Goodwill amortization refers to the process in which the cost of the goodwill of the company is expensed over a specific period of the time i.e., there is a reduction in the value of the goodwill of the company by the way of recording of the periodic amortization charge in the books of accounts.
What is Goodwill Amortization?
Goodwill Amortization means writing off the value of goodwill from the books of accounts or distributing the cost of goodwill in different years. This is because the value which is appearing in the books of account is not actually showing the true value. To show the correct value of goodwill in books of accounts the need for amortization arises.
- Prior to 2001, Goodwill was amortized over a maximum period of 40 years as per US GAAP. However, Goodwill is no longer amortized every financial year anymore. Goodwill will have to be checked every year for impairment and if there is any change, it is recorded in the Income Statement.
- Since 2015, private companies have been allowed to amortize goodwill over a period of 10 years thereby reducing the cost and complexity involved in testing for impairment.
- This implies that the goodwill amortization implies only to the Private companies and Public companies have to test its goodwill for impairments.
Methods of Goodwill Amortization
Below are the two methods for Amortization of Goodwill:
#1 – Straight Line Method
In a straight-line method of goodwill amortization, allocating amortization amount over 10 years (maximum up to 40 years) unless the shorter life is more appropriately known. Every year an equal amount will be transferred to Profit and Loss Account.
The straight-line amortization method is the same as the straight-line method of depreciation. This method is very simple to apply. The logic behind this method is assets are operated consistently or evenly over time.
#2 – Different Useful Life
In different useful life method of goodwill amortization, allocate the cost of the asset to expense over its useful life. For every entity, useful life can be different. Every Entity has its own policy according to its nature of business.
Journal Entry for Goodwill Amortization
Below is an example of journal entry for goodwill amortization.
Examples of Goodwill Amortization
Let’s see some practical examples to understand it better.
Suppose Company BCD is planning to purchase Company XYZ. The Book value of Company XYZ is $50million but Company XYZ has a good market reputation for that Company BCD can pay more than $50million, on the final deal, ABC agrees to pay $65 million. Calculate the value of goodwill amortization.
Calculation of goodwill can be done as follows –
Value of Goodwill = $65 million – $50 million
Value of Goodwill = $15 million
$15 million will be the goodwill amount that will be recorded as goodwill in BCD’s books of account after purchasing XYZ.
In the above Example, 1 after a year ahead Company BCD changed the product features and now deals in a different product this new product is not so successful as the earlier product was, as a result, the fair value of the company starts declining new fair value is $58 million book value is $65 million. Calculate the Impairment loss.
Calculation of impairment loss can be done as follows –
Impairment Loss = 65-58
Impairment Loss = $7 million
In the books, goodwill is recorded as $15 million
Now, this amount of goodwill will get reduced by $7million.
Small Ltd. has the following assets and liability
Small Ltd is acquired by big Ltd and paying the purchase consideration of $1300 million what will be the goodwill value recorded by big Ltd in his books after the acquisition.
- After 2 years
- The fair value of these assets =$1280 million
- How goodwill will be amortized?
- Calculate the amortization amount by a straight-line method in 10 years?
Calculation of amortization amount in 10 years will be –
- Net Worth = Total of assets – Total of liabilities = (85+200+450+92+825+150) – (350+144+65) = 1243
Value of Goodwill:
- Value of goodwill =Purchase Consideration – Net Worth = 1300 – 1243 = 57
- Amortization amount = Book Value of Assets – Fair Value = 1300 – 1280 = 20
Amortization Goodwill :
- Before amortization goodwill is appearing in books $57
- Amortization Goodwill = 57 – 20 = $37 million.
Amortization Amount in 10 Years:
- Amortization Amount in 10 Years = $20million / 10years = $2 million
- Every year up to 10 years to be written off by debiting Profit and Loss account.
You can refer the given above excel template for the detailed calculation of goodwill amortization.
How Amortization Reduces the Tax Liability of an Entity?
- Private companies can elect to amortize goodwill over a period of ten years using the straight-line method.
- Only purchased goodwill is recorded in books of accounts. Self-generated goodwill not recorded in books of accounts.
- The goodwill which no longer exists should be written off from books in the form of amortization
- Conditions that may trigger an impairment of goodwill are increased competition, a big change in management, change in a product line, deterioration in economic conditions, etc.
This has been a guide to What is Goodwill Amortization & its definition. Here we discuss goodwill amortization methods along with examples and its journal entries. You may learn more about accounting from the following articles –