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Goodwill Notes

Economics and Management Notes > Accounting Notes

This is an extract of our Goodwill document, which we sell as part of our Accounting Notes collection written by the top tier of Oxford University students.

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Pip Reeve ACHT11W3T2 'There is no tangible value in Goodwill, and therefore it should be immediately written off.' Critically evaluate this statement by showing your knowledge about different methods of accounting for Goodwill. Goodwill is a possible explanation of why a firm sells for more than the value of its current assets. It tends ot reflect the fact that the business has some prudent value above the value of its assets. Consolidation is essentially a two stage process whereby all balances or transactions that exist between group members are cancelled and the remaining figures are combined to show the group as a single economic entity. So, the subsidiary's retained earnings up to the date it became part of the group are cancelled against the parent's investments. However, 'in the real world it is highly unlikely that the amount paid by the holding company will equal the book value of the equity acquired according to the subsidiary's financial statements.' 1 If there is a difference, these figures cannot be cancelled against one another and so a balancing figure is required. This figure is called 'goodwill on acquisition. For example: Cost of Control Investment in V Share capital 15 8 Retained earnings 2 Goodwill c/d 5 15 15 Goodwill b/d 5 In this case, the acquiring firm, T, has paid a premium of 5 over the nominal value of share capital and reserves acquired. The consolidated statement of financial position will show the goodwill as a noncurrent asset. The Accounting Standards Codification 350 (ASC 350) 'states that companies are required to test for possible goodwill impairment at the reporting unit level at least annually, following a two-step process.'2 The first step in this process is to identify whether there is any potential impairment. The second step in the process is to measure the amount, if any, of the impairment change. So, goodwill impairment tests will be performed either at the end of the year, as required by ASC 350, or following a 'triggering event' which is 'a change in circumstances for the reporting unit that could create a situation where the fair value of the unit is below its carrying value.' 3 A triggering event may, therefore, occur if there are adverse regulatory decisions or a sudden drop in revenue. The recent financial crisis was of course a triggering event for many companies, this occurred 'as a result of the broad stock market decline and equity valuations dropping with the decline of the global economy.' 4 When establishing whether an impairment exists, a process must occur which involves 'comparing the fair value of the net assets of a reporting unit to the carrying value of its net assets.' 5 In order to determine the fair value of net assets, the 'traditional income or market-based valuation methods are 1 'Financial Reporting and Analysis' Dunn 2010 2 'Transaction structures matter in goodwill impairment testing' Lynch & Gandhi 3 'Transaction structures matter in goodwill impairment testing' Lynch & Gandhi 4 'Transaction structures matter in goodwill impairment testing' Lynch & Gandhi 5 'Transaction structures matter in goodwill impairment testing' Lynch & Gandhi

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