Lesson Objectives:- Recording goodwill and how it is used in a real world example
- Defining bargain pricing and gains
- How amortization applies to goodwill
Let's continue reviewing the concept of intangible assets by explaining what goodwill assets are and how they are measured.
The best way to understand goodwill, is by looking at a real life example of a company such as a well established investment company ABC that is looking to acquire company XYZ. Let's say they offer $200,000 to take over the company and company XYZ accepts the acquisition offer.
We would take a look at their balance sheet to see the total amount of assets and liabilities are $171,900. These amounts are the same to ensure both sides of the accounting equation are balanced. The investment company offered $200,000 which is greater than the amount listed on the balance sheet of $171,900.
In order for the investment company ABC to record the acquisition, we would need to write out a journal entry that shows they took on all of the assets on the balance sheet. The accounts are increasing, therefore they would be debited.
Next, we would credit the accounts on the liabilities side. This side of the journal entry would also need to show the $200,000 that the investment company paid out to acquire company XYZ.
At this point, we would have an imbalance in the journal entry because the right side would equal $349,950 and the left side would equal $171,900. We would then need to record the difference on the debits side for the goodwill which would be a debit of $178,050.
The goodwill would also be listed on the balance sheet. Essentially, goodwill is used to show the difference of the fair value and net assets of the company that was acquired.
If the cost of the acquisition is less than the fair value, the company would be getting a "bargain" and goodwill would not apply because the cost is not over the amount of net assets.
An example of this would be if the investment company paid only $20,000 instead of $200,000. The left side would still equal $171,900 but the right side would only be $169,950. In this case, they would need to record of $1,950.
In the past, this type of transaction has been considered an extraordinary gain but updates in IFRS standards have eliminated the use of the term "extraordinary". Now, we just call the difference between the fair value and the bargain price as the gain.
Next, let's talk about amortization.
Earlier in this lesson, we recorded a goodwill amount of $178,050 and this was perceived as an asset when the new company was acquired. The only way that the goodwill asset would no longer is exist is if the investment company went under. This also means that there is no defined usable life for this asset, therefore it would be considered an indefinite asset.
Due to the fact that the usable life time period cannot be determined for an indefinite asset, we would never need to worry about amortization. The value of the asset would be looked at using the concept of impairment and you can always refer back to the previous lesson if you need to review how impairment works.