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Definition of Goodwill Amortization

Goodwill amortization can defines 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.

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Explanation

Goodwill is an intangible asset recorded in books due to business acquisition, which depicts the economic resources that cannot individually identify and separately recorded. Amortization of goodwill happens methodically and standardized, where the amount of goodwill asset balance reduces by maintaining a yearly amortization charge. The amortization may conduct on a straight-line basis or in any other prescribed manner as stated in applicable GAAP.

Usually, the life of goodwill is 10 years without any other specific information. It can be amortized within a lesser period if an asset’s life is 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 carrying 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 of the date of acquisition, the fair value of assets was $30,00,000, and external liabilities amounted 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 individually identify or separately recognized to any asset, will categorize 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 conduct 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 competition, 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 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 amortize as it considers to have an infinite useful life. It is the responsibility of the management to value the goodwill every year and assess if any impairment requires. 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 account 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 amortize.

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 charges 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, implementing more amortization charges. Both deferred tax and impairment charges need to be considered side by side.

Goodwill Amortization Journal Entry Example

Orange Inc. purchased Purple Inc. business for $20,00,000 on 01/01/2023.

The fair value of Assets as of 01.01.2023 was $30,00,000

External Liabilities totaled $15,00,000

Goodwill is valued at $5,00,000.

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

Date

Particulars

Debit

Credit

31-12-2023 Amortization Expense A/c 50000

To Goodwill A/c

50000

(Being Goodwill amortized)

31-12-2023 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 related to the intangible asset value of a company are 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 valued and considered intangible assets. Amortization is the gradual reduction of a fall in the value of intangible assets. In contrast, impairment can be defined as a sudden reduction or fall in the value of goodwill due to 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 to produce revenue. To calculate amortization, the present value of intangible assets is determined, and useful life expectancy is defined.

An asset is said to impair if its fair value is lower than its carrying value(net of amortization). Impairment charges may use to manipulate the balance sheet management to be fair and transparent in judging and estimating the impairment charge.

Advantages

Although amortization of goodwill is nothing more than providing for any business change, there are no predefined sets of benefits. Still, any company can use goodwill amortization to reduce its income tax liabilities by increasing expenses. 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 to potential investors. Writing goodwill also helps management allocate the cost of production and match revenue with its related expenses.

Conclusion

Goodwill is considered 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 or 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 that more accurately defines goodwill usage patterns.