Definition of Goodwill Amortization
Goodwill amortization can be defined as a systematic process of gradually writing-off or reducing the depreciable balance of goodwill (an intangible asset recorded in books as a result of business acquisition or any other means) by charging reduction amount in the statement of profit and loss over a period of time it is expected to generate economic benefits to the organization.
Explanation
Goodwill is an intangible asset recorded in books due to business acquisition, which depicts the economic resources that cannot be individually identified and separately recorded. Amortization of goodwill happens in a methodical and standardized manner where the amount of goodwill asset balance is reduced by maintaining a yearly amortization charge. The amortization may conducted on a straight-line basis or in any other prescribed manner as stated in applicable GAAP.
Usually, the life of goodwill is assumed to be 10 years in the absence of any other specific information. It can be amortized within a lesser period if the life of an asset is proved to be useful and more appropriate than another use of amortization. Or in the case when a business conduct impairment testing when an event indicates that the actual value of an entity has reduced below its caring amount. A company needs to choose and adopt a single.
Example of Goodwill Amortization
Orange Inc. purchased the entire business of purple Inc. for a cash price of $20,00,000. As on the date of acquisition, the fair value of assets was $30,00,000, and external liabilities amount to $15,00,000. Accordingly, the net worth of purple Inc. was $15,00,000(30 – 15), but here Orange Inc. paid $5,00,000 in excess of fair market value. This $5,00,000, which cannot be individually identified or separately recognized to any asset, will be categorized as “Goodwill”,, i.e. a premium amount paid for purchasing an existing well-established business.
Goodwill Amortization GAAP
According to the US accepted principle, GAAP goodwill can’t be amortized by public companies. In place of amortization, these companies are allowed to test goodwill annually for impairment at a minimum and must report the value which occurs. The test must be conducted as, and when an event occurs by which risk arises and lowers the goodwill value, this event is known as a triggering event. Triggering events include unanticipated competitions, negative cash flows, bad debts, loss of a customer, stock market crashes or any other activity which degrades the economy. Impairment write-down will lower the amount of goodwill value in the balance sheet, and side by side will lower the profits too in the profit and loss statement.
Goodwill and impairment do not affect the investor. Goodwill cannot be amortized as it is considered to have an infinite useful life. It is the responsibility of the management to value the goodwill every year and assess if any impairment is required. If the current market value goes below the cost at which goodwill was purchased, impairment is recorded to match it to its market value. However, if there is any increase in the market value, which will not be accounted for in the financial statement, IFRS and other applicable GAAPs may provide useful life of goodwill as 10/20 years over which it needs to be amortized.
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Goodwill Amortization Tax
Amortization of goodwill or any other intangible asset is tax-deductible in IRS as per section 197 – Intangible. As per the ruling section, goodwill needs to be amortized on an adjustment basis over a period of 15 years from the initial date of purchase and recording. Goodwill amortization is charged to the fair value of goodwill that exists in the books. To determine the fair value company uses an assumption sale model, whether taxable or non-taxable. An organization can get a tax benefit of goodwill amortization.
Goodwill amortization charges can lower the deferred tax liability or can grow its deferred tax assets. An increase in deferred tax assets or a decrease in deferred tax liability can upgrade the value of reporting units, which in turn implement more amortization charges. Both deferred tax and impairment charges need to be considered side by side.
Goodwill Amortization Journal Entry
Following are the example are given below:
Example
Orange Inc. purchased Purple Inc. business for $20,00,000 on 01/01/2019.
- Fair value of Assets as on 01.01.2019 was $30,00,000
- External Liabilities totalled to $15,00,000
- Goodwill valued at $5,00,000.
The company assumed a life of goodwill as 10 years. Pass amortization entry as of 31/12/2019?
Solution:
Amortization Expense for the Year is calculated as
Amortization Expense for the Year = Goodwill Value/ Life
- Amortization Expense = 5,00,000/10
- Amortization Expense = 50,000
Journal Entry
| Date | Particulars | Debit | Credit |
| 31-12-2019 | Amortization Expense A/c | 50000 | |
| To Goodwill A/c | 50000 | ||
| (Being Goodwill amortized) | |||
| 31-12-2019 | P&L A/c | 50000 | |
| To Amortization Expense A/c | 50000 | ||
| (Being amortization expense charged to P&L A/c ) |
Goodwill Amortization vs Impairment
Amortization and impairment relate to the intangible asset value of a company reported on the balance sheet. The assets categorized as intangible are goodwill or the name and reputation of the company itself. Copyright, trademark, and patent are also given value and considered as intangible assets. Amortization is the gradual reduction of fall in the value of intangible assets, whereas impairment can be defined as sudden reduction or fall in the value of goodwill as a result of any uncertain internal or external event which significantly reduces or impairs its value. In accounting language, the fair market value of an asset turns significantly lower than its carrying value. Amortization represents the expense of using an intangible asset value for the production of revenue. To calculate amortization, the present value of intangible assets is determined, and its useful life expectancy is defined.
An asset is said to be impaired if its fair value determined is lower than carrying value(net of amortization). Impairment charges may be used to manipulate the balance sheet management to be fair and transparent in judging and estimating the impairment charge.
Advantages
Some of the advantages are given below:
Although amortization of goodwill is nothing else than providing for any charge in business. There does not exist any predefined sets of benefits, but any company can use goodwill amortization to reduce its income tax liabilities by increasing the expenses side. Goodwill represents the fair value of a business, i.e. the premium one needs to pay for purchasing a well-established business. Goodwill usually increases the net worth of companies as an addition to net worth, which may look attractive for potential investors. Writing goodwill also helps management allocate the cost of production and match revenue with its related expenses.
Conclusion
Goodwill is considered as an intangible, i.e. a non-monetary asset without a physical substance. It plays a major role in business valuation during mergers and acquisitions. It cannot be sold, transferred, rented, exchanged, or separated from the entity, nor can it be identified as a separate asset. According to FASB, goodwill cannot be amortized however other GAAPs may provide for amortization over a defined period of 10/20 years or in any other logical manner, which more accurately defines the usage pattern of goodwill.
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