Accounting Treatments of Purchased Goodwill
1. Introduction
It is rather surprising that it has taken so long to develop standards of accounting principles and practices for something as essential as goodwill. These developments are particularly important because of the Accounting Standards Board’s (ASB) Statement of Principles (SOP) focus on assets and liabilities (Lawrence 2000).
Goodwill is defined as “the excess of the cost of the business combination over the acquirer’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities” (Elliott and Elliott 2007, p.450). However, goodwill can only be recognised when an entity has acquired another entity, as goodwill cannot be purchased or sold as a separate item (Dagwell et al. 2006).
Goodwill could be seen as a grey area of the financial statements, and will thereby lead to differences of opinion. Some do not think goodwill meet the requirements of an asset because of worries about exchangeability and controllability of assets, and equating costs and assets (Johnson and Petrone 1998). However, in 1997, ASB determined that goodwill meets the definition of assets as it contributes to generate cash inflows in conjunction with other assets. However, goodwill differs from other identifiable assets in that it lacks legal basis and is not separable from other assets (Nishikawa 2003).
In this essay, treatments of purchased goodwill will be analysed by using the four qualitative characteristics (Relevance, Reliability, Comparability and Understandability) given in the SOP. These characteristics are used to make decisions that will maximise the usefulness of the financial information (FRC 1999).
The three treatments being discussed are:
1. Immediate write off against reserves,
2. Capitalisation with amortisation over a pre-selected number of years, and
3. Capitalisation with annual impairment reviews underpin
2. Treatments of Goodwill
2.1 Immediate write-off against reserves
SSAP 22 (Accounting for Goodwill) recommends
It is rather surprising that it has taken so long to develop standards of accounting principles and practices for something as essential as goodwill. These developments are particularly important because of the Accounting Standards Board’s (ASB) Statement of Principles (SOP) focus on assets and liabilities (Lawrence 2000).
Goodwill is defined as “the excess of the cost of the business combination over the acquirer’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities” (Elliott and Elliott 2007, p.450). However, goodwill can only be recognised when an entity has acquired another entity, as goodwill cannot be purchased or sold as a separate item (Dagwell et al. 2006).
Goodwill could be seen as a grey area of the financial statements, and will thereby lead to differences of opinion. Some do not think goodwill meet the requirements of an asset because of worries about exchangeability and controllability of assets, and equating costs and assets (Johnson and Petrone 1998). However, in 1997, ASB determined that goodwill meets the definition of assets as it contributes to generate cash inflows in conjunction with other assets. However, goodwill differs from other identifiable assets in that it lacks legal basis and is not separable from other assets (Nishikawa 2003).
In this essay, treatments of purchased goodwill will be analysed by using the four qualitative characteristics (Relevance, Reliability, Comparability and Understandability) given in the SOP. These characteristics are used to make decisions that will maximise the usefulness of the financial information (FRC 1999).
The three treatments being discussed are:
1. Immediate write off against reserves,
2. Capitalisation with amortisation over a pre-selected number of years, and
3. Capitalisation with annual impairment reviews underpin
2. Treatments of Goodwill
2.1 Immediate write-off against reserves
SSAP 22 (Accounting for Goodwill) recommends
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