Readers would likely agree that distinguishing between goodwill and other intangible assets can be confusing.
This article clearly explains the key differences between goodwill and other intangible assets, as well as how goodwill is treated for accounting and reporting purposes.
You'll learn definitions of goodwill and other intangibles, understand why goodwill is unique, see how to calculate and record goodwill, interpret goodwill impairments, and examine perspectives on goodwill amortization.
Introduction to Goodwill vs Other Intangible Assets
Goodwill is an intangible asset that arises when one company acquires another company. Specifically, goodwill represents the excess value of the purchase price over the fair value of the identifiable net assets acquired. In other words, goodwill captures things like the value of the acquired company's brand, customers, intellectual property, and other intangibles that are not separately identifiable.
Other common intangible assets like trademarks, patents, and customer lists are specifically identifiable and can be valued separately. Goodwill differs in that it encompasses the vague, overall value of the company being acquired above and beyond those tangible assets.
Some key things to know about goodwill vs other intangibles:
Defining Goodwill in Accounts
Goodwill is an intangible asset that:
- Arises in acquisition accounting when one company buys another
- Represents value like brand, customers, IP, etc. not assigned to specific assets
- Calculated as the purchase price less the fair value of identifiable net assets
- Considered an asset with an indefinite useful life on the balance sheet
- Subject to periodic impairment testing to determine if its value has declined
Key Differences Between Goodwill and Other Intangible Assets
| Goodwill | Other Intangibles |
|---|---|
| Indefinite useful life | Finite useful lives |
| Not amortized | Amortized over useful life |
| Subject to impairment testing | Can be impaired |
| Calculated residually | Specifically valued |
Other major differences have to do with accounting treatment - goodwill is not amortized annually but rather subject to periodic impairment testing. The value of other acquired intangibles like patents or trademarks can usually be specifically determined, whereas goodwill represents the vague excess value beyond those.
Understanding Goodwill Impairment
Goodwill impairment refers to a reduction in the value of the goodwill asset on a company's balance sheet. Goodwill must be tested annually for impairment. Impairment occurs if the carrying value of a reporting unit exceeds its fair value. If impaired, the company must record a write-down, impacting net income and equity. Understanding goodwill impairment is important when analyzing the health and performance of acquired businesses over time.
Goodwill in Balance Sheet: A Snapshot
Goodwill and other intangible assets will be grouped together in the non-current assets section of the balance sheet. They are considered long-term assets. Goodwill is not amortized each year, so its value remains unless an impairment is recorded. The balance sheet provides a snapshot of the goodwill and intangibles a company has acquired over time.
What is the difference between goodwill and other intangible assets?
Goodwill and other intangible assets are two distinct categories of assets on a company's balance sheet. The key differences are:
Goodwill
-
Goodwill represents assets that are not separately identifiable. It arises when a company acquires another company for a premium and is the difference between the purchase price and the fair value of the net assets acquired.
-
Goodwill is an intangible asset but it cannot be bought or sold independently. It only arises through acquisitions and business combinations.
-
Goodwill typically has an indefinite useful life and is not amortized. Instead, it is subject to periodic impairment testing. If impaired, companies must write down or impair goodwill.
Other Intangible Assets
-
Other intangible assets are identifiable non-monetary assets without physical substance. Examples include patents, licenses, trademarks, copyrights, franchises, etc.
-
Unlike goodwill, other intangible assets can be bought, sold and licensed independently from the business.
-
Other intangible assets have definite useful lives and their value diminishes over time. Therefore, they are amortized accordingly.
In summary, while goodwill and other intangibles are both non-physical assets, goodwill is an residual asset that arises from acquisitions and is not separately identifiable or transferable. Meanwhile, other intangible assets can be independently valued, bought and sold.
What are other intangible assets?
Intangible assets are non-physical assets that provide long-term value to a business. Some common examples include:
-
Brand recognition: The value associated with a well-known brand name, which can drive sales and allow a company to charge premium prices. For example, the Coca-Cola brand name has tremendous value.
-
Goodwill: An intangible asset that arises when a company acquires another company for more than the fair market value of its net assets. Goodwill may occur due to the acquired company's strong brand, customer loyalty, talented workforce, or patents.
-
Intellectual property: Legally protected intangible assets like patents, trademarks, and copyrights. These grant the owner exclusive rights to profit from an invention, brand name, creative work, etc. For example, pharmaceutical companies rely heavily on patent protection for their drugs.
-
Licenses and franchises: Legal agreements that allow a company to access another company's trademarks, technology, products, or business model in exchange for fees and royalties. For example, fast food franchises pay an initial fee and ongoing royalties to operate under the franchise brand name.
So in summary, while goodwill arises specifically from acquisitions, there are many other forms of intangible assets that can provide value. Careful accounting for these assets is important, as they are increasingly vital strategic resources for 21st century companies.
How is goodwill amortized like other intangibles?
Goodwill is an intangible asset that represents the value of a company's brand name, reputation, customer relationships, and other factors not directly tied to tangible assets. Unlike other intangible assets like patents or trademarks, goodwill does not have a definite useful life that can be reliably estimated.
Prior to 2001, companies were required to amortize goodwill over a period not exceeding 40 years under generally accepted accounting principles (GAAP). However, in 2001 the Financial Accounting Standards Board (FASB) issued new guidance prohibiting the amortization of goodwill. Instead, companies were required to test goodwill for impairment on an annual basis.
In 2014, the FASB issued new guidance allowing private companies to elect to amortize goodwill on a straight-line basis over a period of 10 years. This election is not required and private companies can still choose not to amortize goodwill. Under this election, companies must still test goodwill for impairment at least annually.
Public companies are still prohibited from amortizing goodwill under GAAP. For public companies, goodwill must continue to be tested for impairment annually or more frequently when events or changes in circumstances indicate the asset might be impaired.
So in summary, private companies now have the option to amortize goodwill like other intangible assets, although impairment testing is still required. Public companies still cannot amortize goodwill and must rely solely on impairment testing. The FASB's decisions around goodwill aim to balance providing useful information to investors while reducing cost and complexity for preparers.
sbb-itb-beb59a9
Why is goodwill considered as an intangible asset but not?
Goodwill is an intangible asset because it represents the value of things that cannot be physically touched or felt, like a company's brand name, customer loyalty, and intellectual capital.
Specifically, goodwill is an accounting concept that captures the excess value of a business over its tangible assets and identifiable intangible assets. It arises when a company acquires another company and is willing to pay more than the fair value of the target company's net assets. This premium paid reflects things like the company's brand, customers, talent, and potential future income - valuable aspects that are not recorded on the balance sheet.
So while goodwill does not have a physical form, it has economic value, which is why accounting standards require it to be recorded as an intangible asset on the balance sheet. It is tested annually for impairment to ensure it is not overvalued compared to the company's ability to generate income.
On the other hand, fictitious assets like preliminary expenses are costs that are written off over time. So they cannot be classified as either tangible or intangible assets. Goodwill is not an expense - it is capitalized and represents true economic value for the business. This is why it is considered an intangible asset, despite not having a physical form.
Accounting Treatment of Goodwill
Goodwill is an intangible asset that arises when a company acquires another company for a price higher than the fair value of the identifiable net assets. The accounting rules around goodwill aim to capture the value of intangibles that are not separately identifiable, such as brand recognition, customer loyalty, talent, and synergies.
How to Calculate Goodwill in Accounting
Goodwill is calculated as the purchase price minus the fair value of identifiable net assets. For example:
- Company A purchases Company B for $1 million
- Company B has identifiable net assets with a fair value of $500,000
- The goodwill is therefore $1 million - $500,000 = $500,000
The $500,000 would be recognized as goodwill on Company A's balance sheet.
Unlike other intangible assets, goodwill does not have a finite useful life and is not amortized. However, goodwill must be tested annually for impairment.
Testing Goodwill for Impairment under IAS 36
Under IAS 36, goodwill impairment testing involves comparing the carrying value of a cash generating unit (CGU) to its recoverable amount:
- Carrying value = assets - liabilities of CGU, including allocated goodwill
- Recoverable amount = higher of CGU's fair value less costs to sell OR value in use
If the carrying value exceeds the recoverable amount, an impairment charge must be recognized. The impairment loss is allocated first to reduce goodwill, then to other assets pro rata based on their carrying amounts.
Impairment testing requires significant judgment around assumptions like discount rates, growth rates and cash flow projections. Changes in these assumptions can result in goodwill write-downs.
Recording an Impairment Loss on Goodwill
When goodwill is impaired, the loss is recorded as an operating expense on the income statement. For example, if goodwill declines from $500,000 to $300,000, the $200,000 impairment is an expense.
This reduces net income and earnings per share. It also reduces assets and equity on the balance sheet. Lenders and investors view impairment losses negatively as indicators of overpayment or deteriorating business performance.
Goodwill and Intangible Assets on Balance Sheet
On the balance sheet, goodwill is listed under non-current assets, separately from other identifiable intangibles like patents or trademarks. Notes to the financial statements disclose information about goodwill allocations, impairment testing approaches, key assumptions and sensitivity analyses.
While finite-lived intangibles are amortized over their useful lives, goodwill has an indefinite life and remains on the books until an impairment write-down or disposal occurs. The balance sheet carrying value of goodwill can vary significantly across companies and industries.
Goodwill Impairment: Process and Impact
Goodwill impairment can have a significant impact on a company's financial statements and key ratios. This section explores some of the key implications.
Effect of Goodwill Impairment on Earnings Per Share
A goodwill impairment charge directly reduces net income in the year it is recorded. This negatively impacts earnings per share (EPS) and return ratios like return on assets (ROA) or return on equity (ROE) for that period.
For example, if a company has net income of $100 million and 100 million shares outstanding, EPS is $1.00. If they take a $20 million goodwill impairment, net income decreases to $80 million, and EPS drops to $0.80 per share, a 20% decline.
This can alarm investors and analysts, as it signals poorer profitability and performance. However, impairment charges are non-cash expenses, so cash flows are unaffected.
Interpreting Goodwill Write-offs in Financial Analysis
When analyzing financial statements that include a material goodwill impairment, it is important to assess the underlying reasons and whether it indicates deeper issues with the business.
In some cases, large impairments are reasonable if market conditions have deteriorated or interest rates increased substantially since the original acquisition. However, impairments can also result from poor management decisions or overpayment for acquisitions.
Analysts should consider management’s explanation for the write-down and whether the accounting seems aggressive or conservative. It may require modifying valuation models and growth assumptions going forward.
Goodwill Impairment: Real-World Case Studies
Several major companies have recorded sizable goodwill impairments in recent years:
-
GE: Took a $22 billion goodwill impairment in 2018 related to its power business due to weaker performance and industry trends. This constituted over half of its goodwill balance.
-
Kraft-Heinz: Impaired over $15 billion of goodwill across multiple reporting units in 2019, stemming from overpayment on acquisitions and changing consumer preferences.
-
HP Inc.: Wrote down $6.6 billion in goodwill and intangibles in 2020 tied to its acquisition of Autonomy as the deal continued to perform poorly.
In each case, the substantial impairments significantly reduced net income and EPS for those periods. The companies cited shifting business conditions and poor acquisition decisions as justification for these large write-downs.
FASB and IFRS Perspectives on Goodwill Impairment
The Financial Accounting Standards Board (FASB) and International Financial Reporting Standards (IFRS) have different approaches to testing and recording goodwill impairment:
-
IFRS allows more flexibility in choosing valuation methods and assumptions used in impairment testing based on management judgement.
-
FASB standards prescribe a more detailed two-step process U.S. companies must follow, using discounted cash flows and fair value estimates.
The FASB previously considered simplifying impairment testing but ultimately decided to retain the two-step method. However, both accounting bodies continue monitoring standards to improve transparency for investors while minimizing cost and complexity for preparers.
Debating the Amortization of Goodwill
Goodwill is an intangible asset that arises when a company acquires another company for more than the fair value of its net identifiable assets. Under current US GAAP and IFRS accounting standards, goodwill is not amortized but instead tested for impairment annually. However, there have been debates around potentially changing this treatment by amortizing goodwill over a useful life.
The Argument for Amortizing Goodwill
Proponents argue that amortizing goodwill would:
- Better match expenses to the periods that benefit from the goodwill
- Reduce volatility from unpredictable goodwill impairments
- Provide more useful information to investors about diminishing value over time
Systematically amortizing goodwill over its estimated useful life would smooth out expenses rather than risk unexpected hits to earnings from impairments.
Challenges with Amortizing Goodwill
However, amortizing goodwill faces criticism:
- Difficulty estimating appropriate useful life
- Risk of overstating expenses if goodwill maintains value
- Complexity and subjectivity in assessments
Useful lives would be difficult to estimate given uniqueness of each acquisition. If goodwill maintains its value, amortization could overly reduce earnings.
FASB Removes Goodwill Project from Its Technical Agenda
In July 2022, the Financial Accounting Standards Board (FASB) removed its goodwill project from its technical agenda. This likely delays any potential changes for the foreseeable future. Reasons cited included:
- Complexity outweighing benefits
- Risk of unnecessary cost and disruption
- Lack of consensus on appropriate useful life
Alternative Approaches to Goodwill Amortization
While standard setters debate goodwill impairment vs. amortization, companies may consider:
- More rigorous impairment testing assumptions
- Supplemental fair value disclosures
- Proxy goodwill amortization in internal reporting
These alternatives provide added insights while avoiding volatility and complexity from formal goodwill amortization.
Conclusion: The Value of a Company’s Name and Beyond
Summary of Goodwill as an Intangible Asset
Goodwill is an intangible asset that represents the value of a company's brand name, reputation, customers, and other non-physical assets. It is recorded when a company acquires another company for more than the fair market value of its net identifiable assets. Goodwill is unique because it has an indefinite useful life and is not amortized. Instead, it is tested annually for impairment.
Principles for Assessing Goodwill Impairment Charges
Several principles can guide the assessment of goodwill impairment charges:
-
Impairment charges indicate potential underlying economic issues at the reporting company. However, other one-time events may also trigger impairments. Careful analysis is required.
-
Charges should be evaluated in the context of the company's operating performance, industry trends, and macroeconomic factors.
-
Significant or frequent charges may indicate issues with management decision-making around acquisitions and valuation.
Future Outlook on Goodwill Accounting Practices
Accounting standard setters aim to improve the consistency and comparability of goodwill impairment testing across companies. Potential changes include more qualitative assessment factors and changes to the impairment testing approach. However, no major changes are expected in the near term.
Goodwill in Accounting: Key Examples and Takeaways
-
Goodwill often arises when larger companies acquire smaller companies with strong brands or customer bases. The excess purchase price over net assets reflects these non-physical assets.
-
Subsequent goodwill impairment charges reflect that past acquisition value has diminished. This could indicate issues with the acquisition price or changes in business conditions.
-
Understanding goodwill accounting requires analyzing impairment in the context of overall company performance and industry trends over the long term.
