Goodwill allocation for intellectual property discussion
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Goodwill allocation for intellectual property discussion
What is goodwill? Reference the official FASB definition and also explain the concept in your own words?The Financial Accounting Standards Board defines goodwill as “an asset representing thefuture economic benefits arising from other assets acquired in a business combination or an acquisition by a not-for-profit entity that are not individually identified and separately recognized.” To put that in our own words, goodwill is the overpayment for the rights of another company with the hope of profiting from those assets. In a purchase involving goodwill, you are willing to overpay for the combinations of another company’s assets and liabilities in order to gain on those assets in the future`. In some cases, when purchasing a company that involves goodwill, you are taking on a monumental financial risk. However, if you were to go through with the acquisition, you are hopeful to make that money back and more in future business endeavors.2. Do you think that the current U.S. GAAP requirements for goodwill accounting provide useful information to investors, creditors and other users of financial statements? Why or why not?We believe that current U.S. GAAP requirements do not provide useful information aboutgoodwill to investors and creditors. The concept of goodwill is too abstract to pinpoint itsbenefits to a company. While it can be a valuable asset, goodwill cannot be traced back toan origin. Goodwill also cannot be revalued upward. This makes it difficult for casual investors because they only see the impaired amount despite the possible increasing value. A more sophisticated investor will have better knowledge about the tendencies of goodwill. Goodwill can also slightly mess with performance ratios. If future economic benefits are reaped beyond the valuation of goodwill, then ratios will not accurately reflect the company’s performance. Goodwill can be a valuable asset to a company, but because of all the cons and the abstractness of the intangible asset, it does not make it a secure source of insight for the typical investor.3. Which set of requirements (U.S. GAAP or IFRS) provides more useful information regarding goodwill? Why?The main reason we believe IFRS is the superior set of requirements is because of the simple, yet effective one step approach to impairment. The two requirements are fairly similar in the treatment of goodwill. However, the most important difference between the treatment of goodwill under GAAP and IFRS is how an impairment loss is recorded. Under GAAP, an impairment loss is recognized following a two-step process. First, you have to determine if the carrying amount of the reporting unit is greater than the undiscounted cash flows it is expected to generate. If the carrying amount is lower then its undiscounted cash flows, there is no impairment loss. If the carrying amount is greater
than the undiscounted cash flows, then there is an impairment loss and you move to the second step. The second step is to measure the difference between the carrying value and the fair value (price at which the asset could be sold in the market) to get the value of impairment. Under IFRS, you are comparing the carrying amount of the asset to the recoverable amount. The recoverable amount is the larger amount of either the assets fair value less the costs to sell or the asset’s value in use. If the recoverable amount is less than the carrying amount, an impairment loss exists, and it exists for the difference in the two numbers. To the average person, it just makes sense to impair goodwill by using whatit’s truly worth (recoverable amount) with what we have it currently listed at (carrying value). United States GAAP requirements, on the other hand, make things more confusing than it has to be. The need to have two steps seems unreasonable, when IFRS shows that we only need one to give a true estimation of how much goodwill we actually have and how much needs to be impaired. We also think the way we get the impairment amount in U.S. GAAP is not the best estimation of the true value it provides. If the carrying amount is $130,000 and goodwill can generate $100,000 in cash flows, but its fair value is only $80,000, the $50,000 in impairment is not really a true measure of how much goodwill is worth. If it can generate $100,000, we believe it should have a value of $100,000 in our financial statement, not the $80,000 fair value. One of the other major differences under IFRS as compared to GAAP is IFRS using a cash generating unit ratherthan an operating segment. This increases the number of occurrences of impairment, which leads to more information on the company’s true goodwill value. The complexity of U.S. GAAP and the simple, yet effective ways of IFRS are the main reasons we believe IFRS provides more useful information regarding goodw