How to Account for Goodwill & Intangible Assets

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Intangible assets are items that a company owns and derives benefit from, but is unable to physically measure and count. Examples of intangible assets include patents, trademarks and copyrights. Goodwill is a special type of intangible asset that normally appears in a company's balance sheet following a business combination. When the fair value of the consideration paid by the purchaser for an entity exceeds the fair value of the net assets they have acquired, the purchaser must recognize the resulting difference as goodwill in their balance sheet.

Goodwill

  • Calculate the goodwill arising on acquisition. Ascertain the price paid to acquire the new business, and from this deduct the net assets that you acquired. Obtain a copy of the latest balance sheet for the acquired business to confirm that the value of the net assets is correct. The difference between these assets and the consideration you have paid will be the initial goodwill that must be recognized in your financial statements.

  • Recognize the goodwill as an asset in your balance sheet by making a debit entry to a goodwill code in your general ledger. Make the corresponding credit entry to a suitable equity account, reflecting the fact that you have purchased a new business. Add a new line for goodwill right at the top of your balance sheet, above the total for tangible assets.

  • Review your goodwill on an annual basis. International Financial Reporting Standards require companies to assess goodwill for impairment at least annually. Determine whether the goodwill continues to bring as much benefit to your business as when you first recognized it. If not, you need to recognize an impairment. Deduct the amount you currently value your goodwill at from the amount originally recognized in the financial statements. The difference is the impairment loss and must be accounted for by a credit entry to reduce the carrying value of goodwill and a corresponding debit entry to take the loss to your income statement.

Other intangible assets

  • Identify your intangible assets. These might be computer software, franchises, customer lists, licenses or marketing rights. If you expect these assets to bring future economic benefits to your company and you are able to measure their value reliably, then accounting standards require you to recognize these assets in your financial statements.

  • Determine the value of the intangible assets. In some cases, this may simply be the price you paid for them. In the case of computer software or other assets that have been developed within your company, calculate the internal cost to your company of designing and creating the asset.

  • Determine whether the life of the intangible asset is finite or infinite. An asset with a finite life is useful to your company only for a set amount of time -- for example, a copyright valid for 20 years. An asset with an infinite life has a life that is not influenced by any legal or economic factors.

  • Calculate the annual amortization amount you must charge to your income statement. Divide the value of the intangible asset by the useful life of the asset to arrive at this value. Deduct this amount from the carrying value of the intangible asset every year, and recognize a corresponding amount as an expense in your income statement. Continue doing this until the carrying value of the intangible asset reaches zero.

Tips & Warnings

  • Goodwill is almost always positive, so check your calculations if you arrive at a negative figure. Speak to your CPA if you genuinely have negative goodwill as the accounting treatment can be complex.

References

  • Photo Credit accounts image by Alexey Klementiev from Fotolia.com
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