The International Journal of Business Management and Technology, Volume 4 Issue 2 March–April 2020

ISSN: 2581-3889

Research Article Open Access

A Study on Goodwill and its Treatments in Accounting

Assoc. Prof. Manh Dung Tran

Abstract: The issue of goodwill being an intangible asset is controversial in accounting field in the world. Treatment of
goodwill after recording it in the consolidated financial statements is very complicated so there are some techniques to
avoid, alter and adjust it. That is why the issue of true and fair presentation of goodwill and its treatment is concern.
Based on the desk review, this paper presents, discusses these issues and gives some comments its treatment in order to
having a true and fair value of goodwill in the consolidated financial statements of reporting firms in the world and
Vietnam as well.

Keywords: Goodwill, asset, treatment, accounting, IFRS.

I. Introduction

Goodwill is often regarded as the value attributed to such intangible assets (among others) as reputation, a well-trained
workforce, good contacts within the industry, favourable business location, and any other unique features of a firm for
which another firm would pay in excess of the value of net assets shown in the financial statements.

Much has been written on goodwill by eminent authorities, and so far as these writers have been able to determine, the
subject of goodwill has not been adequately dealt with from an accounting perspective (Yang, 1927). Thus, goodwill has
been the issue that is very controversial and seriously debated by academics and practitioners all over the world
(Seetharaman et al., 2004). It is commercially valuable and commonly considered as an intangible asset in the
consolidated financial statements, and was defined by Hughes (1982) as the differential ability of a business, in
comparison with others or an assumed average firm, to make a profit.

As early as 1929, Canning noted that the most striking feature of much of the writing on goodwill is the number and
variety of disagreement on the nature of goodwill even though accountants, researchers, engineers and the courts have
all tried to define it. Confusion and disagreements still exist (Falk & Gordon, 1977). Furthermore, goodwill is considered
very hard to measure and even more difficult to account for (Sundararajan, 1995).

There has been little variation in the perspective taken by researchers approaching the issue of goodwill in the
commercial and accounting fields, with goodwill having been described as the black sheep on the balance sheet (Carlin
et al., 2007) and as a will-o-the-wisp (Lee, 1971). Goodwill acquired in a business context is an asset with more
prominence and material in the total assets because of a significant increase in the number of business combinations,
especially in the context of global market development. So the issue of goodwill and a series of questions relating to its
nature, its treatments and its disclosures in the consolidated financial statements are of interest to academics and
practitioners.

Hughes (1982) traced the first known reference to the term „goodwill‟ in a case that dealt with the transmission of an
interest in a quarrying operation from one man to another. Meanwhile, Leake (1914) denoted the confusion surrounding
goodwill as “never defined satisfactorily”.

Goodwill, the most intangible of intangibles (Davis, 1992; Sundararajan, 1995) which can be immeasurable (Seetharaman
et al., 2006), has long been considered an important business asset in the literature. Recognising, measuring and
disclosing goodwill in the consolidated financial statements has also been a controversial issue. Matters have been more

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complicated and confused by differences which have arisen between the legal definition of goodwill, mainly based on
detailed cases, and accounting and economic models of goodwill which are seen to be broader in dimension.

The acceptance of goodwill as an intangible is still disputable in many studies for different reasons. Over time and
across jurisdictions, a variety of practice in either avoiding goodwill recognition by using the pooling-of-interests
accounting method or altering the magnitude of goodwill by using in-process research and development, has existed. A
diversity of practice, to some extent, influences the reliability of financial information in the financial statements.

This paper sets out to cover some of the issues mentioned above. Specifically, section 2 provides evidence to show that
goodwill is an asset. Section 3 presents techniques that avoid and alter the recognition of goodwill. Section 4 offers a
way to measure purchased goodwill. Section 5 reveals some techniques for adjusting goodwill after initial recognition.

II. Is Goodwill an Asset?

2.1. Generally Accepted Definition of Assets

Assets or economic resources are the life-blood of both business and not-for-profit entities. The definition of assets in the
professional literature is numerous (Carnegie, 1987) and has common agreements. According to paragraph 4.4 of
Conceptual Framework for Financial Reporting 2010 issued in October 2010 by HKICPA and paragraph 49 of Framework for
the Preparation and Presentation of Financial Statements issued in July, 2004 by Australian Accounting Standard Board, an
asset is a “resource controlled by the entity as a result of past transactions or events from which future economic benefits
are expected to flow to the entity”.

There are three essential characteristics of assets, namely, future economic benefits, control by a particular entity, and
occurrence of a past transaction or event. The first characteristic implies that an asset has the potential to contribute,
directly or indirectly, to the flow of cash and cash equivalents to the business in some way; for example, it can be
exchanged, or it can be used to settle a liability or it can be used singly or in combination with other assets to produce
products or services.

The second characteristic of assets reveals that the entity must have control over the future economic benefits so that the
entity has the capacity to benefit from the asset. The entity that owns the asset is the one that can exchange it, use it for
producing goods or services, exact a price for others‟ use of it, use it to settle liabilities, or hold it. The third characteristic
of assets denotes that transactions or other events giving rise to the entity‟s control over future economic benefits must
have taken place. Apparently, items become assets of the entity as the result of a transaction or an event or a
circumstance that has already occurred.

2.2. Does Goodwill Match the Definition?

Even though goodwill has not been precisely defined, there seems to be general agreement on some of the
characteristics of goodwill. Determining whether goodwill is an asset entails considering the nature of goodwill to
ascertain whether it possesses the essential characteristics of an asset. Under the International Accounting Standards
Committee‟s definition issued in 1980, goodwill has some characteristics:

(i) Goodwill is indescribable and belongs to a business by its nature. Thus it cannot be separate from the business.

(ii) The value of goodwill can change significantly along with internal and external conditions of the business.

(iii) Goodwill amount and the approach employed for evaluating it vary for each firm.

As discussed in the previous section, the literature is replete with various opinions about the nature of goodwill.
However, two main concepts include many of the assumptions underlying the divergent opinions, namely, goodwill
represents Certain Intangible Resources and Excess Future Profits. Based on these two theories of goodwill,
reconciliation between defined goodwill and the essential characteristics of assets is conducted for evaluating whether
goodwill is an asset or not.

According to Certain Intangible Resources, there is an assumption that intangibles are contributing to the generation of
a business‟s overall profits. Goodwill therefore, representing the collective future benefits from intangibles, should be
viewed as an asset (Carnegie, 1987). With regard to Future Excess Profits, the assumption is that the various intangibles
involved represent future excess profits. As a result, goodwill should be considered as an asset on the premise that it
will produce cash flows over and above normal expectations. However, if the business has not been making a return in

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excess of a normal return, there would be no goodwill and no related asset.

In order to ascertain whether goodwill satisfies the second characteristic of an asset, it is important to determine whether
an entity can obtain the benefit from goodwill and control others‟ access to such benefits. The view of control pertaining
to goodwill was advocated by Beresford & Moseley (1983, p. 21): “control of access to the goodwill is conducted by not
divesting the acquired entity”. This implies that the control criterion will be satisfied providing the resources of the
business acquired are maintained (Carnegie, 1987). Therefore, goodwill acquired in a business combination, commonly
named purchased goodwill, is not banned from being considered an asset. It is argued that “goodwill represents
collective future benefits, with control of the access to these benefits being achieved so long as an entity‟s resources are
not diverted” (Carnegie, 1987, p. 31).

To satisfy the third characteristic of an asset, it is necessary to establish whether goodwill existed as the result of past
transactions or events. There is no particular problem involved if there has been some form of sale transaction arising
from a business combination (Carnegie, 1987). This transaction is normally represented by a sale contract or other
similar supporting documents. Goodwill would also be based on past transactions or events giving rise to internally
generated goodwill.

As defined under the two major goodwill concepts, goodwill is not excluded from being regarded as an asset in
accordance with the generally accepted definition of assets and the International Accounting Standards Committee‟s
definition.

However, not all researchers in this field agree with the opinion that goodwill is an asset. Chambers (1966, p. 212)
concluded that “goodwill is not an asset because it is neither severable, nor measurable, and consequently has no place
on financial statements”. Sands (1963, p. 183) also argued against considering goodwill as an asset, based on the fact that
intangibles are not measurable. May (1975, p. 23) advocated this view by stating that “Goodwill attributable to the
corporation as a whole can have no value to the corporation since it is not possible for the corporation to realize its
value”. Hendriksen (1982, p. 409) also argued that “… since goodwill is not a severable asset, it should not be reported
separately”.

These opinions notwithstanding, there is a huge volume of literature supporting the view that goodwill is an asset.
Paton (1968, p. 143) stated that “assets are not inherently tangible or physical. An asset is an economic quantum … One
of the common mistakes we all tend to make is that of attributing too much significance to the molecular conception of
property.” Gynther (1969, p. 255) concurred that “although these assets might be characterized by a lack physical
substance, they often represent value in the form of future beneficial service potential and are no different, in an
economic sense, from assets with physical substance”.

Smith (1969) argued that goodwill is an investment and should be presented on the balance sheet. MacIntosh (1974)
stated that goodwill is generally correctly accounted for as an asset because it represents an investment in a group of
intangible assets and should be included among the total assets in an entity‟s balance sheet. Bloom (2007, p. 34) assumed
that “the stream of future benefits” definition of an asset meshes well with the super-profit concept; with this mindset,
goodwill does qualify for recognition as an asset, because it is aligned with a specific (through residual) flow of
benefits”.

The fact that goodwill cannot be sold separately from the rest of the business (i.e. goodwill sticks to the business as a
whole), or measured easily, does not negate the fact that goodwill may have significant value to the business and
therefore should be put in the consolidated financial statements (Falk & Gordon, 1977). As analysed above, goodwill
satisfies the characteristics of an asset in the prevailing accounting practice, although there still exist some arguable
issues relating to whether or not goodwill is an asset. It is therefore accepted that goodwill is not excluded from being
defined as an asset.

III. Practice of Avoiding and Altering Goodwill Recognition

Goodwill arising from a business combination, and regarded as an asset in case the acquirer usually pays a higher price
than the market value of the acquired firm‟s identifiable assets, such as equipment and inventories, net of any liabilities
taken on (Sherman et al., 2003). That premium over the net fair value of identifiable assets is regarded as goodwill and is
reflected on the acquirer‟s accounting books as an asset.

To further understand the nature of goodwill, it will be useful to examine the following example. Five hundred
thousand dollars is paid for a firm with net identifiable assets, including current assets and non-current assets less any

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liabilities taken on, of $400,000. The premium, an amount of $100,000, is called goodwill and would be posted as an
intangible asset on the consolidated balance sheet of the acquirer by writing a double entry as below:

Dr. Net identifiable assets $400,000

Dr. Goodwill $100,000

Cr. Purchase consideration $500,000

In principle, the value of goodwill recorded in the balance sheet of the acquirer is the value of the acquired firm‟s name,
reputation and other intangible assets, such as intellectual property and work processes that, because of imperfect
measurement, cannot be identified and measured separately. Goodwill also comprises elements relating to
imperfections such as premiums or discounts arising from the process of negotiations (Carnegie, 1987).

In the example shown above, determining the fair value of identifiable assets seems to be more important than
recording the value of goodwill because goodwill recognition that reflects on the acquirer‟s balance sheet is simple. In
practice, there are a number of approaches that assist in avoiding the recognition of goodwill or altering the magnitude
of goodwill. To some extent, either avoiding the recognition of goodwill or misstating the magnitude of goodwill would
affect the reliability of financial information in the consolidated financial statements. Two methodologies have been
adopted in the United States and widely discussed in the literature, namely, pooling-of-interests accounting, and in-
process research and development.

3.1. Pooling-of-Interests Accounting – Avoidance of Goodwill Recognition

More than 30 years ago, considerable controversy focused on how firms accounted for mergers and acquisitions (Weber,
2004). The controversy emanated from the choice between the pooling-of-interests method and the purchase accounting
method. Under the pooling-of-interests accounting method,1 the balance sheets of each partner in the merger are simply
added together, and the new firm reports a combined historical book value. As a result, there is no item of goodwill
existing in the financial reports of the new firm.

Under the purchase accounting method, one firm must be the acquirer, and the other the acquiree. The acquired firm‟s
identifiable assets are recorded at fair values and any excess of the purchase price is recorded as goodwill. The balance
sheet of the combined firm is reported as the combination of the acquiring firm‟s book value and the acquired firm‟s fair
value plus goodwill (Dunstan et al., 1993; Sundararajan, 1995; Lewis, 2000).

The pooling-of-interests method was first employed in the United States in 1950 by the Committee on Accounting
Procedure (Hughes, 1982) and prior to the release of the Accounting Principles Board (APB) Opinion No. 16 –
Accounting for Business Combinations, and APB Opinion No. 17 – Intangible Assets in 1970. There was no regulation
requiring the choice between pooling-of-interests accounting and purchase accounting in the United States. In practice,
pooling-of-interests accounting was the generally accepted method (Lewis, 2000).

Pooling-of-interests was common among firms because no goodwill was recognised, and as a result, there was no
goodwill to amortise in post-merger accounting periods (Sherman et al., 2003). The Financial Accounting Standards
Board (FASB) suggested that firms were willing to incur costs associated with the use of the pooling-of-interests method
because share prices are favourably influenced by the application of the pooling method (FASB, 1997, p. 24).

In June 2001, the FASB voted to eliminate pooling-of-interests as an acceptable method of accounting for business
combinations and issued the Statement of Financial Accounting Standards (SFAS) No. 142 – Goodwill and Other Intangible
Assets. Under SFAS No. 142,2 United States firms are required to capitalise goodwill and amortise it, applying a straight-
line basis for a period of not more than 40 years (Johnson & Petrone, 1998).3

The amount of goodwill amortisation is recorded as an expense, and consequently this reduces earnings. For this reason,
firms had a tendency to apply the pooling-of-interests method that produces no goodwill value and has no impact on
profits, rather than employ the purchase method that produces goodwill and influences profits (Johnson & Petrone,

1
Pooling-of-interests accounting is also called ‘merger accounting’ (Sherman et al., 2003).
2
Accounting Principles Board (APB) Opinion No. 17 ‘Intangible Assets’. According to APB No. 17, immediate
elimination of goodwill was prohibited, as was the recognition of internally generated goodwill.
3
The majority of United States companies amortize goodwill over the maximum allowable useful life of 40 years
(Duvall et al., 1992).
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A Study on Goodwill and its Treatments in Accounting

1998; Weber, 2004). As a result, firms employing the pooling-of-interests method produced higher reported earnings
than firms using the purchase method. Hence the reason many United States firms kept goodwill off their balance sheets
(Sherman et al., 2003, p. 93).

The generally accepted principle in a business combination was that the purchase method was employed to account for
goodwill if the business combination was not in a merger, otherwise the pooling method would be used. Many firms
doing business in the United States admitted that the business combination in question was a true merger of equals
rather than the acquisition of one firm by another firm to take advantage of employing the pooling method.

The United States firms tried to design purchase consideration to satisfy the requirements of the pooling method.
Purchase consideration, generally, should be all equity (i.e. no cash consideration), otherwise it could be deduced that
the firm paying cash must be buying the other, which would make the deal an acquisition, not a merger.

Few business combinations are genuine mergers of equals, and acquisition is apparently not a merger; but if the
business transaction is structured in the right way it can be regarded as pooling-of-interest (Sherman et al., 2003). Dr.
Lewis, president and chief executive officer of Prospect Technologies Company, did not agree to prohibiting the use of
the pooling-of-interest method of accounting. He stated: “… the result of the merger created a synergy that allowed us
to bid and win contracts that would not have been possible by either of the two previous firms individually” (Lewis,
2000, p. 5). Spacek (1964) supported neither the capitalisation and amortisation of goodwill nor the pooling-of-interest
method.

The basic hypothesis is that a business combination is regarded as an opportunistic activity for maximising post-
acquisition profit. By choosing the pooling-of-interest method, firms can control earnings management.

There is evidence that business combinations were structured in a manner that satisfied the requirements of the pooling-
of-interest method (Watts, 2003) and acquirers offered greater purchase consideration to obtain cooperation with the
target firm to extract the benefit of the pooling method (Nathan, 1988). It has also been found that firms were more likely
to employ the pooling method where fair values substantially exceeded book values and more likely to adopt the
purchase method where the carrying amounts closely matched market values (Copeland & Wojdak, 1969).

Another technique that affects recording the value of goodwill is In-Process Research and Development (IPRD). This
technique, which relates to the classification of the premium over IPRD, rather than classifying the premium, will be
debated in the next section.

3.2. In-Process Research and Development – Altering the Recorded Value of Goodwill

The IPRD phenomenon came to public attention in the mid 1990s, when many firms announced corporate acquisitions,
in which incomplete research and development projects constituted the major asset acquired (Deng & Lev, 2006).

According to Deng & Lev (2006), IBM‟s acquisition of the Lotus Development Corporation in July 1995 was among the
first of the large cases in which IPRD played a prominent role. The total acquisition paid for Lotus Development
Corporation was $3,200 million. Under the purchase accounting method, IBM calculated the fair value of Lotus‟s
tangible net assets (mainly cash, accounts receivables, land and buildings, equipment) at $305 million, and the fair value
of identifiable intangible assets (trademarks, assembled workforce and leasehold improvements) at $542 million.
Current software products were estimated at $290 million. Deferred tax liabilities were valued at $305 million. IBM also
estimated the value of Lotus‟s IPRD, new products and services in the research and development process, at $1,840
million, making up almost 60% of the acquisition price. So, goodwill that represented the difference between the
acquisition price and the total fair value of net assets amounted to $564 million. Goodwill as an asset was reflected in the
consolidated financial statements.

During that period, it was common for IPRD to account for from 60% to 80% of the total acquisition price (Annon, 1999;
Sherman et al., 2003). It is a fact that the higher the percentage of IPRD, the less the percentage of goodwill in the total
acquisition price. Apparently, by taking advantage of opportunistic behaviour in valuing IPRD, the magnitude of
goodwill is misstated.

As shown in the prominent instance above, IPRD is defined as the value allocated to R&D projects in acquisitions
reported under the purchase method, and described as an intangible asset that is included in the acquisition price
(Dowdell & Press, 2004).

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According to the provisions in APB Opinion No. 16 – Business Combinations4 in accounting for business combinations
under the purchase method, acquiring firms should apportion the acquisition price among tangible and intangible
assets, based on the fair value of assets. Moreover, under paragraph 5 of the FASB Interpretation No. 4,5 costs assigned
to assets to be used in a particular R&D project that do not have an alternative future use “shall be charged to expenses
at the date of consummation of the combination”. This provision is consistent with the general treatment of R&D in the
FASB Statement No. 2 – Accounting for Research and Development Costs, which was issued in 1974.

In the process of a business combination, the acquiring firm makes judgments in allocating the purchase price to a series
of assets including tangible and intangible assets. Regarding the value of intangible assets, the acquiring firm also
decides which parts or purchased intangible assets do not have alternative future use (Dowdell & Press, 2004). So the
value of the assets allocated to R&D projects that seem to have no alternative future use is regarded as IPRD, treated as
an expense and charged immediately upon consummation of the acquisition.

The difference between IPRD and goodwill in the purchase method is that IPRD is required to be expensed and charged
immediately against earnings, whereas goodwill is required to be capitalised and amortised over future periods
(Dowdell & Press, 2004; Deng & Lev, 2006). By classifying rather relatively and subjectively, there is a high possibility
that an acquiring firm misstates IPRD; IPRD is usually overstated rather than understated. This affects the value of
goodwill recorded in the consolidated financial reports.

Deng & Lev (2006) argued that the immediate expensing of IPRD significantly reduces the asset and equity bases of the
acquiring firm, thus inflating widely used profitability measures, such as return on assets or return on equity.
Management would prefer recording expense at once and starting the firm off with a clean slate, to treating R&D as an
intangible asset that will affect profits until it is completely amortised (Sherman et al., 2003).

Hence many firms adopt opportunistic behaviour in allocating acquisition price to IPRD for the sake of earnings
management. In responding to earnings management and public criticism, the FASB stated that firms would be required
to expense the amount of IPRD against future periods, rather than expense it immediately at the time of acquisition.
However, in July 1999, the FASB stated that the amount of IPRD applied against future periods should be deferred and
the issue further investigated (Dowdell & Press, 2004).

The FASB also intended to issue an exposure draft that would capitalise IPRD and then impair it periodically. A final
standard pertaining to recognising and treating IPRD was expected in 2005 (Deng & Lev, 2006). In January 2009 the
FASB announced that the project in relation to IPRD treatment was removed. Consequently, a standard of IPRD never
became a reality. Nowadays, the topic of accounting for IPRD remains controversial and is still fertile ground for
mischief in accounting treatments (Sherman et al., 2003).

By restructuring the merger permits United States firms to apply the pooling-of-interest accounting method for avoiding
value of goodwill. Allocating the acquisition price to IPRD based on subjective assumptions resulted in writing it off
immediately upon the date of acquisition. This indicates that United States firms may have had motives for avoiding
goodwill recognition or altering the magnitude of goodwill.

While pooling-of-interests and IPRD did not exist in Hong Kong, there is the question of whether or not Hong Kong
firms employed a means of avoiding goodwill recognition or altering the magnitude of goodwill value.

There would have been some inconsistencies and problems in practice bearing on initial goodwill recognition in the
balance sheet of an entity. The next issue pertaining to goodwill focuses on subsequent treatments of goodwill.

IV. Measurement of Purchased Goodwill

Under the purchase method of accounting for business combinations, goodwill value is the excess of the cost of
acquisition over the fair value of identifiable net assets (Seetharaman et al, 2004). So, in order to measure the amount of
goodwill to be recorded as an asset, determining the cost of acquisition and fair value of identifiable net assets is
necessary.

4
APB Opinion No. 16 – Business Combinations was promulgated by the American Institute of Certified Public
Accountants in 1970.
5
FASB Interpretation No. 4 – Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the
Purchase Method – An Interpretation of FASB Statement No. 2, was promulgated in February 1975.
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A Study on Goodwill and its Treatments in Accounting

At the date of acquisition, the fair value6 of the acquisition cost should be ascertained. The cost of acquisition may
consist of cash in capital and may also consist of non-monetary considerations such as shares issued and liabilities taken
on. In instances where shares are issued as part of the purchase consideration, the value attributed to these shares may
be very difficult to determine, especially where the shares are not listed in the securities market. Even where the shares
are listed, their values may be uncertain if the share prices have been volatile or are temporarily affected by the activity
associated with a business combination (Carnegie, 1987). In the content of paragraph 53 of IFRS 3 – Business
Combinations, acquisition-related costs are generally recognized as expenses.

Having determined the cost of acquisition, the cost is assigned to the underlying net assets (i.e. the identifiable assets
and liabilities acquired) on the basis of their fair values at the date of acquisition. Goodwill, which is the excess of the
cost of acquisition over the fair value of identifiable net assets, will then be recorded as an asset in non-current assets in
the acquiring consolidated balance sheet. The issue of adjustments of goodwill after recognition will be discussed in the
next section.

V. Goodwill Adjustment Subsequent to Recognition

The appropriate adjustment for goodwill subsequent to acquisition has been debated for many years. One view was in
favour of writing goodwill off at once against the reserve account in line with the prudence principle. The second view
was to keep goodwill permanently with no full elimination or amortisation unless a permanent diminution in value was
evident. The other view was to amortise goodwill over the useful economic life in line with the matching principle
(Seetharaman et al., 2004).

It is not uncommon practice to adjust goodwill after it has been recorded in the account. Over time and across a range of
jurisdictions, a tangled web of different goodwill adjustments subsequent to recognition has occurred. There are three
major types of adjustments, namely, lump sum write-off, ad-hoc write-off and systematic (periodic) write-off (Carnegie,
1987).

5.1. Lump Sum Write-Off

According to this approach, the amount of goodwill acquired in a business combination is eliminated immediately
against reserves in the balance sheet or written off to the income statement in the year of acquisition (Elliott & Elliott,
2006).

Capitalisation and amortisation are arbitrary and highly likely to make net income understated (Spacek, 1964); therefore,
a better treatment is to eliminate goodwill immediately against retained earnings. Another argument for immediate
write-off is that it is reasonable to expect the goodwill relating to the firm at the time of purchase will eventually
disappear over time (Seetharaman et al., 2004). Yet another reason is that the write-off achieves the best matching of
benefits with the costs incurred (Carnegie, 1987).

Supporters of this school argue that goodwill poses measurable difficulties and is different from other assets, that is,
goodwill cannot be sold separately in most cases. In these situations, carrying the intangible asset in the consolidated
balance sheet is of little value to users of financial statements (Seetharaman et al., 2004).

5.2. Ad-Hoc Write-Off

An ad-hoc write-off initially capitalises goodwill acquired in a business combination as an intangible, at cost, without
amortisation unless a permanent diminution in value becomes evident (Carnegie, 1987). In the case of apparent
permanent diminution goodwill is usually reviewed periodically, and a write-off equivalent to impairment in value is
reflected in the consolidated financial statements.

In support of this approach, Ballie (1976) and Leo & Hoggett (1984) argued that goodwill itself does not reduce in value
because it is continually maintained or replenished through the normal business operation. If there is any indication that
goodwill is not being maintained or replenished, then the original investment in goodwill will be reduced by an
appropriate amount that is determined by management (Carnegie, 1987).

This school was opposed by other researchers such as Most (1977) and Emanuel (1973) because it confuses or combines
internally generated goodwill subsequent to an acquisition with that purchased at the date of acquisition. As a result, it

6
Fair value is a market value method for measuring cost and reflects the value an asset could be exchanged for in an
arm’s length transaction between knowledgeable and willing parties.
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A Study on Goodwill and its Treatments in Accounting

provides for the recognition of internally generated goodwill in the consolidated balance sheet.

5.3. Systematic Write-Off

When goodwill value is initially capitalised and recorded as an asset in the consolidated financial statements, at cost, a
systematic write-off of goodwill7 should be employed over a finite term. A periodic write-off of goodwill acquired in a
business combination involves a policy of amortisation over a reasonable period of time. Early support for this school
included Guthrie (1898) and Hatfield (1909).

According to Seetharaman et al. (2004), there are three reasons for supporting systematic amortisation. The first is based
on the premise of the matching principle (Leake, 1930; Paton, 1941) where the cost of purchased goodwill should be
amortised as a means of matching the cost of securing the income actually obtained. The second is that under
stewardship accounting, management should be asked to justify acquisition of other firms by proving that cash inflows
from a business combination exceed the cash outflows incurred when the investment was made. The final reason
involves the Momentum Theory of Goodwill (Nelson, 1953), that the purchaser of a firm normally pays a large sum of
money for the goodwill because he/she wants a starting push in the new firm, rather than starting fresh in a similar firm
and devoting so much effort and money over a long period of time to develop such goodwill (Seetharaman et al., 2004).

In calculating the amount of the systematic amortisation of goodwill, determining an arbitrary useful life for goodwill
acquired is necessary. However, it is very difficult to ascertain the accuracy of useful goodwill life. So this creates the
prospect of a mismatch between income and expenses. According to Baillie (1976), any mismatching may be unlikely to
be material and in any event, would be less material than failing to consider the diminution in the value of purchased
goodwill.

According to Morrissey (1966), a systematic policy of goodwill is consistent with the treatment of depreciable assets
which have finite useful lives. However, it is contentious that the selection of an arbitrary period is consistent with the
notion that goodwill eventually disappears (Carnegie, 1987).

In short, the issue of accepting goodwill as an asset has been a debatable issue for a long time. However, based on the
characteristics of goodwill and compared with the characteristics of assets, goodwill is viewed as the most intangible of
intangibles (Davis, 1992) and recorded in the consolidated financial statements.

There have been controversies pertaining to the improper use of the pooling-of-interests accounting method for
avoiding goodwill recognition and profit impact, excessive or deficient IPRD for altering the magnitude of goodwill,
immediate post-acquisition write-offs and the use of aggressive expense deferral amortisation techniques (Carnegie,
1987; Carlin et al., 2007b). To some extent, all affect the reliability of financial information in the statements of reporting
entities.

From 1 January 2005, goodwill treatment has been conducted according to the new method of impairment testing. It is
interesting to recognise that the rejection of the traditional „capitalise and amortise‟ method in treating goodwill after
acquisition is not new. The shift from the traditional method of „capitalise and amortise‟ to the IFRS „capitalise and test
for impairment annually‟ is not inherently new, as evidenced in a growing body of literature dealing with both the
conceptual foundations and practical consequences of the IFRS and US GAAP impairment testing method.

With regard to new method of „capitalise goodwill and test it for impairment‟, there is a lack of evidence showing that
earnings figures under the new regime are more relevant than those generated under the traditional regime of „capitalise
and amortise‟ (Chen et al., 2006). There is also not enough evidence of undue delays in recognising impairment charges
(Ramanna & Watts, 2007) and evidence of gaming in the way in which goodwill is allocated between cash generating
units for minimising the chance of forced impairment charges (Zhang & Zhang, 2007).

References
[1.] Beresford, D. R. & Moseley, R. H., (1983), Goodwill and Other Intangibles, McGraw Hill, New York.

[2.] Canning, J., (1929), The Economics of Accountancy. The Ronald Press Company, New York.

[3.] Carlin, T. M., Finch, N. & Ford, G., (2007), Goodwill Impairment - An assessment of Disclosure Quality and
Compliant Level by Large Listed Australian Firms. Macquarie Graduate School of Management - Working Paper
1/2007.

7
A systematic write-off of goodwill is a periodic write-off of goodwill.
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A Study on Goodwill and its Treatments in Accounting

[4.] Chambers, R. J., (1966), Accounting, Evaluation and Economic Behaviour, Prentice-Hall of Australia Pty Ltd,
Sydney.

[5.] Carnegie, G. D., (1987), Accounting for Goodwill on Consolidation, Deakin University.

[6.] Davis, M., (1992), "Goodwill Accounting: Time for an overhaul", Journal of Accountancy, vol. 173, iss. 6, pp. 75-
83.

[7.] Falk, H. & Gordon, L. A., (1977), "Imperfect Markets and the Nature of Goodwill", Journal of Business Finance &
Accounting, vol. 4, iss. 4, pp. 443-462.

[8.] Gynther, R. S., (1969), "Some "Conceptualizing" on Goodwill", The Accounting Review, April, vol. 44, iss. 2, pp.
247-255.

[9.] Hendriksen, E. S., (1982), Accounting Theory: A History of the Issues and Problems, Georia State University, Georia.

[10.] Hughes, H. P., (1982), Goodwill in Accounting: A History of the Issues and Problems, Georgia State University.

[11.] Leake, P. D., (1914), "Goodwill: Its Nature and How to Value it", The Accountant, vol. January, iss., pp. 81-90.

[12.] Lee, T., (1971), "Goodwill - An Example of Will-o-the-Wisp Accounting", Accounting and Business Research, vol.
Autumn, iss. 8, pp. 318-328.

[13.] May, G. S., (1975), "The Relevance of Goodwill as an Asset", The National Public Accountant, vol. October, pp.
22-25.

[14.] Paton, W. A., (1968), Comments to AICPA Accounting Research Study. No. 10, pp. 143-151.

[15.] Sundararajan, V., (1995), Accounting for Goodwill.

[16.] Seetharaman, A., Balachandran, M. & Saravanan, A. S., (2004), "Accounting treatment of goodwill: yesterday,
today and tomorrow", Journal of Intellectual Capital, vol. 5, iss. 1, pp. 131-152.

[17.] Smith, A. F., (1969), "Purchased Goodwill: The Problems and Alternatives", The Internal Auditor, vol. August,
pp. 31-39.

[18.] Yang, J. M., (1927), Goodwill and Other Intangibles, Ronald Press.

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