largest Goodwill Balances Reported by S&P 500 Companies, by Dollar Size, 2018 (Billions in Dollars)
exhibition 3presents a list of S&P 500 companies with the highest proportion of goodwill to total assets, ranging from 51.0% to 61.3%. Of the 20 companies in the list, most offer technology-related products and services (commonly associated with the two-digit SIC codes 35, 36, and 73). As the proportion of a company's goodwill to total assets increases, its earnings-based financial measures would become more sensitive to a potential accounting change where subsequent measurement of goodwill includes amortization.
Top 20 Goodwill Balances Reported by S&P 500 Companies, by % of Total Assets, 2018 (Billions in Dollars)
exhibits 4,5, and6summarize the impact that reintroducing goodwill amortization would have on the S&P 500.exhibition 4presents an analysis of the key balance sheet ratios for each industry group and the overall sample. The two metrics selected are Return on Assets (ROA) and Basic Earnings Per Share (EPS) and a comparison is made between the metrics calculated based on the values reported in the companies' financial statements (as reported) and a hypothetical goodwill amortization expense (pro forma) in the figures calculated after adjustment. The goodwill amortization calculations used to determine the pro forma percentages and per share amountsexhibits 4,5, and6assume that goodwill will be amortized on a straight-line basis over 10 years consistent with the guidance in ASU 2014-02. In addition, pro forma percentages and per share amounts are presented inexhibits 4,5, and6Ignore any deferred tax implications that might arise from deals structured as asset purchases under Internal Revenue Code (IRC) Section 338.
Impact of pro forma goodwill amortization on key financial metrics, by industry, 2018
Impact of Pro Forma Goodwill Amortization on S&P 500 Companies with Largest Reported Goodwill Balances, 2018
Impact of pro forma goodwill amortization on S&P 500 companies with the largest proportions of goodwill to total assets, 2018
For the ROA comparison, the change for the overall sample is an average decrease of 2.6%, from an average of 6.2% (as reported) to an average of 2.6% (pro forma). Likewise, for the EPS comparison, the change for the full sample is an average decrease of $1.20 per share, from an average of $3.84 per share (as reported) to $2.64 per share (pro forma). Overall, an accounting policy change that reintroduces amortization as part of subsequent goodwill measurement would result in the average S&P 500 company reporting 42% lower ROA and 31% lower annualized EPS.
exhibits 5and6further illustrate the impact of reintroducing goodwill amortization on financial metrics.exhibition 5presents an analysis of the impact a goodwill writedown would have on S&P 500 companies with the largest dollar-sized goodwill balances. For these 20 companies, there is a 2.7% decrease in average ROA, from an average of 2.6% (as reported) to an average of -0.1% (pro forma). Similarly, there is a decline in average earnings per share of $3.47 per share, from an average of $2.45 per share (as reported) to an average of -$1.02 per share (pro forma).
exhibition 6contrasted as reported and pro forma ratio calculations, in this case for S&P 500 companies with the largest share of goodwill in total assets. For these 20 companies, the average ROA is down 5.4%, from an average of 6.9% (as reported) to an average of 1.5% (pro forma). There is a comparatively sharp drop in average earnings per share of $3.85 per share, from an average of $5.34 per share (as reported) to an average of $1.49 per share (pro forma).
signs of the future
Since the publication of APB 24 in 1944, the subsequent accounting of goodwill has been constantly discussed and significantly developed. The FASB's recent ITC and the changes made with the recent ASUs underscore the strong possibility of a return to goodwill amortization. A review of the current goodwill carried on the balance sheets of S&P 500 companies shows, as might be expected, that there would be a significant decline in companies' earnings and earnings-based financial measures if the FASB reinstated goodwill amortization. With such a potentially significant impact on the financial statements, the possibility of a return to amortization raised in the ITC is likely to attract intense comment and discussion from preparers, users and auditors.
Luis Betancourt, PhD, CPA is Professor of Accounting and BDO Faculty Fellow at James Madison University, Harrisonburg, Virginia.
James H. Irving, PhD, CPA is an Associate Professor of Accounting and a Keiter Faculty Fellow at James Madison University.
What are the challenges in calculating goodwill? ›
Goodwill can be challenging to determine its price because it is composed of subjective values. Transactions involving goodwill may have a substantial amount of risk that the acquiring company could overvalue the goodwill in the acquisition and ultimately pay too much for the entity being acquired.How do you solve goodwill in accounting? ›
One of the simplest methods of calculating goodwill for a small business is by subtracting the fair market value of its net identifiable assets from the price paid for the acquired business. Goodwill is an intangible asset that arises when a business is acquired by another.What is goodwill in accounting quizlet? ›
The specific meaning of goodwill in accounting is: The amount by which a company's value exceeds the value of its individual assets and liabilities.What journal entries are passed when goodwill is opened and written off? ›
On retirement of a partner, goodwill appears in the balance sheet , it will be written-off by debiting the capital accounts of partners.What is the journal entry when goodwill is raised and written off? ›
When Goodwill is raised at its full value and it is written off Goodwill account is to be credited.Why is it difficult to account for goodwill? ›
Goodwill is hard to count on because its value can come from abstract and often unreliable things, like ideas and people, neither of which are guaranteed to work for a company forever. Determining goodwill also involves some time to work around accounting conventions.Why is it difficult to calculate goodwill? ›
Goodwill is an intangible asset that accounts for the excess purchase price of another company. Items included in goodwill are proprietary or intellectual property and brand recognition, which are not easily quantifiable.What are the factors affecting goodwill in accounting? ›
- Location of business.
- Quality of goods and services.
- Efficiency of management.
- Business risk.
- Nature of business.
- Favourable contracts.
- Possession of trademark and patents.
Goodwill Meaning in Accounting
Goodwill arises when a company acquires another entire business. The amount of goodwill is the cost to purchase the business minus the fair market value of the tangible assets, the intangible assets that can be identified, and the liabilities obtained in the purchase.
Goodwill means the aggregate of those intangible attributes of a business which contributes to its superior earning capacity over a normal return on investments. Concept: Basic Accounting Terminologies.
What is the formula for goodwill? ›
Goodwill Formula = Consideration paid + Fair value of non-controlling interests + Fair value of equity previous interests – Fair value of net assets recognized.What are the two types of goodwill in accounting? ›
- Purchased Goodwill. Purchased goodwill comes around when a business concern is purchased for an amount above the fair value of the separable acquired net assets. ...
- Inherent Goodwill.
By recording goodwill, you ensure that the books are balanced during and after an acquisition. The concept of goodwill is also useful outside of accounting for valuation purposes. It's used to refer to any value built up within the company due to intangible factors like customer service and teamwork.What are accounting characteristics of goodwill? ›
Among the factors that define goodwill are brand recognition, a solid customer base, good customer relations, good employee relations, and proprietary technology. In accounting, goodwill is an increase in value over the company's assets minus its liabilities.What is the journal entry of goodwill retained in the business? ›
The amount of goodwill brought in by the incoming partner is taken to the books of account. The existing partners apportion the goodwill among themselves in the sacrificing ratio. The amount is retained in the business as additional working capital.When goodwill does not appear in the books journal entry? ›
Case 1: When goodwill does not appear in the books:
The remaining partner's capital account is debited in the gaining ratio, and the retiring partner's capital a/c is credited with the share of goodwill.
When Goodwill Is Written Off, Goodwill A/C Is Debited To All Partner Capital Account In New Profit Sharing Ratio.When should goodwill be written off? ›
If goodwill has been assessed and identified as being impaired, the full impairment amount must be immediately written off as a loss. An impairment is recognized as a loss on the income statement and as a reduction in the goodwill account on the balance sheet.What does it mean when goodwill is written off? ›
The excess purchase price is recorded on the buying company's accounts as goodwill. If it becomes apparent that the purchased asset no longer has the value recorded in the goodwill account (i.e., if the asset cannot be resold at the same price), the value in the goodwill asset account is "written down".What happens when you write off goodwill? ›
If the goodwill amount is written down after the acquisition, it could indicate that the buyout is not working out as planned. In short, goodwill impairment is a message to the markets that the value of the acquired assets has fallen below the amount that the company initially paid.
What is the conclusion of goodwill in accounting? ›
The goodwill represents the future economic benefits arising from the assets that are not capable of being individually identified and separately recognized and includes: the custom, the rights in the goodwill, reputation of business product, the trademark and other intangible elements.
As it involves intangible assets, recording goodwill on financial statements such as balance sheets requires listing them as “noncurrent assets”. This represents an asset that counts as a long-term investment whose full value cannot be realised within the current financial year.How does goodwill affect financial statements? ›
"Goodwill" on a company's balance sheet represents value that the company gained when it acquired another business but that it can't assign to any particular asset of that business. Goodwill doesn't always affect a company's net income, but if that goodwill becomes "impaired," the effect can be substantial.What are the three methods of calculating goodwill? ›
- Average Profit Method. Goodwill's value in this method is considered by multiplying the Average Future profit by a certain number of year's purchase. ...
- Super Profit Method: ...
- Capitalization Method: ...
- Annuity Method:
There are four methods to calculate goodwill . In this method, we calculate previous year's profits average and then we multiply it with number of purchase years. In this method, we calculate normal profit with normal rate on investment. Then we calculate super profit with following formula.Which of the following factors not affecting the goodwill? ›
Here you can find the meaning of Following are the factors affecting goodwill except:a)Nature of businessb)Efficiency of managementc)Technical know howd)Location of the customersCorrect answer is option 'D'.What would cause a goodwill account to increase? ›
The only way goodwill can be increased is through the acquisition of another company as a subsidiary. Assume a business acquires a subsidiary for a price that exceeds the total value of the subsidiary's assets.
Favorable contracts and favorable location.What is a journal answer in one sentence? ›
A journal is a book in which transactions are recorded before they are entered into a ledger. The journal shows all purchases, sales, receipts, and deliveries of securities, and all other debits and credits. Transactions are periodically posted from the journal to ledger accounts.What is an example sentence for goodwill? ›
She has goodwill toward all her coworkers. They allowed him to keep the extra money as a gesture of goodwill.
What is the sentence of answer? ›
Verb She answered all my questions. He answered only three of the test questions correctly. When the police asked him his name, he refused to answer.What is goodwill name any four methods of calculating goodwill? ›
Goodwill valuation is the systematic evaluation of the company's goodwill to be shown in the company's balance under the head intangible assets. Top methods to value include the Average Profits Method, Capitalization Method, weighted average profit method, and the Super Profits Method.How do you calculate goodwill on the basis of profit? ›
In this method, the value of goodwill is calculated by multiplying the average estimated profit or average future profit with the number of years of purchase. Simple average: In the simple average method, the goodwill is calculated by multiplying the average profit with the agreed number of years of purchase.What is base of goodwill value? ›
The valuation of goodwill is often based on the customs of the trade and generally calculated as number of year's purchase of average profits or super-profits.What are the 2 features of goodwill? ›
The following are the features of goodwill:
Goodwill is an intangible asset. It is non-visible but it is not a fictitious asset. 2. It cannot be separated from the business and therefore cannot be sold like other identifiable and separable assets, without disposing off the business as a whole.
The double entry for this is therefore to debit the full market value to the goodwill calculation, credit the share capital figure in the consolidated statement of financial position with the nominal amount and to take the excess to share premium/other components of equity, also in the consolidated statement of ...What is goodwill in accounting journal? ›
In accounting, goodwill is an intangible asset recognized when a firm is purchased as a going concern. It reflects the premium that the buyer pays in addition to the net value of its other assets.What is goodwill and how is it recorded? ›
Goodwill is an intangible asset, meaning that it has no physical presence, but it adds value to the company. Goodwill is not always part of acquiring a business but needs to be recorded in your company's general ledger any time that the cost of purchasing a business exceeds the fair value of its assets and liabilities.When goodwill already appears in the books journal entry? ›
(5) When Goodwill is Already Appearing in the Books:
If the value of goodwill appearing in the books is higher, then the difference i.e. the excess value is debited to the old partners' capital account in their old profit sharing ratio and credit is given to goodwill account.
Goodwill is recorded when a company acquires (purchases) another company and the purchase price is greater than 1) the fair value of the identifiable tangible and intangible assets acquired, minus 2) the liabilities that were assumed. Goodwill is reported on the balance sheet as a long-term or noncurrent asset.
What is goodwill in accounting example? ›
To put it in a simple term, a Company named ABC's assets minus liabilities is ₹10 crores, and another company purchases the company ABC for ₹15 crores, the premium value following the acquisition is ₹5 crores. This ₹5 crores will be included on the acquirer's balance sheet as goodwill.
By recording goodwill, you ensure that the books are balanced during and after an acquisition. The concept of goodwill is also useful outside of accounting for valuation purposes. It's used to refer to any value built up within the company due to intangible factors like customer service and teamwork.What are the elements of goodwill in accounting? ›
Among the factors that define goodwill are brand recognition, a solid customer base, good customer relations, good employee relations, and proprietary technology. In accounting, goodwill is an increase in value over the company's assets minus its liabilities.What is the purpose of goodwill? ›
Goodwill® works to enhance the dignity and quality of life of individuals and families by strengthening communities, eliminating barriers to opportunity, and helping people in need reach their full potential through learning and the power of work.Which type of goodwill is recorded in the books of accounts? ›
As per 26 only purchase goodwill will be recorded in book of accounts When goodwill is purchase by the firm in a consideration in cash or kinds of cash it shown in the balance sheet.Why already existing goodwill is written off? ›
If the existing goodwill is not written off, it will have the effect of crediting partners with an excessive amount of goodwill. To put it in other words, if we want to carry forward existing goodwill in the books, then the value of existing goodwill should be deducted from the new value of goodwill.What happens when goodwill is written off? ›
When Goodwill Is Written-Off, Goodwill A/C Is Debited To All Partner Capital Account In New Profit Sharing Ratio.Why is goodwill credited when written off? ›
Goodwill A/c is credited as it will no longer be appearing in the books of accounts, we know, to decrease an asset, we Credit it.