6 Questions
What is the formula to calculate goodwill using the Purchase Method?
Goodwill = Purchase Price - Net Assets Acquired
How is goodwill presented on the balance sheet?
As a separate line item under the heading 'Intangible Assets'
What is the definition of excess earnings?
The earnings of the acquired business in excess of a normal rate of return on the net assets employed
What is the Capitalization Method used to calculate?
Goodwill
What is the purpose of testing goodwill for impairment?
To recognize an impairment loss when the carrying value exceeds its recoverable amount
What is the purpose of the capitalization rate in the Capitalization Method?
To determine the rate of return on the net assets employed
Study Notes
Accounting Treatment of Goodwill
- Goodwill is an intangible asset that is recognized in the financial statements when one company acquires another
- Goodwill is not amortized, but rather tested for impairment annually or when a triggering event occurs
- Impairment loss is recognized when the carrying value of goodwill exceeds its recoverable amount
- Goodwill is presented as a separate line item on the balance sheet, typically under the heading "Intangible Assets"
Goodwill Calculation
- There are two methods to calculate goodwill:
-
Purchase Method: Goodwill is calculated as the excess of the purchase price over the net assets acquired
- Goodwill = Purchase Price - Net Assets Acquired
-
Capitalization Method: Goodwill is calculated by capitalizing the excess earnings of the acquired business
- Goodwill = Excess Earnings / Capitalization Rate
-
Purchase Method: Goodwill is calculated as the excess of the purchase price over the net assets acquired
- Excess Earnings: The earnings of the acquired business in excess of a normal rate of return on the net assets employed
- Capitalization Rate: The rate of return that a prudent investor would expect to earn on an investment with a similar level of risk
- Net Assets Acquired: The fair value of the assets acquired, minus the fair value of the liabilities assumed
Accounting Treatment of Goodwill
- Goodwill is an intangible asset recognized in financial statements when one company acquires another
- Goodwill is not amortized, but tested for impairment annually or when a triggering event occurs
- Impairment loss is recognized when goodwill's carrying value exceeds its recoverable amount
- Goodwill appears as a separate line item on the balance sheet under "Intangible Assets"
Goodwill Calculation
- Two methods to calculate goodwill:
Purchase Method
- Goodwill = Purchase Price - Net Assets Acquired
- Calculates excess of purchase price over net assets acquired
Capitalization Method
- Goodwill = Excess Earnings / Capitalization Rate
- Calculates goodwill by capitalizing excess earnings of acquired business
- Excess Earnings: Earnings of acquired business in excess of normal rate of return on net assets employed
- Capitalization Rate: Rate of return a prudent investor would expect to earn on investment with similar risk
- Net Assets Acquired: Fair value of assets acquired minus fair value of liabilities assumed
Calculation of share, valuation of share
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