Are you familiar with Goodwill as it applies to Accounting?
While you’ve likely heard of the term “goodwill,” are you aware of its application in accounting? Goodwill is an account on the balance sheet of certain businesses, and it falls into the category of assets. Specifically, it’s what’s known as an intangible asset, or one that isn’t physical. Examples of other intangible assets are copyrights, patents, and trademarks.
Understanding Goodwill in Accounting
Goodwill arises when one company purchases another. When a company pays more for the company that it is acquiring, the difference is booked as goodwill. Goodwill represents the extra value that the acquisition provides for the purchasing company.
When the purchase happens, the assets and liabilities of the acquired company are taken over by the purchasing company. They are recorded on the purchasing company’s books at their fair value. The balancing entry between the fair value of the assets and liabilities purchased and the purchase price is booked to the goodwill account.
What could lead a company to pay more for another company? Things that are not on the balance sheet but are valued could include a solid customer base, great employees, brand reputation, the company name and what it means, technology owned by the company, and a great reputation for customer service.
Normally, an intangible asset like goodwill would be amortized, but it is not. Amortization is when a portion of the asset is expensed each year. A patent, for example, is amortized over its useful life, not to exceed 20 years. If it sounds similar to depreciation, that’s because it is; some physical assets are depreciated, while some intangible assets are amortized.
Before 2001, goodwill was amortized for up to 40 years, but the accounting rules have changed to something less arbitrary. Now, goodwill must be checked each year for “impairment.”
Goodwill impairment happens when the value of the acquisition declines after it has been purchased. One famous example of impairment write-down occurred right after this new accounting rule was implemented. In 2002, $54.2 billion in impairment costs was reported for the AOL Time Warner, Inc. merger.
More recently, in 2020, a few of the largest impairment write-downs included companies, such as Baker Hughes, Berkshire Hathaway, and ATT, due to the latter’s acquisition of DirecTV in earlier years. In 2022, impairment write-downs included Teladoc Health and Comcast. Covid-19 was in part responsible for a large number of impairment write-downs in recent years.
If impairment is required to be booked, the journal entry will look like this:
Debit Impairment Expense (increases expenses and therefore reduces profits)
Credit Goodwill (reduces the asset amount)
If your company has acquired other companies and you have a goodwill account on your balance sheet, you can work with your accountant to determine how to check for impairment and if you are required to correct your books. While this process can be complex and time-consuming, it is crucial in ensuring that the financial statements are a true reflection of the company’s financial position. Goodwill is an important accounting concept that can have a significant impact on the financial statements of a business.