Saturday, July 4, 2009

Goodwill and balance sheet

Goodwill is one of the most common examples of intangible assets and is the one item that lacks specific identification. Goodwill is defined as the amount that a purchaser would pay for a company that is greater than the fair value of the net identifiable assets. Purchased goodwill must be reported as a separate line item on the balance sheet. Generally, other intangibles are combined and reported as one figure on the balance sheet.
Goodwill can be acquired or developed internally, but the only goodwill recognized in the accounting records is purchased goodwill. The amount of goodwill purchased is equal to the difference between the purchase price paid and the fair value of the net assets received. Internally generated goodwill is not recorded in the accounting records because it does not meet the definition of an asset. An asset is something that will benefit the company in the future, is owned currently by the company, and was acquired in a past transaction. In the case of internally generated goodwill, because there was no past transaction in which it was acquired, it is not an asset.
A company should record purchased goodwill on the books as an asset at the cost paid for it. Every year the company must assess its goodwill to determine if it has been impaired during the year. The determination of impairment is done the same way as it was for fixed assets-comparing future cash flows with the recorded cost of the asset. If it has been impaired, it must be written down to the fair market value.
If the purchase price is less than the value of the net assets, this is called negative goodwill. This amount of negative goodwill should first be distributed to the non-current assets are reduced to zero; the amount remaining should be classified as an extraordinary gain on the income statement.
The costs of developing or maintaining goodwill are expensed as they are incurred. Examples of these costs are training employees and hiring employees from the purchased company.

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