What is it Goodwill? In the 1880's, the first definition reflected goodwill as the difference between the purchase price and the book value of an acquired company's assets. Goodwill definitions have evolved since that time. Generally, goodwill has appeared to be an umbrella concept embracing many features of a company's activities that could lead to superior earning power, such as excellent management, an outstanding workforce, effective advertising and market penetration. Goodwill is an intangible asset, probably the most intangible of all intangible assets, hard to measure and even more difficult to account for. Goodwill today constitutes a much larger part of acquisition prices than it did previously, resulting in a much greater impact on financial statements. Goodwill can arise in two different ways: It can be internally generated or it can be acquired as part of the acquisition of another company. Both types of goodwill have been recorded in the past. However, only acquired goodwill is currently allowed to be recorded. We could define Goodwill such as:
- An unidentifiable intangible asset
- May be internally generated (non-purchased) or purchased
What is it Purchased Goodwill? Goodwill which is purchased by the entity must be recognised as a non-current asset at acquisition and must be measured as the excess of the cost of acquisition incurred by the entity over the fair value of the identifiable net assets acquired.
What is it Internally Generated Goodwill? Goodwill which is internally generated by the entity must not recognised by that entity. Goodwill which is internally generated by an entity is not permitted by this Standard to be recognised as an asset by that entity. This principally because of the difficulty, or impossibility, of identifying the events or transactions which contribute to the overall goodwill of the entity. Even if these were identifiable, the extent to which they generate future benefits and the value of such benefits are not usually capable of being measured reliably. Internally generated goodwill which is not recognised as an asset will either go completely unrecognised or will be recognised as an expense.
Definition of task
The value of intangibles including internally generated intangibles and goodwill can be grasped when a company is acquired in the market. The cost paid for the net asset of acquired company in the market also includes amount for internally generated intangibles and goodwill that are not stated on the balance sheet. We try to take a critically think on the meaning of recognition of internally generated goodwill. Because a major part of the problem of accounting for goodwill is agreeing on a definition of the term itself, we try to look at the task from the different points of views.
Financial statements
Anglo-American model, is investor and creditor-oriented; the financial statements are used as an instrument for economic representation and decision-making. In this model, the substance over form principle takes precedence over the conservatism principle, and taxation has no influence. On other side Continental model, is a system where the conservatism principle takes precedence over substance over form, and taxation has a strong influence. From these the two models we can take the substance of the financial statements and try to take a think on the Intangible Fixed Asset of non-purchased goodwill in the Balance Sheet.
An exchange transaction
The value of intangibles including internally generated intangibles and goodwill can be grasped when a company is acquired in the market. The cost paid for the net asset of acquired company in the market also includes amount for internally generated intangibles and goodwill that are not stated on the balance sheet. The purchaser needs to recognise all assets acquired, whether of a tangible or intangible nature. This might involve recognising some intangible assets which, if internally generated by the purchaser, would not normally be recognised as assets because the absence of an exchange transaction usually prevents them from being measured reliably. Only an exchange transaction in the market can measure acquirer's interest in the fair value of the identifiable assets consequently we cannot grasp internally generated goodwill and state it on the balance sheet without any an exchange transaction.
Measurement, metric
However, purchased goodwill can be measured more reliably, on the basis of the amount paid for it, than can internally generated goodwill which is not usually capable of being measured reliably. Consequently, the accounting treatment for purchased goodwill differs from that specified for internally generated goodwill. Internally generated goodwill is not recognised as an asset because it is not an identifiable resource controlled by the entity that can be measured reliably at cost.
If we would like to recognise the changing of value we can define and build a metric system that will be a possible measurement of value through the testing criteria in real time. The testing criteria need to be very strong. We must be able to recognise a situation where the goodwill has been impaired. We can’t define any metric system with robust testing criteria because pre-existing internally generated goodwill of the acquirer is not separated from the measurement of acquired goodwill and measurement is strongly determined and so sensitive to the source options. As a result of this, the recognition of internally generated goodwill is not consistent with the proposal value in time.
The primary reason for not accounting for goodwill developed in this manner is the absence of generally accepted objective methods of measurement.
Interest of parent company
These parent shareholders are interested in the assets that they control and, in the context of goodwill, are interested in holding management accountable for any investment it has made. That objective is met by accounting for the goodwill arising in the acquisition transaction, even though no recognition is given to internally generated goodwill. Where there is a minority interest the parent shareholder is not interested in the goodwill that might have arisen on a hypothetical acquisition of the minority because this is irrelevant to the investment made by management. A portion of goodwill attributable to minority interest is meaningless from the viewpoint of owners of the parent company because they do not control it at all. On the other hand, from the viewpoint of minority interest holders (non-control owners), it is none other than internally generated goodwill and its recognition is inconsistent with the current accounting model which prohibits recognition of internally generated goodwill. Therefore, from either viewpoint, it is not appropriate to recognise goodwill attributable to minority interest.
Self valuation
The purpose of calculation for net profit or loss is to measure the returns on investments. In the light of this view, to recognise full amount of goodwill, which is neither ensured by cost for transaction nor based on funding, is not consistent with such purpose, that is, to measure the returns on investments. In general, we can say that valuation of the entity value, including internally generated goodwill, is a role of investors and the management of the entity should not reveal their own valuation.
Conclusion
The topic of intangibles has been controversial and a source of debate for many years. Various definitions and classifications of intangibles have been suggested over the last few years in order to provide a better understanding of the concept.
Internally generated goodwill:
- it is not recognised as an asset because it is not an identifiable resource controlled by the entity that can be measured reliably at cost
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it is not appropriate to recognise goodwill attributable to minority interest
- may account for much of the difference in magnitude between book value and market capitalisation
- it is not attributable to minority interest
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it is a role of investors and the management of the entity should not reveal their own valuation
- only an exchange transaction in the market can measure acquirer's interest in the fair value of the identifiable assets consequently we cannot grasp internally generated goodwill and state it on the balance sheet without any an exchange transaction.
- it has generated the various classifications adopted for intangibles by different regulations.
Everything together explaining why some intangible items like internally generated goodwill makes a mockery of the Balance Sheet and consequently it is not included in the balance sheet of a company.
References
1) International Accounting Standards (2004 Edition)
2) Handbook Of Intarnational Auditing, Assurance, And Ethics pronouncements (2004 Edition)
3) Council On Corporate Disclosure And Governance:
4) Ernst&Young:
SSAP 29 - .Intangible Assets (may 2001)
5) Venkatesan Sundararajan:
Accounting for Goodwill (1995)
6) Hervé Stolowy (professor) & Anne Jeny (research assistant)
HEC School of Management (Groupe HEC)
How Accounting Standards Approach And Classify Intangibles An International Survey
