Goodwill Amortization

What is Goodwill Amortization?

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.

In simple words, Goodwill Amortization means writing off the value of Goodwill from the books of accounts or distributing the cost of Goodwill in different years. It is because the value which is appearing in the books of account is not showing the true value. To show the correct value of Goodwill in books In BooksIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price.read more of accounts, the need for amortization arises.

Goodwill Amortization

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Methods of Goodwill Amortization

#1 – Straight Line Method

In the Straight Line MethodStraight Line MethodStraight Line Depreciation Method is one of the most popular methods of depreciation where the asset uniformly depreciates over its useful life and the cost of the asset is evenly spread over its useful and functional life. read more, amortization is allocated 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.

Amount Transfer to Profit and Loss Account Every Year = Amortization Amount / Number of Years

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 policy according to its nature of business.

Journal Entries

Below is an example of a journal entry.

Goodwill Amortization Entry 1
Goodwill Amortization Entry 2

Examples of Goodwill Amortization

Let’s see some practical examples to understand it better.

You can download this Goodwill Amortization Excel Template here – Goodwill Amortization Excel Template

Example #1

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.

Solution:

Calculation of Goodwill can be done as follows –

Goodwill Amortization Example 01

Value of Goodwill = $65 million – $50 million

Value of Goodwill = $15 million

$15 million will be the goodwill amount that BCD will record as Goodwill in their books of account after purchasing XYZ.

Example #2

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.

Solution:

You can do the calculation of impairment loss as follows –

Example 02

Impairment Loss = 65-58

Impairment Loss = $7 million

In the books, Goodwill is recorded as $15 million.

Now, this amount of Goodwill will reduce by $7million.

Example #3

Small Ltd. has the following assets and liability

ParticularsValue (Millions)
Cash85
Investments200
Stock450
Bank Balance92
Property & Equipment825
Other Current Asset150
Term Loan350
Creditors144
Current Liabilities65

Big Ltd acquires small Ltd and paying the purchase consideration of $1300 million; what will be the goodwill value big Ltd will record in his books after the acquisition.

  • After 2 years
  • The fair value of these assets =$1280 million
  • How will Goodwill be amortized?
  • Calculate the amortization amount by a straight-line method in 10 years?

Solution:

Calculation of amortization amount in 10 years will be –

Example 03

Net Worth:

  • Net Worth = Total of assets – Total of liabilities = (85+200+450+92+825+150) – (350+144+65) = 1243

Value of Goodwill:

Amortization Amount:

Amortization Goodwill :

  • Goodwill appears in books = $57
  • After Amortization it will be = 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 to the given above excel template for the detailed calculation of goodwill amortization.

How Amortization Reduces the Tax Liability of an Entity?

As you debit the amortization amount to profit and loss account, the taxable income reduces, and tax liability also gets lower.

Conclusion

Recommended Articles

This article 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 –

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