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16 Seiten, Note: A+
Chapter 1. Introduction
Chapter 2. About goodwill
2.2 Definition and Nature of Goodwill
2.3 Accounting for business combinations
2.4 Accounting for goodwill
Chapter 3. Goodwill accounting - US GAAP
3.2 The current FASB approach
3.3 New approach – Impairment only
Chapter 4. Goodwill accounting - IAS
4.2 The IASB approach
Chapter 5. German rules in goodwill accounting
5.1 Basic information for the German accounting legislation
5.2 Goodwill accounting according to HGB
5.3 Goodwill accounting according to GAS
Chapter 6. Example
Chapter 7 Conclusion
Over the last few years a lot of acquisitions and mergers have taken place. In many cases goodwill is an important matter in acquisitions constituting a large part of the takeover price. Therefore the valuation method applied is crucial while there are still discussions about how it should be accounted for.
Especially in the ‘new economy’ goodwill is an important issue. For instance, at the end of July 2000 Deutsche Telekom AG announced the acquisition of the US cell phone corporation Voicestream Wireless. The price was 50.3 billion USD. With a balance sheet equity value of approximately 8 billion USD according to US-GAAP a goodwill of 44.2 billion euros would have been the result. This goodwill had to be successfully written off over 15 years according to Deutsche Telekom. The resulting burden on the earnings of 3 billion euros plus the additional writing off of the UMTS licenses would bring the firms financial results in a problematic situation. This is only one of many examples, that shows the dramatic situation of the usage of goodwill in the consolidated financial statements.
In this paper we will first discuss goodwill in general. The way it occurs and the theoretical background. Then we discuss the specific approaches the FASB, IASB and German institutions have concerning goodwill.
Goodwill is an intangible asset, probably the most intangible of all intangible assets, hard to measure and even more difficult to account for. Some of the intangibles are identifiable, like patents and copyrights. On the other hand, intangibles such as favorable government regulations, outstanding credit ratings, superior management and good labor relations are examples of unidentifiable intangible assets. Goodwill comprises the complete set of unidentifiable intangible assets held by the reporting entity.
Goodwill can arise in two different ways:
1) It can be internally generated or;
2) it can be acquired as part of the acquisition of another company (business combination).
Because only acquired goodwill can be accounted for, this paper excludes internally generated goodwill. The definition of goodwill may then be defined in two different manners:
1. The residuum approach
In the residuum approach, goodwill is defined as the difference between the purchase price and the current or fair market value of an acquired company's assets.
2. The excess profits approach
In the excess profits approach, goodwill is the difference between the combined company's profits over normal earnings for a similar business. Under this definition, the present value of the projected future excess earnings is determined and recorded as goodwill. This concept is very difficult to measure since future earnings have no certainty.
Because only the residuum approach is allowed the excess profits approach will not be discussed any further in this paper.
Accounting for business combinations is a very complex and controversial issue but extremely important due to the magnitudes of transactions involved. A business combination is handled in either of the two basic ways:
1. Pooling of Interest Method
In this method, the consolidated balance sheet is constructed by simply adding together the balance sheets of the combined companies. In essence, the concept of a pooling of interest is that nothing of real economic substance has occurred in the combination. All the previous shareholders remain as shareholders, the assets of the combined companies are same as before. As a result there is no goodwill showing in the balance sheet.
2. Purchase method
The purchase method is based on the assumption that a business combination is a transaction in which one entity acquires the net assets of other combining companies. The acquiring company records net assets received at fair market value at the date of combination. Any excess of cost over the fair value of net assets acquired is allocated to goodwill.
If the purchase method is used, four basic methods basic methods of accounting for goodwill can be used. The section below discusses them.
1. Write-off method
Under this method, goodwill is immediately written off against an account in the stockholders' equity section, generally retained earnings. Advocates of this method argue that goodwill is not measurable and has no true future value. Thus, it should be written off against stockholders' equity.
Another rationale for this method is that overpayment for the assets of an acquired company represents the expectation of superior future earnings. Since these earnings eventually end up in the stockholders' equity, they can be offset against the excess acquisition payment.
2. Capitalization, no amortization method
Capitalization of goodwill without amortization allows the most advantageous financial reporting figures. A company gets to record an asset instead of a decrease in stockholders' equity and net income is not periodically reduced. The rationale for non-amortization is premised on the notion that goodwill does not decrease in value. High managerial ability, good name and reputation, and excellent staff generally do not decrease in value but they increase in value.
3. Capitalization and amortization method
Amortization enables companies to match the cost of intangible assets over the period deemed to benefit from their acquisition. Main arguments for amortization are the abuse of non-amortization and the unreliability of earnings without some attempt to recognize the impact.
4. Impairment method
Every period the implied fair market value of the goodwill has to be compared to the carrying amount. If the carrying amount of goodwill exceeds its implied fair market value, an impairment loss is recognized equal to the excess and presented as a separate line item on the financial statements. If the fair market value is greater than its carrying amount, goodwill is not considered impaired and nothing needs to be accounted for.
The implied fair value of goodwill is determined by allocating the fair value of the reporting unit to all of the assets and liabilities of that unit (including any unrecognized intangible assets), as if the reporting unit had been acquired in a business combination. The fair value of the reporting unit is the purchase price. The excess "purchase price" over the amounts assigned to assets and liabilities would be the implied fair value of goodwill.
The principal sources of generally accepted accounting principles in the Unites States (GAAP) are Statements of Financial Accounting Standards (SFASs) issued by the Financial Accounting Standards Board (FASB) together with Accounting Research Bulletins (ARBs) and Accounting Principles Board Opinions (APBs) which were issued by predecessor bodies of the FASB. The FASB is the designated organisation in the private sector for establishing financial accounting and reporting standards. First we will discuss the current FASB approach and then a new approach called Impairment Only.
While both purchase and pooling-of-interests accounting are used in the US, they are not alternatives. Pooling must be used if certain criteria are met. The main criterion is that at least 90% of outstanding common voting stock must be acquired. Otherwise the purchase method must be used.
Using the purchase method means all intangible assets including positive goodwill have to be capitalized and amortized over their useful lives, never exceeding 40 years. Companies are required to capitalize the cost of intangible assets acquired from other entities or individuals, including purchased goodwill. In addition, APB 16 requires the purchased goodwill to be allocated to the acquired business operations on a timely basis as goodwill is inseparable from the acquired business units to which it relates. The value of goodwill is affected by developments at those acquired business units and unless the goodwill is allocated on a timely basis, its value cannot be monitored effectively.
If the price paid for the assets and related liabilities of a company is less then the book value, negative goodwill occurs. Negative goodwill is allocated proportionately to reduce the values assigned to non-current assets (except long-term investments in marketable securities). If these non-current assets are thereby reduced to a zero value, any remaining negative goodwill is treated as a deferred credit and is amortized systematically to income over the period estimated to benefit, not exceeding 40 years.
This approach has a lot of disadvantages. Once a certain amount of goodwill is capitalized, its value can be changed only by systematic writing off. No significant connection can be created between the actual book value and fair market value of the assets. When an acquisition is brought to book using the Pooling of Interest Method, the same problem emerges.
That was the reason why the FASB framed a new regulation called the Impairment-Only Approach. The heart statement of the new approach is that enterprises receive a quasi electoral law, to load the goodwill as before into the new balance and to avoid loads of the result thus through goodwill writing-off. Goodwill is interpreted now as an asset with indefinite service life and only is through the Impairment Approach to test and to depreciate where appropriate extraordinarily on asset value shrinkage. A systematic writing-off is dropped. The Pooling of Interest Method is eliminated. Five different steps might illustrate the function of the Impairment Approach:
1st – goodwill allocation: The acquired goodwill is in reasonable kind and manner onto the individual functional enterprise units. FASB determines that the firms must apply also the identifiable immaterial capital items with their fair market value strongly than up to now so that these do not sink in the goodwill.
2nd – benchmark assessment: It has to be clearly determined, which grounds speak for the acquisition, which valuation methods at the future impairment tests are supposed to be applied. In case of a too high purchase price extraordinary writing-off must be carried out.
3rd – test releasing indicators: The FASB set up a list of indicators of potential asset value shrinkage, for example: functional operative losses, evolutions that influence included evaluation parameters, law or regulation changes, probable (>50%) sale of the reporting unit, long term not line-typical market price decay.
4th – impairment test: The book value of the goodwill is to be compared with its fair value and to be depreciated where appropriate extraordinarily. The test works directly with discounted payment rivers through which a former recognition of the asset value shrinkage is possible.
5th – disclosure duties: The Income Statement has to contain a separate identity card of the goodwill-writing-off with the reasons of acquisition, purchase prices and impairment-writing-off.
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