Corporate management sets proper procedures to ensure that personnel record transactions in accordance with generally accepted accounting principles, or GAAP. Senior executives also establish specific policies, such as goodwill amortization and tax management, to make sure employees do not run afoul of fiscal laws and report accurate, complete financial statements.
Goodwill, or customer goodwill, draws on a company’s competitive clout or advantage, its reputation in the marketplace or the combined intellectual capital of its personnel. Goodwill only arises when a company acquires another business. It’s an intangible asset -- meaning, it lacks physical substance, unlike tangible or fixed assets like equipment and buildings. Customer goodwill equals the purchase price of an acquired business minus its net worth, which equals corporate assets minus liabilities. For example, an investor buys a company with a book value of $1 million, but remits $1.5 million. Goodwill equals $500,000, or $1.5 million minus $1 million.
Amortizing goodwill, or any other intangible asset, means spreading the asset's cost over several years -- generally over the resource's useful life, which is the number of periods a company will benefit from the asset. Intangible assets run the gamut from trademarks and patents to franchises and copyrights. Under GAAP, amortization works the same way for intangible assets as depreciation does for tangible assets. To record amortization expense, a corporate bookkeeper debits the amortization expense account and credits the corresponding intangible asset account. Amortization and depreciation are non-cash expenses -- meaning, a company doesn't pay for them, unlike such operating charges as rent and office supplies along with salaries and litigation.
A business pays taxes on its operating income, generally at the federal, state and local levels. Taxes also pertain to payroll levies, such as Social Security and Medicare withholdings. To determine its true operating performance, a company often pays more attention to its pre-tax operating income than its net income -- which takes into account fiscal charges. The business may use such metrics as EBITDA or gross income. EBITDA stands for “earnings before interest, taxes, depreciation and amortization.” Gross income equals gross sales minus cost of goods sold.
Taxes and goodwill are different concepts, but they sometimes interrelate. Both items are income statement components -- although amortization doesn’t call for a cash remittance, whereas fiscal settlements involve payments to state revenue agencies and the Internal Revenue Service. An income statement incorporates a company’s revenues, expenses and net income -- or loss, if revenues are lower than expenses. Accountants often use the terms “statement of profit and loss,” “statement of income” and “P&L” when referring to an income statement.
- Drexel University Lebow College of Business: Accounting for Income Taxes
- University of Idaho College of Business and Economics: Accounting for Income Taxes
- Cornell University Law School; United States Code: Section 197 -- Amortization of Goodwill and Certain Other Intangibles
- The University of Arizona; Notes on Goodwill -- Tax and FASB Regulations; Chris Lamoureux, Ph.D.
- NYU Stern School of Business; In Practice: Acquisitions: Purchase, Pooling and Goodwill; Aswath Damodaran
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