Goodwill Amortization

Updated on January 2, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

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, i.e., there is a reduction in the value of the goodwill of the company by recording 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 appearing in the books of account does not show the true value. The need for amortization arises to show the correct value of Goodwill In in booksBooksIn 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 over ten years (maximum up to 40 years) unless the shorter life is more appropriately known. An equal amount will be transferred to the Profit and Loss Account every year.

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. The logic behind this method is assets are operated consistently or evenly over time. This method is very simple to apply.

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#2 – Different Useful Life

In different useful life methods of goodwill amortization, allocate the asset’s cost 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.

Goodwill Explained in Video

 

Journal Entries

Below is an example of a journal entryExample Of A Journal EntryA journal entry example would be the country's purchase of machinery, where the machinery account would be debited and the cash account would be credited.read more.

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 that Company BCD can pay more than $50million. In 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

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

Example #2

In the above Example, one year later, Company BCD changed the product features and now deals in a different product. This new product is not as successful as the earlier product was. As a result, the company’s fair value starts declining. The 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 pays 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:

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:

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 the 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 journal entries. You may learn more about accounting from the following articles –

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