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The most controversial goodwill issue is whether the internally generated goodwill should be confirmed, which is a hot topic in financial accounting. In this essay, the author will introduce the goodwill, which including internally generated goodwill and consolidated goodwill. Then, will expound the opinion that internally generated goodwill should be confirmed, accompanied with arguments of the rationality and necessity. Furthermore, it will illustrate by a UK list company. Moreover, it will discuss how to confirm internally generated goodwill. Finally, author will make a conclusion.
Key words: goodwill, internally generated goodwill, consolidated goodwill, confirmation,
Currently, there is no a generally accepted concept of goodwill. While three representative views are favourable attitudes concept, excess earnings concept and master valuation account concept (Andrea, 2009). More specifically, in favourable attitudes concept, goodwill arises because of beneficial business contacts, good staff relations and good impression of customer (ibid). Moreover, in the view of excess earnings concept, goodwill is the discounted value that expected future benefits which not including goodwill exceeds the normal returns of total investment (ibid). Furthermore, as for the view of master valuation account concept, goodwill is the difference between overall value of assets and value of individual tangible assets and identifiable intangible assets. It believes that goodwill is not a kind of interest-bearing assets, but a special pricing account and shows the total value of all the assets of the entity exceeds the sum of individual value (ibid). Based on above views, goodwill could be identified that it is a present discounted value cash flow of future excess returns come from synergies of combination of various elements of organisation. Therefore, according to this definition, it might be stated that internally generated goodwill is the value generated under the existing synergies by combinations of elements of business; while consolidated goodwill is the value produced expected synergies of both parts of acquisition expect the combination of elements (Michael, 2010). The elements of each company might form a new synergy because of combination after the merger and acquisition activity. So that a company could obtain a new internally generated goodwill when it mergers others (Andrea, 2010). It possibly can be said that internally generated goodwill is the basis of consolidated goodwill; consolidated goodwill is converted form of internally generated goodwill. However, there are differences between two forms of goodwill. Specifically, consolidated goodwill is a trading price reached by two parties voluntarily through a clear and specific deal. It is formed in result of a certain level of competition in a mergers and acquisitions market. Yet, internally generated goodwill is unilateral (Michael, 2010).
Internally generated goodwill issue
According to the framework for the preparation and presentation of financial statements IAS 38 and IFRS 3 (2012), internally generated goodwill cannot be shown onto the statement of financial position, but consolidated goodwill must be confirmed in the statement of financial position. However, as knowledge based economy coming, the value formed by knowledge and intelligence increased greatly. Goodwill occupies proportion of total assets growing in an enterprise. Especially in some high technology companies, goodwill has gradually become the main body of total asset. Facing intensified and complex competition, more and more enterprises are relying on internally generated goodwill to dominate the market (Martin, 2008). Thus, it probably can be claimed that it is necessary to confirm internally generated goodwill.
The negative effects of unrecognising internally generated goodwill
There are some negatives if the internally generated goodwill is not confirmed. Specifically, in the following aspects mainly: firstly, violation of the principle of objective which can cause a serious distortion of accounting information (Martin, 2008). More detail, goodwill in the proportion of corporate assets is growing, and some have been dominant, which comparing to fixed assets in the proportion of corporate assets become smaller. In this case, if it still insisted on principle of prudent accounting that internally generated goodwill is not confirmed, it will deviate from book value of and the actual value, which will lead to a distortion of accounting information and violates the accounting principles of objectivity and the importance (ibid). Secondly, it does not meet principle of consistency. It could be said that goodwill is always internally generated, regardless self-generated goodwill or consolidated goodwill (ibid). As purchased goodwill is the internally generated goodwill of acquired company which just have not been confirmed before merger, but only until the acquisition is confirmed (ibid). Internally generated goodwill originally owned by the acquired enterprise is confirmed as internally generated goodwill of a new group when the merger occurs. Yet, the new group would only confirm this part without the confirmation of internally generated goodwill of the original acquisition of companies (ibid). It probably can be stated that it is inconsistent with the accounting principle of consistency. Furthermore, it violates the principle of accrual. More specific, the consolidated goodwill is performance form of internally generated goodwill in market. It is always existed, but it will not be confirmed until being acquired, which is inconsistent with the principles of accrual (ibid). Moreover, internally generated goodwill is the result of long term producing and managing process, it should be confirmed in the financial statements, which consistent with the principles of accrual. Or it applies cash basis principles (ibid). Finally, it is contrary to the relevance and reliability of accounting information. Specifically, it might not reflect the excess profitability of the company timely and accurately if confirm the goodwill only when mergers and acquisitions occur. As it cannot provide information about goodwill timely, neither satisfies the requirements of fiduciary duty to operators, nor satisfies the needs of interested parties to use accounting information for economic decision-making (ibid). Therefore, it could be said that it is contrary to the relevance and reliability of accounting information if internally generated goodwill is not confirmed.
Rationality and necessity of confirmation of internally generated goodwill
Firstly, considering about the objective of financial reporting, internally generated goodwill is an important manifestation of future excess profits of a company, and it has a great impact of creation of future cash flows. So providing the information generated goodwill to information users, which is conducive assess the prospects of future cash flows of information and benefit to provide the useful information to stakeholders to make rational decisions (Nina, 2010), which is the content of objectives of financial accounting. Therefore, it might be stated that objectives of financial accounting requiring confirmation of internally generated goodwill.
As for accounting principles, firstly, with the age of knowledge economy, the goodwill accounts assets for an increasing proportion, which can be seen from mergers and acquisitions activities. For instance, Chelsea football club plc, which is the UK listed company, had been sold to Roman Abramovich for 137 million pounds in 2003. While the book value of Chelsea football club plc is 56 million pounds (Chelsea, 2003), that means 81 million pounds were used for purchase the goodwill. Thus, it possibly can be said that according to the principle of importance, internally generated goodwill should be confirmed. Moreover, confirmation of internally generated goodwill meets the principle of comparability. It is lack of comparability between one with consolidated goodwill and one with internally generated goodwill if does not confirm it (Nina, 2010). Furthermore, it matches the principle of matching, as internally generated goodwill is a result of prolonged precipitation information and past experience is accumulated (ibid), it can be said that it has value and effectiveness. While, the expenditure of this process are identified as costs. Therefore, internally generated goodwill which can bring the excess returns only if put onto the financial statements, so that reflect the principle of matching revenues and expenses (ibid).
Way to confirm the internally generated goodwill
The nature of goodwill is that bring the excess economic interests to the company. Therefore, it might indicate that goodwill only exists among companies that obtained excess profits. In the meantime, it need to prevent it becomes a way to manipulate profits (Michael, 2010). Therefore, a reasonable way to confirm goodwill should be that the company should apply goodwill assess application to professional goodwill asset evaluation agencies when a company obtain higher profits continuously than the industry average over several accounting periods. There is internally generated goodwill in a company when it shows there is positive difference between assessed overall values and assessed fair value individual tangible asset (ibid).
Under IAS 38 (2012), internally generated goodwill cannot be shown onto the statement of financial position; while under and IFRS 3 (2012) consolidated goodwill must be confirmed in the statement of financial position. It is not correspond with requirements of objectives of accounting and accounting principles in contemporary era, and it is rational and necessary to confirm the internally generated goodwill. Therefore internally generated goodwill should be confirmed on the statement of financial position.