Anglo-American Accounting World to the Recognition, Measurement, and Amortization of Goodwill - Literature review Example

rроrаtе Ассоunting Student’s Name Subject Professor University/Institution Location Date Introduction There has been existing controversy in accounting for goodwill for a very long time as Paugam (2011) indicates. When there are ambiguous topologies and with borders which are very difficult to delineate, accounting rules and requirements are poorly developed thereby providing businesses and organizations an opportunistic behavior. Inevitably, there have been an ongoing tussle between various regulators for developing and implementing rules that are more detailed that would also help organizations and businesses to maximize their utility. Importantly, goodwill is a residual value with various ambiguous features; there are different views from experts on recognition and measurement of goodwill as an asset and consequently the subsequent its treatment in the financial statements of an organisation.Zanoni (2009) asserts that the many methods of accounting for goodwill indicate that there is no universally accepted method of accounting for goodwill. This report discusses the concept of goodwill in gene1ral. In addition, the report explores goodwill accounting in continental Europe and the Anglo-American accounting systems with particular attention on the recognition, measurement and amortization of goodwill. The report concludes by explaining the principles of valuation and impairment of assets as prescribed by the IASB specifically focusing on the valuation of the intangible assets that do not have established market values. The Concept of Goodwill Generally, goodwill involves a favorably and fitting disposed attitude towards something or someone. It is taken as an attitude of friendliness or a show of kindness after an exchange of something of value. Goodwill in business has existed for long and it is given willingly as an approval and kind interest. Goodwill is given as additional act of kindness after a purchase of something of value or after exchange whereby, one person replaces the other or takes over something of value. In most case, goodwill is always given in prime locations where some aspects are always taken into account. For instance, after an exchange, indirectly transfer the right of ownership, business reputation and long-established relationships and customers. In most cases, goodwill is required in prime business locations. However, there is no set limit or amount of money that is set for goodwill (Lhaopadchan 2010). In accounting, goodwill arises once a company set to acquire another. The company that acquires ends up paying more than the actual market value of net assets. On the balance sheet, goodwill is classified under intangible asset. Goodwill is never paid back but it takes the management to value it year after year to determine whether there would be any impairment required. Where fair market value falls below the historical cost or below what it was purchased for, the impairment have to be recorded so as to bring it down to the value of its fair market. All these increases are not accounted for and do not reflect in financial statements. A paradox exists between the internally generated goodwill and externally generated goodwill. The former cannot be recognized as asset as it is not something that can be identified. This type of goodwill is not separable and still does not arise from legal and other contractual rights. However, when intangible asset is internally developed, the accounting is slightly different. The initial cost of internally generated and intangible asset is limited to administrative and legal fees to an established asset. Externally acquired asset is acquired through external transaction like when a patent is purchased and an excess of a purchase price is paid. In this matter, the purchasing company is taken to acquire the other company’s reputation, customers, its market share, its employees and its research and development. For whatever the reason, the company pays for something intangible and that is represented by goodwill (Godwin & Alderman 2012). For internally generated goodwill, the company counts goodwill on something that is not yet in existence but a foreseen benefit from its previous operations. For instance, a pharmaceutical company that has researched and developed a patent but have not taken it in the market might count the benefits that would result from such patent as goodwill. Subsequently, it appears like those intangible assets are overstated. It is difficult to know whether the research and development done towards a particular patent will result to any productive results. In both case, goodwill is set on intangible assets (Godwin & Alderman 2012). However, inconsistency exists since in one case, goodwill is established on something that has immediate value. On the other, goodwill is set on something on probability. Historical Development of Accounting for Goodwill across the Continental European and in the Anglo-American Accounting Systems There is wide discussion on the recognition and measurement of goodwill across the continental Europe and the Anglo-American accounting systems as Bloom (2009) emphasis. These two bodies have considerable influence on recognition and measurement of goodwill; they keep issuing exposure drafts as well as accounting standards dealing with goodwill accounting such as IAS 36. These bodies exploit the opportunity that there is no universally accepted method of treating goodwill. As such, they issue their own methods and ways of treating goodwill as well as regulatory aspects. However, they are complex and they keep changing regularly and therefore leading to high amounts of volatility. The continental Europe and the Anglo-American accounting systems indicate different historical developments of accounting for goodwill. One of the major difference in the application of different methods of accounting for acquired goodwill by these two bodies. The continental Europe, which is credited by the IASB, uses capitalization and the subsequent impairment of the goodwill. On the other side, the Anglo-American accounting systems, this is credited by the FASB, use capitalization and the subsequent amortization of goodwill (Beattie 2005). Although there is a thin line separating the two methods, the difference is very visible in the presentation of the financial statements.As Paananen& Lin (2009) asserts, there is an important similarity in both continents is that the value of goodwill does not diminish by time but increases by time and therefore they advocate for treatment of goodwill as an investment that should be kept in the balance statement of financial position with no subsequent loss in value. There are major approaches applied by both the continental Europe and the Anglo-American accounting systems in harmonization and treatment of goodwill for the purpose of financial reporting practices.They apply approaches such as index based techniques as well as statistical models. Despite lack of harmonization and a universal method of goodwill treatment, there are great efforts channeled towards convergence of universal standards for goodwill accounting, the continental Europe and the Anglo-American accounting systems leading the line in converging on the same. Anglo-American Accounting World to the Recognition, Measurement and Amortization of Goodwill The international accounting standards board and the financial accounting services board outline goodwill as one of the long lived assets that provide economic benefits to an organization for a number of future periods (Nobes& Parker 2008). The accounting principles regarding goodwill involve the recognition, measurement and amortization. In essence, it involves the determination of the appropriate costs of the goodwill to record in the financial statements initially, the amount at which an organization to present the goodwill at the subsequent reporting periods and the appropriate method of allocating costs of the goodwill. Under the United States GAAPs, the aggregate purchase price of goodwill allocates to the organization assets.The US GAAPs record and account for goodwill as the excess of cost of the price of acquisition over the fair value of the acquired asset. It provides that, this can only be written down in a situation where the carrying amount of the goodwill acquired surpasses the implied fair value. In addition, it provided that organizations must assign the goodwill purchased to the reporting units first in order to test the goodwill for impairment. This is a new accounting treatment, in the past before its introduction, the Anglo-American allowed for recording of goodwill in ,total and it did not allow assign the individual reporting units. The Anglo-American measures goodwill as the excess of the cost of purchase price over the fair value of the assets acquired unlike the International Financial Reporting Standard (IFRS) (Bugeja& Gallery 2006). The IFRS measures goodwill as the difference between the acquisition costs over the acquirer’s interest in the fair value of the net identifiable assets in an organisation being acquired. The Anglo-American impairs goodwill annually or on more frequent circumstances in order to indicate more additional impairment of the goodwill. On the other side, the IFRS follows annual impairment. The Anglo-American accounting uses two-step process in testing goodwill impairment while the AASB does not used two step processes. In elimination of the impairment losses, the Anglo-American does not permit the reversals of impairment losses in any circumstances. There big difference in that the IAS does allow reversals of impairment losses. Toms (2010) underpin that the Anglo-American recognizes any discount upon acquisition of net indefinable assets of an organisation in the income statement. The recognition of goodwill in the financial statements of an organisation is very important because it indicates that the organisation have acquired another company inform of making investment. Amortization of goodwill The Financial Standards Accounting Board (FASB) recognizes several methods of amortizing goodwill. One of these methods the straight line method, this is over the useful life of the goodwill. Lipton (2006) indicates that the useful life is based on the remaining useful life after an organization acquires another company or considerable share of another organIsation. In addition, Chambers (2006) adds that there may be circumstances and situations that may warrant the revision of the remaining carrying amount of the goodwill. The Anglo-Americans recognizes various methods of testing goodwill impairment. Upon the occurrence of a triggering event an organisation may examine some qualitative factors affecting goodwill recognition. Some of these methods of testing goodwill are bypassing the fair value of goodwill. Principles of Valuation and Impairment of Assets As Prescribed By the IASB Valuation of Assets Hayn& Hughes (2006) points out that valuation is the value that an organisation or a person would pay to acquire an assetor transfer of a liability sin an ordinary market. Valuation is the fair value of an asset as defined and interpreted by the international accounting standards board. Affair value is based on market Based measurement and it is not based on measurement by an organIsation or a person. The purpose or the use of an asset is not necessary in determination of the fair value of an asset. Essentially, fair value is the price that an organisation would receive to sell an asset or pay for liabilities between market participants at a certain market date. There are four crucial elements in valuation of assets as prescribed by IASB as Beatty & Weber (2006) outline in the research work. These are the asset or liability, the transaction, the market Participants and the price. Price is the cost paid for transfer of an asset or liability while the market participants use the assumptions that they would use when pricing assets or liabilities, it assumes that the market participants would act in the their best economic interest. For the transaction, the valuation assumes that the transaction would take place in a principlemarket for the transaction to take place as well as in the most important market for the transaction in the absence of principle market. When determining the valuation of an asset, it takes in to account the traits of the asset if the participants in the market would consider the traits when pricing the asset at the date of measurement. Such traits include the location and condition of the asset as well as restrictions if any on the use or sale of the asset. Impairment of Assets The standard dealing with impairment of assets is IAS 36 on impairment of assets. This standard sets out the requirements needed for accounting for and reporting the impairment of assets especially those that do not have prescribed market values. This standard sets out when an organisation wants to test for impairment, how to carry out the impairment testing as wellas recognition of the impairment losses or discount. Bloom (2013) underscores that this standard requires that organizations to carry assets at no more than their recoverable amounts. To achieve this, the standard outlines that an organisation to test their assets that are within their scope for probable impairment when there are impairment indicators or at least once every financial year for assets with identifiable useful life. An organisation may apply several DCF techniques in valuation of assets as well as in making impairment decisions.DCF valuation is valuation of an asset using the intrinsic value of an organisation. It works out the present value basing it on the projections of all cash made available for future investment in the asset. Therefore, it takes in to account the “time Value of money”. The DCF techniques are such as valuation of project companies, going concern Valuation, free cash flow valuation as well as firm value. The application of these prescriptions will not resolve the goodwill controversy. This is because there is no uniform method of determining the recognition measurement and impairment of the goodwill for the DCF techniques. This only widens the gap and controversy in goodwill accounting. Conclusion There is growing importance of intangible assets in the knowledge economy. Goodwill is one of the most important intangible assets and it represents a future benefits to an organisation. As such, it is important to recognizes, to measure and manage the current accounting standards provides for testing for goodwill impairment while slowly doing away with goodwill amortization. The American standards have made major steps after the introduction of IFRS 3. The standard brought in two major changes in eliminating goodwill amortization as well as pooling of interests method is also not in application. It therefore promotes the purchase method to recognize goodwill upon acquisition. There is progress in the process of convergence of the IFRS and the Anglo-American GAAPs although there is still domain. After the full convergence, there will be more compatible financial statements prepared by organizations across the world. There is great difference on the argument concerning information content of impairment charges as well as the subjective part of the new method of accounting treatment. It is also important for organizations to consider the consequences of adopting new standards in the financial statements; this is not withstanding the better content of information and superior write off disclosures. There is still no clear definition of goodwill despite the all efforts by the FASB and IASB, there is no universally accepted accounting treatment. This report focused on the concept of goodwill and its contrast to the prevailing accounting. It examines the paradox between recognition/unrecognition of internally “generated” goodwill and externally “created” goodwill. In addition, the report focuses on the historical development of accounting for goodwill across the continental European and in the Anglo-American accounting systems. This is not forgetting exploring the attempts in the Anglo-American accounting world to the recognition, measurement and amortization of goodwill. Finally, the report discuss the principles of valuation and impairment of assets as prescribed by the IASB with particular focus on valuation of intangible assets and those assets that do not have established market values. References Beattie V 2005 Moving the financial accounting research front forward: the UK contribution. The British Accounting Review, 37(1), 85-114. Beatty, A & Weber, J 2006 Accounting discretion in fair value estimates: An examination of SFAS 142 goodwill impairments. Journal of Accounting Research, 44(2), 257-288. Bloom M 2009 Accounting for goodwill. Abacus, 45(3), 379-389. Bloom, M 2013 Double accounting for goodwill: A problem redefined. Routledge. Bugeja, M & Gallery, N 006 Is older goodwill value relevant?. Accounting & Finance, 46(4), 519-535. Chambers, D 2006 Is goodwill impairment accounting under SFAS 142 an improvement over systematic amortization of goodwill. Available at SSRN 953649. Godwin, N & Alderman, C 2012 Financial ACCT Mason, Ohio Andover: South-Western Cengage Learning distributor. Hayn, C & Hughes, P 2006 Leading indicators of goodwill impairment.Journal of Accounting, Auditing & Finance, 21(3), 223-265. Lhaopadchan, S 2010 Fair value accounting and intangible assets: Goodwill impairment and managerial choice Journal of Financial Regulation and Compliance, 182, 120-130. Lipton, M 2006 Merger Waves in the 19th, 20th and 21st Centuries. The Davies Lecture, Osgoode Hall Law School, York University, 14. Nobes C & Parker R 2008 Comparative international accounting.Pearson Education. 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