There are different type of intangible assets surrounding the business world but not all are recognisable when preparing accounts according to FRS 38.
Some examples of the intangible assets recognisable includes copy rights, cost for research and development and the widely seen goodwill, which is today’s focus.
Goodwill is only recognisable in the company’s Balance Sheet when a company paying an amount for the target firm (in an acquisition) which is greater than the target’s net worth, after adjusting the assets and liabilities to fair value. The excess amount is in fact business’s goodwill. In situation where the acquisition price is lesser than the business’s net worth, then the acquisition is said to be made with a negative goodwill.
Who would pay a higher price for something that is not worth as much? The logical answer to that is because some intangible assets like the business’s trademark name, great client relationships, solid client base, proprietary innovation, and strong employee management does worth something but not recognisable in the books of the target’s company. As mentioned, goodwill is an intangible asset as it does not have physical appearance like other plant and equipment and that is why such valuable assets is not recognisable until it is crystallised when the acquisition took place.
Relating to that, the main challenge for recognising such valuable assets is that it is difficult to establish the precise worth when a high degree of subjectivity involved. However, it makes an organisation more valuable. For example, how much will you value a business that has been operating for years with premium items compare to a smaller one firm that is new and high uncertainty on the product’s quality?
Everyone has a different answer to that question and that is exactly why there is always a huge chance where a business could overstate goodwill in acquisition. This is basically telling the shareholders that the dear purchase price were supported by “assets” that does not exist at all, nor it is expected to bring future value to them.
How do Accountants Accounts for Goodwill?
The word “Consolidation” is what makes most accountant goes bald but only experience accounting firm (We work with partners that provide accounting service in Singapore as well) understand that the core (and most challenging part) is always on the Goodwill calculation.
As stated above, it is a comparison of purchase cost paid for the business and the fair value of the net worth of the acquired company. For those that is unsure, net worth is basically what is left after deducting the total liabilities from the total assets of the company’s liabilities.
Recognition of Goodwill
The FRS 38 stated that the proper way to record a positive goodwill is by recognising it as an intangible asset in the balance sheet but immediately record a negative goodwill as other income in the Profit or Loss Account. The recognised Goodwill will then have to go through an impairment test periodically so its actual value is always properly reflected.
The estimate of goodwill is definitely not an easy job, even to a senior accountant. If you lack the confident on exactly how it need to be done, it’s a good idea to seek help by contacting an accounting firm in Johor Bahru.