STUDY MATERIAL C2
156
ACCOUNTING FOR NON-CURRENT ASSETS
6.8.1 What is goodwill?
Goodwill . The difference between the fair value of a business as a whole and the aggregate
of the fair values of the separable and identifi able assets and liabilities.
This implies that it is not possible to identify goodwill separately from the business, and
this is largely because it is an intangible asset.
The defi nition above explains that goodwill is the value placed upon a business in
excess of the sum of its individual assets; thus goodwill represents the value of the busi-
ness continuing as a going concern, as compared with its assets being sold individually.
However, it could be said to be more than that. All established businesses have some
goodwill. Goodwill comprises business contacts, good staff relations, the right to occupy
certain pieces of land and so on. All of these have a value – the diffi culty lies in placing a
value on them.
Purchased and non-purchased goodwill
When a business fi
rst star
ts, it is either created by its owners or purchased from an exist-
ing business. In the latter case there will have been a certain amount of negotiation over
the purchase price. The vendors will obviously seek to obtain the highest price possible,
whereas the purchaser will seek to minimise the price. It is likely, however, that the fi nal
price will be greater than the purchaser’s valuation of the tangible assets taken over. This is
accepted because the price includes the rights to the existing business’s customer base, pos-
sibly its name, its staff, and their experience and expertise, and so on. This difference is the
goodwill and, more precisely, is said to be purchased goodwill .
However, whether the business is created as a new start-up business or is the result of
the acquisition of another business, new goodwill is earned or created by the new owners
over a period of time. This is known as non-purchased goodwill .
Accounting treatment
The accounting treatment of purchased goodwill is for the purchaser to place a fair value
on the net tangible assets (i.e. assets–liabilities) of the business acquir
ed and to consider
the differ
ence between the sum of these values and the total purchase price to be goodwill.
This amount is debited to the goodwill ledger account. The purchaser will hope that the
value of the goodwill will at least be maintained and that, if he were to sell the business, he
would be paid for its goodwill.
However, it is important to note, when applying the concept of prudence, that assets
should not be overstated. It could be that the factors which caused goodwill to exist in the
past, for example location and customer base, no longer apply and that the value of the
goodwill is now less than the price paid for it.
It is therefore necessary to estimate, on an annual basis, the value of the goodwill. If the
current estimated value is less than the amount in the statement of fi nancial position, then
the goodwill is said to be ‘ impaired ’ . Impairment occurs when the value of a non-current
asset is less than its carrying amount in the statement of fi nancial position. In this situa-
tion, the goodwill is reduced to its new lower value and the difference (the ‘ impairment ’ ) is
charged to the income statement as an expense.