What are treatments of goodwill in financial statements?
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Question
What are treatments of goodwill in financial statements?
Answer
Goodwill is an intangible asset that is represented by the purchase price (or a reasonable offer) minus the book value (or fair valuation) of a company. Thus the goodwill is an asset that is payed for in addition to the value of a company’s other assets, and should fundamentally be recorded as such.
In the UK the Financial Reporting Council determines the standards to be applied in financial reporting – which is currently determined by the September 2015 FRS 102 (FRC, 2015).
The FRS 102 specifies that the recorded value of goodwill needs to be subjected to amortisation, meaning that it (alongside other intangible assets) is considered to have a ‘finite useful life‘ (FRC, 2015 p.142). If the company cannot produce a reliable estimate of its useful life, then it should not exceed 10 years. Over this period the company must apply depreciation and record the result in the profit and loss accounts.
The method of applying depreciation is at the company’s discretion based on the way they expect to use the asset, but as standard a straight-line method should be used. The residual value of intangible assets should always be considered to be zero, unless there is an agreement or an active market for the sale of the asset that can determine value.
The company also needs to consider impairment of the goodwill, this refers to loss of recoverable value (i.e revenue generation or asset value). Goodwill needs to be valued based on the fair value of the cash generating units that the goodwill is associated with. If these cash generating units have decreased in recoverable value, then the goodwill may also have decreased in value and this should be recorded in profit and loss accounts. An impairment loss on goodwill cannot be reversed in a later period.
References
FRC, 2015, FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland, Available [https://www.frc.org.uk/Our-Work/Publications/Accounting-and-Reporting-Policy/FRS-102-The-Financial-Reporting-Standard-applicab.pdf] Accessed: 12/06/16
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