What is Goodwill Amortization?

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.

  • Before 2001, Goodwill was amortized over a maximum of 40 years as per US GAAP. However, it is no longer amortized every financial year anymore. Goodwill will have to be checked every year for impairment, and if there is any change, it is recorded in the Income StatementRecorded In The Income StatementThe income statement is one of the company’s financial reports that summarizes all of the company’s revenues and expenses over time in order to determine the company’s profit or loss and measure its business activity over time based on user requirements.read more.Since 2015, privately held companies have been allowed to amortize over ten years, reducing the cost and complexity of testing for impairment.It implies that the goodwill amortization implies that only the private and Public companies have to test its Goodwill for impairmentsTest Its Goodwill For ImpairmentsGoodwill impairment is the process of writing off the accounting charge amounting to the excess of the acquired asset’s book value as recorded in the financial statements over its fair value. A higher impairment charge reflects the company’s irrational investment decisions. read more.

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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.

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.

#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.

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.

Examples of Goodwill Amortization

Let’s see some practical examples to understand it better.

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 –

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.

You can do the calculation of impairment loss as follows –

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

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 yearsThe fair value of these assets =$1280 millionHow will Goodwill be amortized?Calculate the amortization amount by a straight-line method in 10 years?

Calculation of amortization amount in 10 years will be –

Net Worth:

  • Net WorthNet WorthThe company’s net worth can be calculated using two methods: the first is to subtract total liabilities from total assets, and the second is to add the company’s share capital (both equity and preference) as well as reserves and surplus.read more = Total of assets – Total of liabilities = (85+200+450+92+825+150) – (350+144+65) = 1243

Value of Goodwill:

  • Value of goodwillValue Of GoodwillGoodwill valuation is the systematic evaluation of the goodwill of the company to be shown in the balance of the company under the head intangible assets and top methods to value include Average Profits Method, Capitalization Method, weighted average profit method and the Super Profits Method.read more =Purchase Consideration – Net Worth = 1300 – 1243 = 57

Amortization Amount:

  • The Amortization amount = Book Value of AssetsBook Value Of AssetsBook Value of Assets is the asset’s value in the books of records of a company or an institution at any given instance. Assets Book Value Formula = Total Value of an Asset – Depreciation – Other Expenses Directly Related to it
  • read more – Fair Value = 1300 – 1280 = 20

Amortization Goodwill :

  • Goodwill appears in books = $57After Amortization it will be = 57 – 20 = $37 million.

Amortization Amount in 10 Years:

  • Amortization Amount in 10 Years = $20million / 10years = $2 millionEvery year up to 10 years to be written off by debiting Profit and Loss accountProfit And Loss AccountThe Profit & Loss account, also known as the Income statement, is a financial statement that summarizes an organization’s revenue and costs incurred during the financial period and is indicative of the company’s financial performance by showing whether the company made a profit or incurred losses during that period.read more.

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

  • Private companies can amortize goodwill over ten years using the straight-line method.Only purchased Goodwill record in books of accounts. Self-generated Goodwill is not recorded in books of accounts.Goodwill, which no longer exists, should be written offWritten OffWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets.read more in the form of amortization.Conditions that may trigger an impairment of Goodwill are increased competition, a big change in management, change in a product lineProduct LineProduct Line refers to the collection of related products that are marketed under a single brand, which may be the flagship brand for the concerned company. Typically, companies extend their product offerings by adding new variants to the existing products with the expectation that the existing consumers will buy products from the brands that they are already purchasing.read more, deterioration in economic conditions, etc.

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 –

  • What are Impaired Assets?Formula to calculate GoodwillWhat is Negative Goodwill?Fully Depreciated Assets