Glossary

is a crucial concept in business combinations, representing the excess value paid for a company beyond its identifiable net assets. It's an intangible asset that reflects future economic benefits like brand reputation and synergies.

Accounting for goodwill involves , , and . Unlike other assets, goodwill isn't amortized but is tested annually for impairment. This process ensures its carrying value accurately reflects its economic benefits to the acquiring company.

Definition of goodwill

  • Goodwill represents the excess of the purchase price over the of the identifiable net assets acquired in a business combination
  • Arises when a company acquires another business and pays more than the fair value of the target company's net assets
  • Reflects the value of that are not separately identifiable, such as customer relationships, brand reputation, and skilled workforce

Characteristics of goodwill

Intangible asset

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  • Goodwill is classified as an intangible asset because it lacks physical substance
  • Represents the value of non-physical assets that contribute to the company's future economic benefits
  • Cannot be sold or transferred separately from the business as a whole

Future economic benefits

  • Goodwill is expected to generate future economic benefits for the acquiring company
  • These benefits may include increased market share, synergies, cost savings, or higher profitability
  • The value of goodwill is based on the expectation of these future benefits

Acquired in business combination

  • Goodwill can only be recognized when it is acquired through a business combination (acquisition of another company)
  • Cannot be internally generated or purchased separately from a business
  • Arises as a result of the process in a business combination

Accounting for goodwill

Initial recognition

  • Goodwill is initially recognized on the balance sheet of the acquiring company at the acquisition date
  • Recorded as an asset and measured as the excess of the purchase price over the fair value of the identifiable net assets acquired
  • If the fair value of the identifiable net assets exceeds the purchase price, a gain is recognized in profit or loss

Measurement of goodwill

  • Goodwill is measured as the difference between:
    1. The aggregate of the consideration transferred, , and the acquisition-date fair value of any previously held equity interest in the acquiree
    2. The net identifiable assets acquired and assumed, measured at their acquisition-date fair values
  • Consideration transferred includes cash, other assets, liabilities incurred, and equity interests issued by the acquirer

Bargain purchase

  • A bargain purchase occurs when the fair value of the identifiable net assets acquired exceeds the purchase price
  • In this case, the acquirer recognizes a gain in profit or loss on the acquisition date
  • The gain is calculated as the difference between the fair value of the identifiable net assets and the purchase price
  • Bargain purchases are rare and require careful assessment to ensure that all assets and liabilities are properly identified and measured

Subsequent measurement of goodwill

Impairment testing

  • After initial recognition, goodwill is not amortized but is subject to annual impairment testing
  • Impairment testing is performed to ensure that the of goodwill is not overstated
  • The impairment test compares the carrying amount of the cash-generating unit (CGU) or group of CGUs to which goodwill is allocated with its recoverable amount
  • Recoverable amount is the higher of the CGU's fair value less costs of disposal and its value in use (present value of future cash flows)

Frequency of impairment tests

  • testing is required at least annually, regardless of whether there are any indications of impairment
  • Impairment tests may be performed more frequently if events or changes in circumstances suggest that goodwill might be impaired (triggering events)
  • The can be performed at any time during the year, provided it is performed at the same time every year

Indicators of impairment

  • Indicators of impairment that may trigger an impairment test include:
    • Significant decline in market share or profitability
    • Adverse changes in the business environment or market conditions
    • Technological obsolescence or significant changes in technology
    • Changes in key management personnel or high employee turnover
  • If any of these indicators are present, an impairment test should be performed, even if it is not the regular annual testing date

Impairment loss calculation

  • If the recoverable amount of the CGU is less than its carrying amount (including goodwill), an impairment loss is recognized
  • The impairment loss is allocated first to reduce the carrying amount of goodwill allocated to the CGU
  • Any remaining impairment loss is then allocated to the other assets of the CGU on a pro-rata basis, based on their carrying amounts
  • The impairment loss is recognized in profit or loss and cannot be reversed in subsequent periods

Allocation of goodwill

Cash-generating units (CGUs)

  • Goodwill is allocated to the or groups of CGUs that are expected to benefit from the synergies of the business combination
  • A CGU is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets
  • CGUs can be identified based on factors such as product lines, geographical areas, or customer segments

Allocation to CGUs

  • Goodwill is allocated to CGUs or groups of CGUs at the lowest level within the entity at which goodwill is monitored for internal management purposes
  • The allocation should not be larger than an operating segment as defined by IFRS 8 Operating Segments
  • The allocation of goodwill to CGUs is important for impairment testing purposes, as the impairment test is performed at the CGU level

Reallocation of goodwill

  • If the composition of CGUs changes (e.g., due to a reorganization or disposal), goodwill should be reallocated to the affected CGUs
  • The reallocation is based on a relative value approach, using the fair values of the CGUs involved
  • Reallocation ensures that goodwill continues to be tested for impairment at the appropriate level

Disclosure requirements

Goodwill movement schedule

  • Companies are required to disclose a reconciliation of the carrying amount of goodwill at the beginning and end of the reporting period
  • The reconciliation should show separately:
    • Gross carrying amount and accumulated at the beginning of the period
    • Additional goodwill recognized during the period (e.g., from new business combinations)
    • Impairment losses recognized during the period
    • Other changes (e.g., disposals, foreign currency translation differences)
  • This disclosure helps users understand the changes in goodwill over time

Impairment losses

  • If an impairment loss is recognized for goodwill, the following information should be disclosed:
    • The events and circumstances that led to the recognition of the impairment loss
    • The amount of the impairment loss recognized
    • The CGU or group of CGUs to which the goodwill is allocated
    • The basis for determining the recoverable amount (fair value less costs of disposal or value in use)
  • These disclosures provide transparency about the reasons for and the impact of goodwill impairment

Assumptions in impairment testing

  • Companies should disclose the key assumptions used in determining the recoverable amount of CGUs for impairment testing purposes
  • These assumptions may include:
    • Discount rates
    • Growth rates
    • Projected cash flows
    • Other relevant assumptions specific to the company or industry
  • Disclosing these assumptions allows users to assess the reasonableness of the impairment test and the potential impact of changes in key assumptions

Goodwill in consolidated financial statements

Goodwill from subsidiary acquisition

  • When a parent company acquires a subsidiary, goodwill arising from the acquisition is recognized in the consolidated financial statements
  • The goodwill is calculated as the difference between the consideration transferred (including the fair value of any previously held equity interest) and the fair value of the identifiable net assets acquired
  • The goodwill is allocated to the CGUs or groups of CGUs that are expected to benefit from the synergies of the business combination

Non-controlling interests

  • If the parent company acquires less than 100% of the subsidiary, there will be a non-controlling interest (NCI) in the subsidiary's net assets
  • The goodwill recognized in the consolidated financial statements includes both the parent's share and the NCI's share of goodwill
  • The NCI's share of goodwill can be measured using either the full goodwill method or the partial goodwill method
    • Full goodwill method: NCI is measured at its proportionate share of the subsidiary's identifiable net assets plus its share of goodwill
    • Partial goodwill method: NCI is measured at its proportionate share of the subsidiary's identifiable net assets only

Disposals and deconsolidation

  • When a parent company disposes of a subsidiary or loses control over it (deconsolidation), the goodwill associated with that subsidiary is derecognized
  • The gain or loss on disposal or deconsolidation includes the carrying amount of the goodwill allocated to the subsidiary
  • If the disposal or deconsolidation involves a CGU or a group of CGUs to which goodwill was allocated, the goodwill is allocated to the disposed or deconsolidated portion based on relative fair values

Tax implications of goodwill

Non-deductibility for tax purposes

  • In most jurisdictions, goodwill is not deductible for tax purposes
  • This means that the amortization or impairment of goodwill does not generate a tax benefit
  • The non-deductibility of goodwill creates a permanent difference between the accounting and tax treatment, which affects the effective tax rate

Deferred tax liabilities

  • The non-deductibility of goodwill can give rise to
  • Deferred tax liabilities arise when the tax base of the identifiable net assets acquired is lower than their fair value recognized in the business combination
  • The deferred tax liability is calculated as the difference between the fair value and tax base of the identifiable net assets, multiplied by the applicable tax rate
  • The recognition of deferred tax liabilities on acquisition increases the amount of goodwill recognized

Comparison of IFRS vs US GAAP

Similarities in goodwill accounting

  • Both IFRS and US GAAP require goodwill to be recognized as an asset in a business combination
  • Goodwill is measured as the excess of the consideration transferred over the fair value of the identifiable net assets acquired
  • Goodwill is not amortized under both frameworks but is subject to annual impairment testing
  • Impairment losses on goodwill cannot be reversed under both IFRS and US GAAP

Differences in impairment testing

  • One-step vs. two-step approach:
    • IFRS: One-step approach, comparing the carrying amount of the CGU (including goodwill) with its recoverable amount
    • US GAAP: Two-step approach, first comparing the fair value of the reporting unit with its carrying amount (including goodwill), and then, if necessary, comparing the implied fair value of goodwill with its carrying amount
  • Level of testing:
    • IFRS: Goodwill is tested at the CGU level or group of CGUs level
    • US GAAP: Goodwill is tested at the reporting unit level, which is an operating segment or one level below an operating segment
  • Allocation of impairment loss:
    • IFRS: Impairment loss is allocated first to goodwill and then to other assets of the CGU on a pro-rata basis
    • US GAAP: Impairment loss is allocated entirely to goodwill

Key Terms to Review (34)

Acquisition method: The acquisition method is an accounting approach used to account for business combinations, where one company acquires another. This method requires the acquirer to recognize the fair value of the acquired assets and liabilities at the acquisition date, which is essential for determining goodwill and proper consolidation of financial statements. This approach ensures that the financial position of both entities reflects the true economic reality of the combination.
Allocation to cgus: Allocation to cash-generating units (CGUs) refers to the process of distributing the carrying amount of an asset or a group of assets to individual CGUs for the purpose of impairment testing. This process is crucial as it helps in determining whether the value of an asset has decreased and needs to be adjusted on financial statements. Proper allocation ensures that each CGU reflects an accurate valuation and aids in the evaluation of operational efficiency and profitability.
Annual impairment test: The annual impairment test is a process used to evaluate the carrying value of an asset, primarily goodwill, to determine if it exceeds its fair value. If the carrying amount is greater than the fair value, the asset is considered impaired, and a loss must be recognized in financial statements. This test ensures that assets are not overstated on the balance sheet and reflects their current market conditions.
ASC 350: ASC 350, or Accounting Standards Codification Topic 350, provides guidance on the accounting for intangible assets and goodwill. This standard outlines how to recognize, measure, and disclose intangible assets acquired in business combinations and addresses the impairment testing process for both intangible assets with finite lives and indefinite lives, including goodwill. It plays a crucial role in determining how companies report these assets on their financial statements.
Assumptions in impairment testing: Assumptions in impairment testing refer to the key judgments and estimates made by management when evaluating whether an asset, particularly goodwill, has lost value. These assumptions include future cash flow projections, discount rates, and market conditions, which directly influence the outcome of the impairment test. Accurate assumptions are crucial as they determine how assets are valued on financial statements and can significantly impact a company's financial health.
Balance sheet impact: Balance sheet impact refers to the effect that transactions and events have on a company's balance sheet, which includes assets, liabilities, and equity. Understanding this impact is crucial for assessing a company's financial health, as changes can affect liquidity, solvency, and overall valuation. It highlights how various accounting treatments influence financial statements and can have significant implications for decision-making and investor perceptions.
Bargain purchase: A bargain purchase occurs when a company acquires another entity for less than the fair value of its net identifiable assets at the acquisition date. This situation typically arises in distressed sales, where the seller is under pressure to sell quickly, leading to a purchase price that is significantly lower than the value of the assets acquired. This excess of fair value over purchase price often results in the recognition of a gain in the acquiring company's financial statements.
Carrying Amount: Carrying amount refers to the value at which an asset is recognized on the balance sheet, after deducting any accumulated depreciation, amortization, or impairment costs. It reflects the net value of an asset and plays a crucial role in assessing financial health, particularly in relation to effective interest rates, impairment of intangible assets, goodwill, and long-lived assets.
Cash-generating units (CGUs): Cash-generating units (CGUs) are the smallest identifiable groups of assets that generate cash inflows independently from other assets or groups of assets. These units are crucial for assessing the recoverable amount of non-current assets, including goodwill, as they help determine whether an asset is impaired by analyzing the future cash flows expected from these units.
Deferred Tax Liabilities: Deferred tax liabilities are amounts owed to tax authorities that are expected to be paid in the future due to timing differences between when income is recognized in accounting and when it is recognized for tax purposes. They arise primarily because of differences in depreciation methods or revenue recognition practices, resulting in taxes being postponed to future periods. Understanding deferred tax liabilities is essential for analyzing a company's financial position and performance, especially when looking at classified balance sheets or assessing the implications of goodwill on valuations.
Differences in Impairment Testing: Differences in impairment testing refer to the varying methods and criteria used to assess whether an asset, including goodwill, has suffered a decrease in value. This process can involve different approaches based on the type of asset being evaluated, leading to diverse implications for financial reporting. Understanding these differences is crucial as they can impact how companies recognize losses and adjust their asset valuations, particularly regarding goodwill, which is subject to specific impairment tests under accounting standards.
Disclosure Requirements: Disclosure requirements refer to the rules and guidelines that dictate how companies must report financial information to stakeholders. These requirements ensure transparency and allow users of financial statements to understand a company’s financial health, risks, and other relevant factors. Proper disclosure is critical for maintaining trust and compliance with regulatory standards, especially in the contexts of intangible assets and the evaluation of long-lived assets.
Disposals and Deconsolidation: Disposals refer to the process of selling or otherwise relinquishing control over an asset or a subsidiary, while deconsolidation occurs when a parent company no longer consolidates a subsidiary's financial results into its own due to loss of control. Both processes are significant in accounting as they affect the measurement of goodwill and the overall financial statements of a company, particularly in relation to how assets and liabilities are reported after a sale or change in ownership.
Equity method: The equity method is an accounting technique used to record investments in associated companies where the investor has significant influence, typically defined as owning between 20% to 50% of the voting stock. Under this method, the investment is recorded at cost and subsequently adjusted for the investor's share of the associate's profits or losses, reflecting the performance of the associated company directly in the investor's financial statements. This approach connects closely with goodwill, as it may arise when an investor acquires a stake in an associated company at a premium over its book value.
Fair Value: Fair value is the estimated price at which an asset or liability could be bought or sold in a current transaction between willing parties, reflecting current market conditions. It connects to the valuation of both long-term and intangible assets, as well as the recognition of changes in value due to impairment or disposition. Understanding fair value is essential for accurate financial reporting, as it affects the presentation of various assets and liabilities on financial statements.
Goodwill: Goodwill is an intangible asset that represents the excess value of a business beyond its identifiable net assets at the time of acquisition. It often reflects factors such as brand reputation, customer relationships, and employee relations that contribute to future earnings. Goodwill is important in understanding types of intangible assets and plays a role in amortization, impairment assessments, and consolidation processes.
Goodwill from subsidiary acquisition: Goodwill from subsidiary acquisition is an intangible asset that arises when a company acquires another company and pays more than the fair value of its net identifiable assets. This excess payment often reflects factors like brand reputation, customer relationships, or synergies expected from combining the two businesses. Goodwill signifies the premium that buyers are willing to pay over the net asset value, showcasing the acquired company’s future earning potential and strategic value.
Goodwill impairment: Goodwill impairment refers to the permanent reduction in the carrying value of goodwill on a company's balance sheet, signaling that the asset has lost value and is no longer justifiable at its previous amount. This situation often arises when the acquisition of a business does not yield the expected financial benefits, leading to a reassessment of the goodwill associated with that acquisition. Understanding goodwill impairment is crucial as it can significantly impact a company's financial statements and indicate underlying issues with business performance or market conditions.
Goodwill movement schedule: A goodwill movement schedule is a detailed financial report that tracks the changes in goodwill on a company's balance sheet over a specified period. This schedule highlights the factors contributing to increases or decreases in goodwill, such as acquisitions, impairments, or disposals, allowing stakeholders to understand how goodwill is evolving and its impact on the overall financial position of the company.
IFRS 3: IFRS 3 is an international financial reporting standard that outlines the accounting requirements for business combinations. This standard provides guidelines on how to identify, measure, and recognize assets acquired, liabilities assumed, and any goodwill or gain from a bargain purchase during a merger or acquisition.
Impairment losses: Impairment losses refer to the reduction in the carrying value of an asset when its recoverable amount falls below its book value. This concept is crucial for ensuring that assets are reported at a value that reflects their current worth, particularly in the context of goodwill, where the economic benefits of acquired assets can diminish over time.
Impairment Testing: Impairment testing is the process of evaluating the carrying value of an asset to determine whether it exceeds its recoverable amount. If an asset's carrying value is higher than its recoverable amount, an impairment loss must be recognized, which reduces the asset's value on the balance sheet. This testing is crucial for ensuring that both intangible assets and goodwill are not overstated, reflecting their true economic worth.
Income statement effect: The income statement effect refers to how certain transactions or events impact a company's income statement, ultimately influencing its net income. This concept is crucial for understanding how various accounting practices, such as the recognition of expenses and revenues, alter a company's financial performance over a specific period. The income statement effect is particularly relevant when evaluating intangible assets and lease agreements, as these can lead to significant changes in reported earnings.
Initial recognition: Initial recognition refers to the process of formally acknowledging an asset or liability in the financial statements at the moment it meets the criteria for recognition. This concept is essential in determining when an entity should record cash equivalents and intangible assets like goodwill, as it establishes the basis for how these items will be reported and valued in the future.
Intangible assets: Intangible assets are non-physical assets that provide long-term value to a company, including items such as patents, trademarks, copyrights, and goodwill. These assets play a crucial role in a company's valuation and can significantly impact its financial position and performance over time.
Liabilities: Liabilities are obligations that a company owes to external parties, typically arising from past transactions or events. They represent future sacrifices of economic benefits and are settled over time through the transfer of assets, such as cash or services. Understanding liabilities is crucial for financial reporting, as they directly impact a company's financial position and are essential for assessing its overall performance and risk.
Non-controlling interests: Non-controlling interests represent the portion of equity in a subsidiary that is not owned by the parent company. This term is crucial in the context of consolidated financial statements, as it reflects the interests of minority shareholders in a subsidiary while ensuring that the parent company accounts for its ownership stake. Non-controlling interests are also essential when calculating goodwill, as they affect how the total value of a subsidiary is allocated between the parent and other investors.
Non-deductibility for tax purposes: Non-deductibility for tax purposes refers to expenses that cannot be subtracted from taxable income when calculating taxes owed. This concept is particularly significant in financial accounting, as it influences the valuation of assets, liabilities, and overall financial health of a business. Understanding non-deductibility helps businesses make informed decisions about expenditures and how they report their financial performance.
Purchase price allocation: Purchase price allocation refers to the process of assigning the purchase price of an acquired company to its individual assets and liabilities at fair value. This method ensures that the financial statements accurately reflect the true value of what was acquired, including identifiable intangible assets and any goodwill resulting from the acquisition. This allocation is crucial for proper accounting, tax purposes, and understanding the financial health of the combined entity.
Reallocation of Goodwill: Reallocation of goodwill refers to the process of adjusting the carrying value of goodwill on a company's balance sheet, often due to changes in the underlying business conditions or acquisition structures. This concept is closely linked to how companies assess and report their intangible assets, particularly when an acquisition occurs or when there are indicators of impairment. Goodwill is the excess amount paid over the fair value of identifiable net assets during a business acquisition and can fluctuate based on various financial assessments and strategic decisions.
Similarities in Goodwill Accounting: Similarities in goodwill accounting refer to the consistent methods and principles used by companies to recognize, measure, and report goodwill on their financial statements. This involves treating goodwill as an intangible asset that arises during business combinations and necessitates regular impairment testing rather than systematic amortization. Recognizing these similarities helps in understanding how companies assess the value of acquired goodwill and maintain transparency in financial reporting.
Step-one analysis: Step-one analysis is a method used to determine the fair value of an acquired entity’s identifiable net assets during a business combination. This analysis serves as the foundational step in assessing goodwill by evaluating the fair value of assets and liabilities, enabling a clearer understanding of the excess purchase price that will be recorded as goodwill. Accurately conducting this analysis is crucial for proper financial reporting and compliance with accounting standards.
Subsequent measurement: Subsequent measurement refers to the process of valuing an asset or liability after its initial recognition on the financial statements, reflecting any changes in value due to events or transactions that occur over time. This concept is crucial as it ensures that financial statements accurately represent the current value of assets and liabilities, impacting income statements and balance sheets significantly. It encompasses various methods such as cost model, fair value model, and impairment assessments, all tailored to specific types of assets and liabilities.
Tangible Assets: Tangible assets are physical resources owned by a company that have a definite monetary value and can be touched or measured. These assets play a crucial role in a business's operations and financial statements, as they include items such as machinery, buildings, and land. Proper accounting for tangible assets is essential, particularly in understanding how they depreciate over time and how they relate to intangible assets like goodwill.
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