Firms where good will is significant part of Assets warrants for closer investigation since good will entries can be a playground for dubious management. As a thumb rule, it is advisable for an investor to understand how a management values an acquisition.
Questions for Goodwill accounting –
Q1. How did the management value the acquisition?
Q2. How much percentage is good will of the total assets of the target?
Q3. Did the acquirer firm revalue the targets assets and liabilities for fair valuation?
Note – If the assets are re-valued upwards then acquisition good will be less, which is good in general because good will is not amortised, it is tested fir impairment annually and dubious management can play around good will at will to cheat share holders.
The following article will discuss accounting entries related to good will.
Accounting for Goodwill
- During acquisition both entities continue to exist in parent-subsidiary relationship. When the percentage ownership is less than 100%, the parent prepares consolidated financial statement but reports the un owned (minority interest) on its balance sheet.
- In acquisition all of subsidiaries revenue, expenses, assets and liabilities are combined with the parent. Intercompany transactions are excluded.
- The equity of the firm being acquired is ignored on the balance sheet of the combined entity.
The non-controlling interest in the acquired firm is represented on the balance sheet in the equity side. The formula to calculate the minority interest or non-controlling interest is percentage of acquired firm not owned by the acquirer multiplied by the fair value of equity of the acquired firm (share capital+ retained earnings).
Re Valuation of the Assets & Liabilities of the Acquired Firm
Net assets value or Book Value (equity) of the acquired firm is 16,000 Rs (6,000+10,000).
Acquirer acquired 80% of the acquired firm for 8,000 Rs.
Let’s suppose fair value of the PP&E of the firm being acquired is 6,000 (5,000 +1,000).
All other assets and liabilities of the acquired firm are already fairly valued.
Post-acquisition, PP&E of the consolidated entity will be 10,000 + 6,000 (acquirer PP&E + fair value of PP&E of the firm being acquired)
Good will (6,000) in the acquired firm is completely ignored in the consolidated balance sheet post acquisition.
Re valued Net Asset Value (book value or equity) of the Acquired Firm (Target)
After revaluing PP&E and other assets and liabilities of the acquired firm, fair value of net asset value or equity is calculated as follows-
16,000 (current asset) +8,000 (other asset) + (5,000+1,000) (fair value of PP&E) – 19,000 (current liabilities) = 11,000.
Older Net asset value (book value or equity) of the acquired firm, 6,000 + 10,000 = 16,000 Rs.
Good will should not be high of the acquired firm. During acquisition, the good will of the acquired firm is completely ignored post which you re-evaluate the fair value of net assets of the acquired firm. You value PP&E, other assets and liabilities and arrive at new equity value for the acquired firm. If the good will of the acquired firm is a high percentage of total assets and if the purchase price falls short of the fair value of net assets then it is detrimental for the shareholders of the acquired firm.
Shareholders are better off in firms where good will is low in the acquired firms since it does not get amortised, it is evaluated for impairment annually.
Our acquired firm had a good will of 6,000, or 17% of all assets, which then got excluded post acquisition.
We can have 3 scenarios for the purchase price of the acquired firm–
- 20,000 Rs
- 16,000 Rs
- 10,000 Rs
Acquisition good will is recorded on the balance sheet of the combined entity.
In situation where the acquisition price is less than fair value of net assets acquired. Both IFRS and GAAP require that difference between fair value of net assets and purchase price be recognised as a gain in the income statement.
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