Treatment of Goodwill : IFRS v. GAAP


Goodwill is an intangible asset which represents the future economic benefit arising from assets which cannot be recognised separately. It constitutes an essential part of assets, especially for those companies which are operating in high technology industries. Due to the growing importance of intangible assets, there has also been a significant change in the standards associated with the accounting treatment of goodwill.

International Accounting Standard Board issued International Financial Reporting Standard (IFRS) 3- Business and Combination in 2004. This new standard provides significant changes for the accounting treatment of intangible assets, goodwill and business combinations.

According to new standards,  firms must not amortise the goodwill, but it has to be tested for annual impairment. The new accounting rule move head American General Accepted Accounting Principal (US GAAP), which introduced such an approach a few years earlier for the accounting treatment of Goodwill.

On July 20, 2001, the Financial Accounting Standard Board (FASB) issued the statements of the standard such as; Standard -141 Business Combination and 142- Goodwill and Other Intangible. Under the US GAAP goodwill is not amortised but has to be tested for impairment. A firm does not consider goodwill as a separate asset, so it is evaluated for impairment as a part of the cash-generating unit under IFRS or reporting unit in US GAAP.

U.S. GAAP Treatment of Goodwill Impairment

According to U.S. GAAP (Statement of Financial Standard Accounting Board -142 business Combinations and 142- Goodwill and Other Intangible assets) laid down the rules for the accounting treatment of Goodwill in the books of account.

Under U.S. GAAP, the value of goodwill is recorded as the excess of the cost of an acquisition price over the fair value of acquired net assets.  It will be recorded only when the carrying amount of goodwill exceeds its implied fair value. Before the new accounting standards, companies generally recorded the total amount of goodwill in the books and not assign the value of goodwill to the individual reporting unit of business.

A reporting unit is defined in the Statement of Financial Accounting Standard 142.30 as an operating unit or its component. Companies assign the value of goodwill to reporting units by comparing the estimated value of the operating unit with the fair value of the reporting unit’s identifiable net assets. There should be followed two-steps impairment to identify potential goodwill impairment as well as to measure the amount of impairment loss to be recognised if any.

Step 1:-Test for Impairment Goodwill

The companies should need to follow the first step to identify the fair value of reporting unit includes goodwill; Compare the fair value of reporting unit with the carrying amount if the fair value of reporting unit is higher than the carrying amount then there is no Impairment and test is completed at the first step (we do not need to perform the second step of the impairment) on other hand if the fair value of reporting unit that includes the goodwill less than the carrying value of assets (including goodwill) fewer liabilities, then the second step should be performed to measure the impairment loss (if any).

Step 2:- Measures the Amount of Goodwill Impairment Loss

For calculating the amount of impairment loss of goodwill the companies should follow the rules of accounting standard such as-

(A) Allocate the fair value of reporting unit step 1 to identifiable assets and liabilities of the reporting unit based on their current fair value;

(B) Allocate any excess fair value to goodwill;

(c) compare the amount allocated to goodwill In step 2(b) with the balance sheet carrying a value of goodwill

(d) An organisation can recognize an impairment loss on goodwill by reducing the carrying value of goodwill to its fair value computed in step 2b.

For Example

A Philips company spent $100 million to acquire the tangible assets and brand name of Tommy spices.  A Philips intends to sell Tata sky in warehouse stores like sam’s club and cast. At the time of the acquisition, the fair value of identifiable assets were $15 million of tangible assets, $35 Brand name with identifies life, and $50 million of goodwill.   After soon the acquisition due to market pressure from its competitor, the MK spices company, forced to Philips Company to offer the Higher- than anticipated cash discount and slotting fees to its large customers and reducing the fair value of Tommy spices as an entity of $60 million.

Philips company first identified and measured the impairment loss on the tangible assets. The Philips estimated undiscounted cash flow related to tangible assets total worth $25 million and that their fair value is $ 15 million. The tangible assets are not impaired because the undiscounted cash flows $25 million exceeds their carrying value of $15 million.

The Philips next identifies and measures the impairment loss on the brand name. The fair value of brand name is now $25 million, which is less than the carrying, value $35 million. The Philips recognised $10 million loss on the brand name. This loss reduces the carrying value of Tommy spice to $90 million. ($15 millions tangible assets+ $25 millions for brand name and+ $50 million for goodwill). The Philips incurred a goodwill impairment loss because the fair value of Tommy spice of $60 million is less than $90 million after the impairment loss on the brand name.

The Philips remeasures the fair value of Tommy spice’ tangible assets and brand name $15 million and $25 million, respectively- already measured. The residual value of $20 million assigned to goodwill solely to measure the amount of goodwill impairment loss. Carrying value of goodwill on the balance sheet, $50 exceeds its implied fair value $20 million by$30 million. Therefore, the Philips Company recognise $30 million goodwill impairment loss.

IFRS treatment of Goodwill

Under IFRS, the value of goodwill is measured as the difference between recoverable amount over the balance sheet carrying value  (including identifiable assets, liabilities and contingent liabilities). An organisation requires the valuation of the fair value of all identifiable fair value of all tangible and intangible assets of the business for recognition of goodwill.

On the day of acquisition of goodwill, the impairment test is applied at the level of the cash-generating unit. The term cash-generating unit has been defined in IFRS. It is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets and the group of assets. An organisation recognises an impairment loss if the recoverable amount of unit is less than the balance sheet carrying value.

As above the Same example proceed: –

AssetsCarrying valueRecoverable value
Land, Building, and Equipment (Tangible assets) $15 $15
Brand names $35 $25
Goodwill $50 $20
Cash-generating unit $100 $60

Philips recognises an impairment loss of $40 million. Because the carrying value of the cash-generating unit exceeds its recoverable amount of $60 million.

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