Goodwill Essay, Research Paper

Abstract

Goodwill is an unidentifiable intangible asset that has always been a debatable issue when it arrives during financial reporting. The reason being that it is dependable on various factors, which are of a variable nature, for its value determination.

Nevertheless, it is an important asset that can not be neglected and has to be accounted for properly for realistic financial statements. Other than that, it plays an extremely crucial role in giving a competitive edge to companies against their foreign competitors. With no standard international methods and tax policies for accounting of goodwill, it becomes all the more controversial.

Introduction

This paper aims to discuss the following statement:

Goodwill is defined by AASB 1013 the future benefits from unidentifiable assets. Therefore, annual reports of Australian companies will always show the future benefits arising from the assets like the intellectual capital found in its people and processes or relationships with customers. Furthermore, it is useful to benchmark the goodwill reported by an Australian company against that reported by international competitors.

It also aims to understand the meaning and nature of goodwill and the accounting practices associated with it in Australia and around the world.

Understanding Goodwill

Goodwill is defined by AASB 1013 as the future benefits from unidentifiable assets. To discuss this statement and to understand the meaning of goodwill; it is important that we first determine what are unidentifiable (intangible) assets .

According to Henderson S. et al (1998: 316), Intangibles are those assets that represent future economic benefits to an organization due to its past transactions or other events. He has then categorized intangibles as identifiable such as patents, copyrights, trademarks etc or unidentifiable such as efficient employees, an established client database, a good public image etc. We will focus on unidentifiable intangible assets for the purpose of this discussion.

Bazley M. Et al (1999: 212), states that unidentifiable intangible assets are the benefits that flow to an organization from such things as good location, outstanding image in the market place or excellent customer relations. Goodwill is the name used to describe the future economic benefits which flow from the collection of all these unidentifiable assets.

Goodwill, according to Henderson S. et al (1998: 320), has been termed as K an entity s unidentifiable intangible assets. In his terms, these assets may include loyal and efficient employees, established clientele, suppliers who can be depended upon K

Thus, it can be said that Goodwill of a company is an asset that cannot be associated with any other asset and its value is a collection of all the favorable factors of a business that cannot be really put down on paper or shown as a materialistic commodity. So, they are all put together under goodwill enabling a firm to extract some favorable and cashable value out of them.

Due to its this unique characteristic and its variable constituents, most authors argue that goodwill should only be added in the balance sheet at the time of an arm s-length transaction , Henderson S. et al (1998: 319). He also states, pg. 320, that it is a generally agreed by accountants that goodwill should not be recognized in the accounts unless there is an arm s length purchase of one entity by another. Goodwill will appear as an asset on a balance sheet only when it was paid for in connection with the acquisition of another company , (www resource 1). Another supporting reason for this practice is that an appropriating value can only be determined at the time of the business being sold, Stanley P. (2000: 150). Therefore, based on the above evidence, I would like to differ from the essay s discussion statement, Kannual reports of Australian companies will always show the future benefits arising from assets like K . However, another perspective of this statement could be that the reason behind recording the future benefits and intangible assets will point out the healthy and solid standing of the business which can be gained only over time.

Definition of goodwill

Goodwill has been a source of controversies in the world of accounting since a long time.

However, there are two widely accepted definitions of the term now. These approaches are:

h Residuum approach

Under this method, goodwill is taken to be the difference between the purchase price and the fair market value of an acquired company s assets . (Www resource 2)

h Excess profits approach

Under this method, the present value of the projected future excess earnings over normal earnings for similar businesses is recorded as goodwill. Due to uncertainty of future earnings, valuing goodwill using this method is difficult . (Www resource 2)

The nature of goodwill

Since, goodwill has been a debatable issue in the world of financial reporting since early times, it is important to understand that the goodwill of a firm may fluctuate over various periods of time due to the factors that it depends on. Some of these factors other than the ones discussed earlier may be:

h The human resource pool of the firm

h The brand name value of the company s products and/or services

h The socio-economic environment in which the business exists.( Robbins, P. www resource 4)

Acquisition of goodwill

A natural question in one s mind while discussing goodwill is where does a firm gets its goodwill value. There are two ways by which goodwill can be acquired (www resource 3):

h Goodwill can be internally generated within a firm over a period of time owing to various factors such as favorable location, expert workforce, brand popularity of its products etc.

h Goodwill may also be acquired while purchasing a firm. This is purchased goodwill.

However, it is interesting to note that till date only purchased goodwill is allowed to be recorded, Hoggett J. et al (2000: 528)

Accounting methods for goodwill

There are four basic methods to account for goodwill. Different methods are currently practiced around the world in a singular or combined fashion. These four methods are:

h Write-off method

According to the write-off method, goodwill should be immediately written off against an account in the stockholders’ equity section, generally retained earnings. Arguments against this method state that it can lead to distorted results allowing goodwill to be overvalued (www resource 3). The method is practiced in many countries across the world including U.K., Japan, Hong Kong and Netherlands to name a few.

h Capitalization method

This method promotes the recording of goodwill on the balance sheet as an asset in conjunction to the fact that many believe goodwill to be an equally important asset as any other. At present, the value of goodwill for the purpose of accounting through this method is to follow residuum approach (www resource 3).

h Non-Amortization method

According to this approach, a company records goodwill as an asset instead of a writing it off in the stockholders equity section. This methods works on the assumption that goodwill does not decrease in value but increases thus should be viewed as an investment (www resource 3).

h Amortization method

This method allows companies to match the cost of intangible assets over a period deemed to benefit from their acquisition (www resource 3). Since the life of goodwill as an asset is undeterminable, different countries use different lengths of time as the amortization period. For example, the U.S. uses a period of 40 years for this purpose.

International accounting for goodwill

Now that we have seen the various methods that can be used alone or in combination with each other for the accounting of goodwill, let us see the different trends that various countries around the world and that of Australia to determine the last part of the discussion statement.

U.S. companies must capitalize and amortize goodwill against income for financial reporting purposes, and are not permitted a tax deduction for that amortization. (Www resource 6). The period for this amortization may be the life of the business, or 40 years; whichever is less.

The method for accounting for goodwill in the U.K. is to write it off against reserves in the stockholders’ equity section. U.K. also allows the option to capitalize and amortize goodwill but very few companies use that option. (Www resource 6)

Japanese firms get the option to both capitalize and amortize or immediately write off the goodwill. Though writing off is encouraged, goodwill is tax deductible in both cases. (Www resource 6)

The Canadians use the same rules as the Americans except that tax deduction is allowed in Canada. (Www resource 6)

In Australia, capitalization and amortization over its determinable life is recommended. For tax purposes, no goodwill amortization deduction is allowed. However, most companies immediately write off goodwill to stockholders’ equity, keeping with the common practice of going against official accounting standards if they do not agree with them. (Www resource 6)

Conclusion

To summarize it all, we have discussed the need to understand goodwill as an unidentifiable asset, its accepted definitions, the nature of goodwill, ways of acquiring it, the methods by which it can be accounted for and the various approaches used worldwide regarding its accounting.

Bibliography

Henderson, S. and Pierson, G., 1998, Issues in Financial Accounting, Eight Edition, Longman, Australia.

Bazley, M., Hancock, P., Berry, A., Jarvis, R., 1999, Contemporary Accounting: A conceptual approach, Third Edition, Nelson ITP, U.K.

Hoggett, J. and Edward, L., 2000, Accounting in Australia, Fourth Edition, John Wiley & Sons, Australia.

Stanley, P., 2000, How to read and understand Balance sheets and Financial reports in the new millennium, New edition, Brown Prior Anderson, Australia.

Net Resources

1 http://www.mhhe.com/business/accounting/spiceland/courseresources/ec-goodwill.html

2http://www.themanagementor.com/EnlightenmentorAreas/Finance/contentF_AccGoodwill.asp

3 http://home.att.net/ s-prasad/GW.htm

4 http://www.acca.co.uk/resources/publications/students_newsletter/2000/04_00p76.html

5 http://www.mscpaonline.org/lounge/goodwill.htm

6 http://www.nysscpa.org/cpajournal/old/14152806.htm