Accounting for Goodwill

In lieu of an abstract, below is the first paragraph of the paper. Goodwill has become an increasingly larger portion of the assets transferred to a company during an acquisition. Financial statement users are now in need of better information about goodwill. This paper will ( 1) compare the prior method of accounting for goodwill to the new method of accounting for goodwill, (2) examine some of the controversies surrounding the accounting method, and (3) examine some of the effects the new accounting method has had on businesses. Goodwill has become an increasingly larger portion of the assets transferred to a company during an acquisition. The value of many companies has shifted from land, buildings, equipment and other tangible items to intangible (and sometimes unidentifiable) items such as brand name, market reputation, efficient and effective internal processes, customer lists, and level of customer loyalty. Financial statement users are now in need of better information about goodwill. This paper will compare the prior method of accounting for goodwill to the new method of accounting for goodwill. The change in method has created controversy. The interpretation of the kind of asset goodwill represents is part of the controversy. The most useful method of recording the decline in value of goodwill is another part of the controversy. The method of recording the decline in value becomes particularly controversial when examined in terms of reliability. This paper will further explain the arguments of this controversy. Finally, this paper will identify the different stakeholders who will be affected by the implementation of the new accounting method. This article is available in The Review: A Journal of Undergraduate Student Research: http://fisherpub.sjfc.edu/ur/vol7/iss1/7 Accounting For Goodwill By Julie Bennett Abstract Goodwill has become an increasingly larger portion of the assets transferred to a company during an acquisition. Financial statement users are now in need of better information about goodwill. This paper will ( 1) compare the prior method of accounting for goodwill to the new method of accounting for goodwill, (2) examine some of the controversies surrounding the accounting method, and (3) examine some of the effects the new accounting method has had on businesses. Goodwill has become an increasingly larger portion of the assets transferred to a company during an acquisition. The value of manyGoodwill has become an increasingly larger portion of the assets transferred to a company during an acquisition. Financial statement users are now in need of better information about goodwill. This paper will ( 1) compare the prior method of accounting for goodwill to the new method of accounting for goodwill, (2) examine some of the controversies surrounding the accounting method, and (3) examine some of the effects the new accounting method has had on businesses. Goodwill has become an increasingly larger portion of the assets transferred to a company during an acquisition. The value of many companies has shifted from land, buildings, equipment and other tangible items to intangible (and sometimes unidentifiable) items such as brand name, market reputation, efficient and effective internal processes, customer lists, and level of customer loyalty. Financial statement users are now in need of better information about goodwill. This paper will compare the prior method of accounting for goodwill to the new method of accounting for goodwill. The change in method has created controversy. The interpretation of the kind of asset goodwill represents is part of the controversy. The most useful method of recording the decline in value of goodwill is another part of the controversy. The method of recording the decline in value becomes particularly controversial when examined in terms of reliability. This paper will further explain the arguments of this controversy. Finally, this paper will identify the different stakeholders who will be affected by the implementation of the new accounting method. The New Accounting Method For many years, goodwill was accounted for similarly to other intangible assets. A company would estimate the useful life of the goodwill it incurred, which could be as much as 40 years, and would amortize the goodwill over the estimated life. In June of 200 l , the Financial Accounting Standards Board (FASB) issued SFAS 142. This new statement on Accounting for Goodwill and Other Intangibles no longer allows companies to amortize their goodwill. Companies are now required to test goodwill on an annual basis for impairment. Impairment tests are familiar to the accounting industry. They are used for the write-downs of accounts receivable to net realizable value, of inventory to lower of cost or market value, of property plant and equipment to current market value (Massoud and Raibom, 2003). 25 Other intangible assets that are determined to have a finite useful life will continue to be amortized. The new accounting approach for goodwill is a two-step process. In the first step, a company must estimate the fair value of the reporting unit that the goodwill is attached to and then compare the fair value to the carrying value (including the goodwill) of that reporting unit. If the fair value is greater than the carrying value, then goodwill is not impaired and should not be reduced. Companies are not allowed to record a gain to goodwill if the fair value is determined to be greater than the carrying value. If the fair value is less than the carrying value, then the company must continue to the second step. In the second step, a company would apply the fair value it had calculated to the assets and liabilities of the reporting unit. The remaining balance of the fair value is the new value of goodwill and the carrying value of goodwill should be reduced to the new value. Initial impairment charges in December 2001 and in 2002 could be reported as extraordinary losses, however impairment charges in subsequent periods should be recorded as an operating expense. The impairment test may be performed at any time during the year, so long as date is consistent from year to year. Additionally, companies must perform an interim test if a triggering event occurs. Examples of triggering events include market decline, regulatory action, new competition or a loss of key personnel (Moehrle and Reynolds-Moehrle, 2001). Companies will also have to perform an interim measurement if they plan on selling or disposing of a reporting unit or a material portion of one. Goodwill cannot have a fair market value as a stand alone asset because it represents an intangible value created by a combination of other tangible and identifiable intangible assets. Because of the nature of goodwill, the definition of a reporting unit is vital to assessing its value. A reporting unit is described as the level of a business that management reviews and assesses as a separate segment. Reporting units can be distinct business lines, geographic segments, or even the company as a whole if no reporting unit exists (Moehrle and Reynolds-Moehrle, 2001). A company can also use a level of operation within the reporting unit if financial data of the functions of that level are