According to financial terms, goodwill is defined as the net difference between the actual value of the business as a whole, and the fair value of the inseparable net assets. Given the fact that the goodwill figure does not result from accounting transactions, it is not normally recognized on balance sheets. The most interesting fact about goodwill is that it is usually in existence at all times in the company but difficult to measure objectively. For instance, during the valuation of goodwill some assets that form part of a company’s goodwill such as employees, business reputation, and customers among others are normally not recognized hence giving the wrong figure.
There are two categories of goodwill distinguished as purchased and internally generated goodwill. Just as the name suggests, purchased goodwill arises from transactions involving the sale of business ventures. For instance, when one company buys another company at a value higher or lesser than the actual value, the resulting difference in price is normally regarded as goodwill. On the other hand, internally generated goodwill also referred to as non-purchased goodwill arises from all other sources excluding that obtained through purchase.
The difference in the two types of goodwill comes about during their accounting treatment. That is under SSAP 22 ‘Accounting for Goodwill’, whereby business entities have two options for the treatment of goodwill: capitalization or have it written off to reserves.When goodwill is purchased, it is treated as a non-current asset in the balance sheet, on acquisition. The only exception for this is when an associate company purchases the goodwill as an investment. If the company losses goodwill during purchase/sale, it is treated as an expense at the time of acquisition. Alternatively, the goodwill could be written off against the company reserves during acquisition (Australian Accounting Standards Board 8). In addition to this, purchased goodwill is in most cases viewed as a future benefit of the company in accordance to FRS 10. The treatment of purchased goodwill in the aforementioned methods has several effects on the company’s financial statements. For instance, writing off purchased goodwill against the company reserves, is normally viewed as unacceptable since it does not discern the acquired future benefits of the company.
Given the fact that internally generated goodwill is normally generated by the business entity, it should not be recognized by the entity (Australian Accounting Standards Board 7). This goodwill is therefore not recognized as an asset of the business entity because the transactions behind the accumulation of the goodwill are difficult or rather impossible to identify. Nevertheless, even if it were possible to identify the transactions leading to the accumulated goodwill, the values would not be measurable in a reliable manner. In that case, if the internally generated goodwill is not recognized as a company’s asset as per IAS 38, it means that it is recognized as an expense. In other cases, it goes unrecognized in the financial statement. This has the effect of increasing the company expenses, which are difficult to account for. As such, the goodwill value may be lost if not recognized (Australian Accounting Standards Board 7).
Despite the several differences in the two types of goodwill discussed in the paper, it should be noted all goodwill are the same regardless of whether it is because of purchase or transactions. The main difference noted, is that purchased goodwill can be measured objectively given the amount paid while internally generated goodwill is normally difficult to measure (Nikolai et al. 579). Finally yet most importantly, is that the two goodwill are given different accounting treatments.
Works Cited
Australian Accounting Standards Board. Accounting for Goodwill. 1996. Web.
Nikolai, Loren et al. Intermediate Accounting. Boston: Cengage Learning, 2009. Print.