What Is Amortized Goodwill?
Amortized goodwill refers to the historical accounting practice of systematically reducing the value of goodwill on a company's balance sheet over a predetermined period. While this was once a standard component of financial accounting under Generally Accepted Accounting Principles (GAAP), the concept of amortized goodwill is largely obsolete for public companies today. Goodwill, an intangible asset representing the non-physical value of an acquired business—such as brand reputation, customer base, or proprietary technology—is generally not amortized but instead tested annually for impairment loss. However, specific rules allow certain private companies to elect to amortize goodwill.
History and Origin
The accounting treatment of goodwill has undergone significant evolution. Historically, after a business combination where one company acquires another, the goodwill recognized as part of the purchase price was considered a wasting asset and was amortized over its estimated useful life, typically not exceeding 40 years. This practice was mandated by Accounting Principles Board (APB) Opinion No. 17.
However, in 2001, the Financial Accounting Standards Board (FASB) issued Statement No. 142, "Goodwill and Other Intangible Assets," which fundamentally changed how goodwill is accounted for. This statement eliminated the amortization of goodwill for public companies, reasoning that straight-line amortization over an arbitrary period did not accurately reflect economic reality or provide useful information for investment analysis. Instead, Statement 142 introduced an impairment-only model, requiring goodwill to be tested for impairment at least annually.,
A9 8partial rollback of this change occurred in 2014. The FASB issued Accounting Standards Update (ASU) No. 2014-02, "Intangibles—Goodwill and Other (Topic 350)," which allowed private companies to elect to amortize goodwill on a straight-line basis over 10 years or less if another useful life is more appropriate. This change aimed to reduce the cost and complexity of annual impairment testing for private entities.,
7Key Takeaways
- For public companies, goodwill is generally not amortized but is subject to annual impairment testing.
- Amortized goodwill refers to the systematic reduction of goodwill's value over a set period, a practice common before 2001 and now primarily available to private companies.
- The primary reason for reintroducing amortization for private companies was to simplify accounting and reduce the cost of compliance compared to complex impairment tests.
- Goodwill arises in an acquisition method of accounting when the purchase price exceeds the fair value of identifiable net assets acquired.
Formula and Calculation
The concept of amortized goodwill implies a periodic reduction of its carrying value. When goodwill is amortized, the calculation is typically straightforward, often using the straight-line method. The annual amortization expense is determined by dividing the initial goodwill amount by its estimated useful life (e.g., 10 years for private companies electing this option).
Annual Amortization Expense = (\frac{\text{Initial Goodwill Amount}}{\text{Amortization Period (in years)}})
This calculated expense is then recognized on the income statement, reducing the company's reported net income. Concurrently, the goodwill balance on the balance sheet is reduced by the same amount. No complex formula is typically involved beyond this direct write-down over the chosen period.
Interpreting the Amortized Goodwill
When a company elects to report amortized goodwill, it signifies a commitment to systematically account for the decline in the value of the goodwill over time. For private companies, electing to amortize goodwill can provide a more predictable and less volatile impact on their financial statements compared to the potential for large, irregular impairment loss charges under the impairment model.
The presence of amortized goodwill on financial statements, particularly for a private entity, indicates adherence to a specific accounting election designed to ease the burden of compliance with accounting standards related to intangible assets. Users interpreting such financial statements should understand that the goodwill's value is being steadily reduced, and a sudden, significant drop due to impairment is less likely unless a "triggering event" occurs, even for amortizing entities.
Hypothetical Example
Consider "Alpha Co.," a private company, that acquires "Beta Inc." for $5 million. The fair value of Beta Inc.'s identifiable net assets (like property, plant, equipment, and patents) is $4 million. The difference, $1 million, is recorded as goodwill.
If Alpha Co. elects to amortize this goodwill over a 10-year period using the straight-line method, the annual amortization expense would be:
Annual Amortization Expense = (\frac{$1,000,000}{10 \text{ years}} = $100,000)
Each year, Alpha Co. would record a $100,000 amortization expense on its income statement, and the carrying value of goodwill on its balance sheet would decrease by $100,000. After five years, the goodwill balance would be $500,000 ($1,000,000 - 5 * $100,000). This process continues until the goodwill is fully amortized or an earlier impairment event occurs.
Practical Applications
While not applicable to all entities, the accounting for goodwill, whether through amortization or impairment, is a critical aspect of financial reporting. For private companies that elect it, amortized goodwill simplifies compliance by providing a clear, predictable method of expensing this intangible asset. This approach avoids the need for complex, often costly, annual valuation techniques required for impairment testing in the absence of amortization.
Furthermore, the OECD (Organisation for Economic Co-operation and Development) recognizes goodwill in its broader definition of intangibles for transfer pricing purposes, highlighting its economic significance beyond strict accounting treatment in financial statements. The OECD's definition of intangibles includes goodwill and ongoing concern value, underscoring its relevance in assessing the overall value created by multinational enterprises.
L6imitations and Criticisms
The primary criticism of amortized goodwill, particularly before the 2001 FASB Statement 142, was that it did not accurately reflect the economic reality of goodwill. Critics argued that goodwill, representing factors like brand recognition and customer loyalty, often does not diminish in value over a fixed period in a predictable, straight-line manner. Instead, its value can fluctuate based on market conditions, competitive landscape, and business performance. This led to the shift towards an impairment model, where goodwill is only written down if its fair value falls below its carrying amount.
Even for private companies that elect to amortize, the method can be criticized for its arbitrary period (e.g., 10 years), which may not align with the true economic life of the goodwill. While it simplifies accounting, it might not always present the most accurate financial picture. The ongoing debate around goodwill accounting highlights the challenge of valuing and reporting such complex intangible assets.
Amortized Goodwill vs. Goodwill Impairment
The fundamental difference between amortized goodwill and goodwill impairment lies in their underlying accounting philosophy and timing of recognition.
| Feature | Amortized Goodwill | Goodwill Impairment |
|---|---|---|
| Method | Systematic, periodic reduction over a fixed period. | Event-driven or annual assessment of fair value vs. carrying value. |
| Timing | Regular, predictable expense (e.g., annually). | Irregular, occurs only when value decline is identified. |
| Recognition | Annual amortization expense on the income statement. | Impairment loss recognized on the income statement when goodwill's carrying value exceeds its fair value. |
| Applicability (US GAAP) | Optional for private companies (per ASU 2014-02). | Mandatory for public companies and private companies not electing amortization (per ASC 350 guidance). |
| Assumed Value Change | Assumes gradual decline in value over time. | Assumes value remains intact until evidence of decline exists. |
Amortized goodwill provides a stable, predictable expense, whereas goodwill impairment can lead to significant, sudden charges on the income statement if a reporting unit's fair value drops.
FAQs
Why is goodwill no longer amortized for public companies?
The Financial Accounting Standards Board (FASB) eliminated the amortization of goodwill for public companies in 2001 with Statement 142. They reasoned that goodwill's value doesn't typically decline predictably over time and that annual impairment testing provides more relevant information by reflecting actual economic changes.,
###5 4Can any companies still amortize goodwill?
Yes, private companies in the U.S. have the option, under specific FASB Accounting Standards Updates, to elect to amortize goodwill on a straight-line basis, typically over 10 years or less. This provides a simpler alternative to the often complex annual impairment tests required for public companies.,
3How does amortized goodwill affect a company's financial statements?
When goodwill is amortized, an annual amortization expense is recorded on the income statement, which reduces net income. Concurrently, the carrying value of goodwill on the balance sheet decreases by the same amount each period.
What is the alternative to amortizing goodwill?
The alternative to amortizing goodwill is the impairment model, primarily used by public companies. Under this model, goodwill is not systematically written down but is tested at least annually (or more frequently if triggering events occur) to determine if its fair value has fallen below its carrying amount. If it has, an impairment loss is recognized.,[1]2(https://viewpoint.pwc.com/dt/us/en/pwc/accounting_guides/business_combination/business_combination__28_US/chapter_9_accounting_US/95_impairment_model_US.html)