Question

King Company is contemplating the purchase of a smaller company, which is a distributor of King’s products. Top management of King is convinced that the acquisition will result in significant synergies in its selling and distribution functions. The financial management group (of which you are a part) has been asked to analyze the effects of the acquisition on the combined company’s financial statements. This is the first acquisition for King, and some of the senior staff insist that based on their recollection of goodwill accounting, any goodwill recorded on the acquisition will result in a “drag” on future earnings for goodwill amortization. Other younger members on the staff argue that goodwill accounting has changed. Your supervisor asks you to research this issue.

Instructions

Access the IFRS authoritative literature at the IASB website (http://eifrs.iasb.org/). (Click on the IFRS tab and then register for free eIFRS access if necessary.) When you have accessed the documents, you can use the search tool in your Internet browser to respond to the following questions. (Provide paragraph citations.)

1. Identify the accounting literature that addresses goodwill and other intangible assets.
2. Define goodwill.
3. Is goodwill subject to amortization? Explain.
4. When goodwill is recognized by a subsidiary, should it be tested for impairment at the consolidated level or the subsidiary level? Discuss.

Short answer

Answer

1. IFRS 3 addresses goodwill.
2. Goodwill gives benefits in the future.
3. No, goodwill is not subject to amortization.
4. Yes, goodwill should be tested for impairment

Step-by-step solution

Meaning of IFRS

International Financial Reporting Standards are a collection of accounting standards produced by the International Accounting Standards Board, a non-profit organization (IASB). It is a collection of globally agreed accounting standards that lays out the rules and procedures.

(a) Explaining the accounting literature that addresses goodwill and other intangible assets.

IAS 38 deals with intangible assets, whereas IFRS 3 deals with goodwill. Goodwill is the fraction of the purchase price greater than the net fair value of all the assets and liabilities sold. When a firm buys a new business, it obtains goodwill, which is an intangible asset (one that isn't tangible but has a long-term, worth).

(b) Definition of goodwill by IFRS

IFRS 3 defines goodwill as “an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.”

(c) Explaining if the goodwill subject to amortization.

No, goodwill does not depreciate. However, as noted in IAS 36, it is susceptible to impairment.

The term "impairment" refers to a reduction of the market value of fixed or intangible assets, indicative of a reduction in an asset's quantity, quality, or market value. The idea is that an asset should never be reported in your business's financial statements above the maximum amount that could be recouped through its sale.

(d) Explaining the situation when the subsidiary recognizes goodwill.

Goodwill is an asset that represents a benefit in the long run to the organization. Goodwill does not generate cash flow on its own. It is frequently used to supplement the cash flows of various cash-generating units.

Goodwill cannot always be allocated to individual cash-generating units on a non-arbitrary basis but only to groupings of cash-generating units. As a result, the lowest level inside the business where goodwill is tracked for internal management reasons frequently includes several cash-generating units to which the goodwill refers but cannot be allocated.

Goodwill is evaluated for impairment at a level representing a business operating its activities and with which the goodwill is naturally related. As a result, developing extra reporting systems is usually unnecessary.

On the off chance that the primary assignment of goodwill procured in a trade combination cannot be completed before the conclusion of the annual period in which the business combination is completed, it must be completed before the conclusion of the first year period after the procurement date.