Goodwill is a kind of intangible asset; it is especially relevant in the sale of a business because the term is used to account for items that factor into the purchase price or value of the company but are not easily quantifiable, including proprietary or intellectual property and brand recognition.
Amortization refers to an accounting technique that is intended to lower the value of a loan or intangible asset over a set period of time. In 2001, a legal decision prohibited the amortization of goodwill as an intangible asset. However, in 2014, parts of this ruling were rolled back; amortization is now allowable in certain situations.
- Goodwill is a kind of intangible asset; in the context of the purchase or transfer of business, it may refer to proprietary property, intellectual property, and/or brand recognition.
- In accounting, goodwill is accrued when an entity pays more for an asset than its fair value, based on the company’s brand, client base, or other factors.
- In 2001, a legal decision prohibited the amortization of goodwill as an intangible asset; however, in 2014, parts of this ruling were rolled back.
- Now, private companies can elect to amortize goodwill on a straight-line basis over 10 years, although this election is not required.
Here are a few important characteristics of goodwill:
- Goodwill can't be separated or divided from the entity with which it is associated.
- Goodwill can't be sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability.
- Goodwill does not carry contractual or other legal rights, regardless of whether those are transferable or separable from the entity, other rights, or obligations.
Changes to Accounting Rules for Goodwill
In accounting, goodwill is accrued when an entity pays more for an asset than its fair value, based on the company’s brand, client base, or other factors. Corporations use the purchase method of accounting, which does not allow for automatic amortization of goodwill. Goodwill is carried as an asset and evaluated for impairment at least once a year.
However, in 2014, this policy was partially rolled back with the FASB Accounting Standards Update No. 2014-02, "Intangibles—Goodwill and Other (Topic 350)." The FASB re-allowed private companies to elect to amortize goodwill on a straight-line basis over 10 years. However, the election is not required. If desired, the option to amortize enables private companies to forgo the costly annual impairment tests that are required of public companies.
How Goodwill Is Calculated
Until 2001, goodwill could be amortized for a period of up to 40 years. Many companies used the 40-year maximum to neutralize the periodic earnings effect and report supplementary cash earnings that they then added to net income. The FASB changed this in June 2001 with the issuance of Statement 142, which prohibits this.
The first step of the impairment test required under the new standard must be performed within the first half of the company's fiscal year. If an impairment is found, the company reduces the goodwill carrying value and recognizes an impairment loss. Any material impairments found are listed as line items above “income from continuing operations.”
Because the annual valuation of goodwill is particularly expensive and time-consuming for private companies, the FASB created alternative goodwill accounting provisions for them. FASB Accounting Standards Update No. 2014-02, Intangibles—Goodwill and Other (Topic 350): Accounting for Goodwill allows these companies to use straight-line amortization of goodwill for up to ten years, or less if the company is able to demonstrate a useful alternative lifespan. Private companies only need to conduct impairment tests when a triggering event indicates that the company's fair value is less than its carrying amount rather than having to do so every fiscal year.