9.5 Goodwill

Goodwill is a crucial concept in business combinations, representing the excess value paid for a company beyond its identifiable net assets. It's an intangible asset that reflects future economic benefits like brand reputation and synergies.

Accounting for goodwill involves initial recognition, subsequent measurement, and impairment testing. Unlike other assets, goodwill isn't amortized but is tested annually for impairment. This process ensures its carrying value accurately reflects its economic benefits to the acquiring company.

Definition of goodwill

• Goodwill represents the excess of the purchase price over the fair value of the identifiable net assets acquired in a business combination
• Arises when a company acquires another business and pays more than the fair value of the target company's net assets
• Reflects the value of intangible assets that are not separately identifiable, such as customer relationships, brand reputation, and skilled workforce

Characteristics of goodwill

Intangible asset

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• Goodwill is classified as an intangible asset because it lacks physical substance
• Represents the value of non-physical assets that contribute to the company's future economic benefits
• Cannot be sold or transferred separately from the business as a whole

Future economic benefits

• Goodwill is expected to generate future economic benefits for the acquiring company
• These benefits may include increased market share, synergies, cost savings, or higher profitability
• The value of goodwill is based on the expectation of these future benefits

Acquired in business combination

• Goodwill can only be recognized when it is acquired through a business combination (acquisition of another company)
• Cannot be internally generated or purchased separately from a business
• Arises as a result of the purchase price allocation process in a business combination

Accounting for goodwill

Initial recognition

• Goodwill is initially recognized on the balance sheet of the acquiring company at the acquisition date
• Recorded as an asset and measured as the excess of the purchase price over the fair value of the identifiable net assets acquired
• If the fair value of the identifiable net assets exceeds the purchase price, a bargain purchase gain is recognized in profit or loss

Measurement of goodwill

• Goodwill is measured as the difference between:
  1. The aggregate of the consideration transferred, non-controlling interests, and the acquisition-date fair value of any previously held equity interest in the acquiree
  2. The net identifiable assets acquired and liabilities assumed, measured at their acquisition-date fair values
• Consideration transferred includes cash, other assets, liabilities incurred, and equity interests issued by the acquirer

Bargain purchase

• A bargain purchase occurs when the fair value of the identifiable net assets acquired exceeds the purchase price
• In this case, the acquirer recognizes a gain in profit or loss on the acquisition date
• The gain is calculated as the difference between the fair value of the identifiable net assets and the purchase price
• Bargain purchases are rare and require careful assessment to ensure that all assets and liabilities are properly identified and measured

Subsequent measurement of goodwill

Impairment testing

• After initial recognition, goodwill is not amortized but is subject to annual impairment testing
• Impairment testing is performed to ensure that the carrying amount of goodwill is not overstated
• The impairment test compares the carrying amount of the cash-generating unit (CGU) or group of CGUs to which goodwill is allocated with its recoverable amount
• Recoverable amount is the higher of the CGU's fair value less costs of disposal and its value in use (present value of future cash flows)

Frequency of impairment tests

• Goodwill impairment testing is required at least annually, regardless of whether there are any indications of impairment
• Impairment tests may be performed more frequently if events or changes in circumstances suggest that goodwill might be impaired (triggering events)
• The annual impairment test can be performed at any time during the year, provided it is performed at the same time every year

Indicators of impairment

• Indicators of impairment that may trigger an impairment test include:
  • Significant decline in market share or profitability
  • Adverse changes in the business environment or market conditions
  • Technological obsolescence or significant changes in technology
  • Changes in key management personnel or high employee turnover
• If any of these indicators are present, an impairment test should be performed, even if it is not the regular annual testing date

Impairment loss calculation

• If the recoverable amount of the CGU is less than its carrying amount (including goodwill), an impairment loss is recognized
• The impairment loss is allocated first to reduce the carrying amount of goodwill allocated to the CGU
• Any remaining impairment loss is then allocated to the other assets of the CGU on a pro-rata basis, based on their carrying amounts
• The impairment loss is recognized in profit or loss and cannot be reversed in subsequent periods

Allocation of goodwill

Cash-generating units (CGUs)

• Goodwill is allocated to the cash-generating units (CGUs) or groups of CGUs that are expected to benefit from the synergies of the business combination
• A CGU is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets
• CGUs can be identified based on factors such as product lines, geographical areas, or customer segments

Allocation to CGUs

• Goodwill is allocated to CGUs or groups of CGUs at the lowest level within the entity at which goodwill is monitored for internal management purposes
• The allocation should not be larger than an operating segment as defined by IFRS 8 Operating Segments
• The allocation of goodwill to CGUs is important for impairment testing purposes, as the impairment test is performed at the CGU level

Reallocation of goodwill

• If the composition of CGUs changes (e.g., due to a reorganization or disposal), goodwill should be reallocated to the affected CGUs
• The reallocation is based on a relative value approach, using the fair values of the CGUs involved
• Reallocation ensures that goodwill continues to be tested for impairment at the appropriate level

Disclosure requirements

Goodwill movement schedule

• Companies are required to disclose a reconciliation of the carrying amount of goodwill at the beginning and end of the reporting period
• The reconciliation should show separately:
  • Gross carrying amount and accumulated impairment losses at the beginning of the period
  • Additional goodwill recognized during the period (e.g., from new business combinations)
  • Impairment losses recognized during the period
  • Other changes (e.g., disposals, foreign currency translation differences)
• This disclosure helps users understand the changes in goodwill over time

Impairment losses

• If an impairment loss is recognized for goodwill, the following information should be disclosed:
  • The events and circumstances that led to the recognition of the impairment loss
  • The amount of the impairment loss recognized
  • The CGU or group of CGUs to which the goodwill is allocated
  • The basis for determining the recoverable amount (fair value less costs of disposal or value in use)
• These disclosures provide transparency about the reasons for and the impact of goodwill impairment

Assumptions in impairment testing

• Companies should disclose the key assumptions used in determining the recoverable amount of CGUs for impairment testing purposes
• These assumptions may include:
  • Discount rates
  • Growth rates
  • Projected cash flows
  • Other relevant assumptions specific to the company or industry
• Disclosing these assumptions allows users to assess the reasonableness of the impairment test and the potential impact of changes in key assumptions

Goodwill in consolidated financial statements

Goodwill from subsidiary acquisition

• When a parent company acquires a subsidiary, goodwill arising from the acquisition is recognized in the consolidated financial statements
• The goodwill is calculated as the difference between the consideration transferred (including the fair value of any previously held equity interest) and the fair value of the identifiable net assets acquired
• The goodwill is allocated to the CGUs or groups of CGUs that are expected to benefit from the synergies of the business combination

Non-controlling interests

• If the parent company acquires less than 100% of the subsidiary, there will be a non-controlling interest (NCI) in the subsidiary's net assets
• The goodwill recognized in the consolidated financial statements includes both the parent's share and the NCI's share of goodwill
• The NCI's share of goodwill can be measured using either the full goodwill method or the partial goodwill method
  • Full goodwill method: NCI is measured at its proportionate share of the subsidiary's identifiable net assets plus its share of goodwill
  • Partial goodwill method: NCI is measured at its proportionate share of the subsidiary's identifiable net assets only

Disposals and deconsolidation

• When a parent company disposes of a subsidiary or loses control over it (deconsolidation), the goodwill associated with that subsidiary is derecognized
• The gain or loss on disposal or deconsolidation includes the carrying amount of the goodwill allocated to the subsidiary
• If the disposal or deconsolidation involves a CGU or a group of CGUs to which goodwill was allocated, the goodwill is allocated to the disposed or deconsolidated portion based on relative fair values

Tax implications of goodwill

Non-deductibility for tax purposes

• In most jurisdictions, goodwill is not deductible for tax purposes
• This means that the amortization or impairment of goodwill does not generate a tax benefit
• The non-deductibility of goodwill creates a permanent difference between the accounting and tax treatment, which affects the effective tax rate

Deferred tax liabilities

• The non-deductibility of goodwill can give rise to deferred tax liabilities
• Deferred tax liabilities arise when the tax base of the identifiable net assets acquired is lower than their fair value recognized in the business combination
• The deferred tax liability is calculated as the difference between the fair value and tax base of the identifiable net assets, multiplied by the applicable tax rate
• The recognition of deferred tax liabilities on acquisition increases the amount of goodwill recognized

Comparison of IFRS vs US GAAP

Similarities in goodwill accounting

• Both IFRS and US GAAP require goodwill to be recognized as an asset in a business combination
• Goodwill is measured as the excess of the consideration transferred over the fair value of the identifiable net assets acquired
• Goodwill is not amortized under both frameworks but is subject to annual impairment testing
• Impairment losses on goodwill cannot be reversed under both IFRS and US GAAP

Differences in impairment testing

• One-step vs. two-step approach:
  • IFRS: One-step approach, comparing the carrying amount of the CGU (including goodwill) with its recoverable amount
  • US GAAP: Two-step approach, first comparing the fair value of the reporting unit with its carrying amount (including goodwill), and then, if necessary, comparing the implied fair value of goodwill with its carrying amount
• Level of testing:
  • IFRS: Goodwill is tested at the CGU level or group of CGUs level
  • US GAAP: Goodwill is tested at the reporting unit level, which is an operating segment or one level below an operating segment
• Allocation of impairment loss:
  • IFRS: Impairment loss is allocated first to goodwill and then to other assets of the CGU on a pro-rata basis
  • US GAAP: Impairment loss is allocated entirely to goodwill