ACCOUNTING TREATMENT FOR GOODWILL

Dra. ADE FATMA, MAFIS, MBA

Fakultas Ekonomi
Universitas Sumatera Utara

I. The significance of accounting for goodwill

The topic of Goodwill as an accounting subject has been discussed

continuously in accounting texts and periodical literature for over thirty years. It has
become more important while as there ISSN increased interest in the accounting
problems arising from business combinations.

Today business combinations still dominate our media. In Cleveland, the most
publized example was the" merger" of Society National Bank and Ameritrust National
Bank. Business combinations are sometimes referred to as mergers, acquisitions,
LBO'S, MBO,S, combined companies and so on. The most important motivation for
using the pooling accounting treatment in the view of most accountants, is the
problem concerning the matter of goodwill. When classified as a "pooling of interest",
a business combination ISSN not faced with the problem of amortizing goodwill. In
the case of the AT&T pooling with NCR in May 1991, AT&T agreed to sell all of its
shares to obtain the pooling treatment, which avoided the creation of $5.7 Billion of
goodwill that would have been reported under purchase accounting.1

When classified as "purchase", the surviving company is frequently required

to record any resulting goodwill on its Balance sheet. Then, since this goodwill must
be amortized to income annually after taxes, the reduction in net income is often
significant.

According to APB Opinion No.16, the only exception to accounting for a

business combination as a purchase is situations in which the surviving company
issues only voting common stock for all the assets of an acquired firm in an assets
acquisition ; or issues only voting common stock for at least 90% of the voting
common stock of the acquired firm in a stock acquisition.2

APB Opinion No.16 provides very restrict:ed criteria for the use of the pooling
method. Currently, very few combinations meet the criteria. In recent years, less
than 10% of the firms surveyed in Accounting Trends and Techniques used the
pooling method.3

If the transaction does not qualify for pooling of interest treatment, then the
purchase method must be used. The underlying concept of the purchase method is
that one company has acquired the business of another company and a sale has
occurred.

1
Arnold J. Pahler, Joseph E Mori, Advanced accounting concept and practice, fifth
edition, The Dryden Press 1991, p. 257
2
Fisher, Taylor, Leer, Advanced Accounting, South Western, Publishing Co,
Cincinnati 1993, p. 11
3
Fisher, ibid p. 32

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 The Miller Comprehensive GAAP Guide (1992) states that a "Business
combination accounted for by the purchase method are recorded at cost. The
determination of cost is usually based on their fair market value (FMV) of the
property acquired or the fair value of the property given up, which ever is more
clearly evident.4

Under the purchase method, the acquiring company's cost must be allocated
to the individual assets acquired. In most situations the acquired assets are valued at
their current values to the extent that the acquiring company's costs exceeds the
current value of the identifiable net assets, then goodwill arises.

In theory, a "purchase" is the buying of one company by another. When an

acquisition occurs, accounted for as a"purchase," all assets should be valued
according to the eventual payment. Any debt or equity that could be issued based on
future contingencies are not included until the future contingency is resolved. The
difference between consideration given less the FMV assets acquired plus the present
value of liabilities assumed, is goodwill. If the previous result is negative, non-
current assets (except marketable investments), should be reduced pro-rata. If a
negative amount still occurs then negative goodwill should be recorded.

Concerning negative goodwjll, Arnold J Pahler does not agree with this term.
"Goodwill either does or does not E!xist "there is no such thing as a company having
negative goodwill".5

There has been criticism of APB Opinion No.16, since its issuance. It has been
widely criticized for not being a sound or logical solution to the issues associated with
business combinations. Pooling of interests method often does not accurately portray
the Underlying economics of the business combination, because the small company
could "pool" its resources and management with a large company. Most accountants
agree with the fundamental concept of the purchase method, except for the
treatment of goodwill.6

Many accountants and corporate executives think that goodwill should not be
shown as an assets of the acquiring company, but should be charged to the equity
section of the acquiring company at l the acquisition. This reasoning is that acquiring
entity has in substance, given up some of its equity with the hope of regrouping it in
subsequent years through that acquiring company's superior earning.

When the significance of accounting for goodwill in terms of the "purchase

method" of business combination, this paper will examine the accounting treatment
for goodwill at the International accounting level and compare the accounting
treatments for goodwill in U.S., Indonesia, Japan, and Australia.

According to research procedures and major source of data, goodwill may be

viewed on three levels : 1) the nature of goodwill, 2) the allocation problem and 3)
the amortization problem.7

4
Martin Miller, HBJ Miller comprehensive GAAP guide 1992 (Orlando, FI 1991) p 3.02
5
Arnold J Pahler, ibid p. 86
6
Arnold J Pahler, ibid p. 133
7
Hugh P Hughes, Goodwill in accounting history of thr issues and problems, CBA
Georgia State University p. 2

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A. The nature of goodwill
Goodwill is perhaps the most unique of all intangibles, because unlike other
types of intangibles, it is not separable from the business and thus cannot be sold
apart from the business as a whole. In general, goodwill represents an existing or
perceived future capability to achieve superior earning.

According to Nelson, related to his survey and his deductive 4 studies,

goodwill generally consists of the following elements:
a. Customer lists
b. Organization costs
c. development costs
d. Trade marks, trade names and brands
e. secret process and formulas
f. patent
g. copy rights
h. licenses
i. franchises and
j. Superiors earning powers1

Mace and Montgomery divided 5 major factors affecting a firm's decision to

purchase another firm which are as follows:
a. Accomplishment of market objectives
b. Saving time in expanding into a new era
c. acquiring management skills
d. achieving product diversification and
e. achieving integration

In comprising the above two lists, Called & Vulcan said that there are a lack of
agreement as to the identity of the components of goodwill. The difference mainly is
in the levels of aggregation of these components. The first list contains general
factors underlying goodwill, the second list specifies individual items.2

An empirical study by Falk and Gordon provide the most comprehensive list of
empirically identifiable factors of goodwill and then mathematically determines the
interrelationship of these elements to form a set of factors. These four factors are
labelled as:
a. increasing short run cash flow
b. stability
c. human factors
d. Exclusiveness see exhibit 1.

The concept issues for goodwill are as follows3

1. Should goodwill-either purchase or internally generated-be reported as an asset?
The accounting alternatives are: 1. capitalizing it or 2. charging it to equity (either
directly or through the income statement) and
2. If goodwill is reported as an asset, how should its valuation be determined
subsequent to the date it is recorded as an asset?

1
R. H Nelson, The momentum theory of goodwill, Accounting review (oktober
1953), p.495
2
Arnold J. Pahler, ibid p.92
3
FASB, Original Pronouncement Volume II, Irwins Homewood Illinois business
combination, Accounting research study No. 5, AICPA 1963, p. 62

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 The accounting alternatives are: 1. treat goodwill as a permanent asset, 2.
Amortize it systematically, or 3. write it down when its value has been impaired. See
exhibit 2.

According to APB Opinion no.17, goodwill is the excess of the cost of an

acquired company over the sum of identifiable net assets. It is the most common
unidentifiable intangible assets.4

The amount of goodwill arising in the consolidation process between a parent

and subsidiary company, as well as other amounts which many times might more
acculately be described by a term other than goodwill.

Goodwill has no physical substance, it differs from other intangible assets

(such as franchises or patents). It is not protected by specific legislation or by legal
instruments. When the use of the term is extended beyond its narrow sense the
difficulties of a logical allocation of the amount to future income period is increased.
According to FASB discussion memorandum on the conceptual frame work proposed
to identify eight elements of financial statements of business enterprise, Assets are
probable future economic benefits attained or controlled by a particular enterprise as
a result of part transaction or events affecting the enterprise.5

Because goodwill is commercially valuable; it is commonly regarded as an asset.

There may be specific factor's such as: a good location, that contributes to the ability
to generate excess profits, or the presence of excess profits may be inferred as
indicating goodwill.

Many combination are structured as tax free exchanges as to the seller, in

which case, the purchaser must base future depreciation charges on the selling firm's
book value. Goodwill amortization charges are not tax deductible before August
1993. This means that while other expenses are mitigated by tax deductibility, the
goodwill amortization and added depreciation on assets caused by a purchase are
not. The use of purchase accounting for "tax-free" business combinations would tend
to widen the difference between taxable income and accounting income. Effective
after August 1993, goodwill is tax deductible, but only if the goodwill was acquired.

However in 1991, the General Accounting Office (GAO) recommended to

Congress that the tax code be amended to allow goodwill (as well as other purchased
intangible assets) to be deducted to eliminate the continuously, costly, and counter
productive legal warfare between the internal revenue service and corporate tax
payer on the issue. More significantly, in a historical shift of position, the house ways
and means committee, supported by the treasury department introduced a bill in late
1991 that would allow goodwill and other intangibles to be deducted over 14 years.

In August 1993, this legislation (modified to allow amortization over 15 years)

was enacted as part of the omnibus. The budget Reconciliation Act of 1993 (OBRA),
permits only goodwill purchased after August 1993 in a business combination is tax
deductible.

4
Arthur R Wyatt Phd, CPA, A critical study of accounting for business combination,
Accounting research study No.5, AICPA 1963, p. 62
5
FASB, ibid p. 226

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 Goodwill is closed related to trade names and trade marks, when the trade
names or trade marks carried by the original creator, there will come a time when
business man himself, or his executor after his death will want to sell his business, or
his executor will want to realize this intangible property along with the works, stock-
in-trade, and other visible and tangibles assets. What he can pass on to another of
this tangible property is commonly known as goodwill.6

In direct asset acquisition, goodwill on the books of an acquired firms is

disregarded. In the case of stock acquisition, however, a subsidiary's recorded
goodwill is included in the subsidiary Balance Sheet which is to be consolidated. But,
no goodwill should appear on the consolidated Balance sheet until all long lived
assets are stated at full market value. If interest rates increase and the market value
of the debt decrease, the net assets are adjusted upwards, and the excess available
for long-lived assets decreases. In a bargain purchase, goodwill recorded by the
subsidiary should be recognized to long-lived assets, however, the maximum amount
of goodwill available for reassignment is the subsidiary's previously recorded goodwill
multiplied by the parent's ownership interest.

According to APB Opinion No. 18: "the equity method of accounting for
investment in common stock". If the price paid for an unconsolidated and influential
investment was in excess of its underlying book value, the excess was attributed to
goodwill. The investor would have to deduct the amortization of the goodwill firm, its
percentage share of the investee firm's income.7

Related to determining cost of an acquired enterprise if the quoted market

price is not the fair value of stock, either preferred or common stock, both the
conf:'ideration received, including goodwill, and the extend of the adjustment of the
quoted market price of the stock issued shall be weighed to determine the amount to
be recorded.8

Because goodwill was not deductible for income tax reporting purposes before
August 1993, acquiring companies often tried to include in the acquisition agreement
a tax deductible feature known as a covenant not to compete. Non compete class are
intangible assets similar to goodwill. Such a covenant prevents the targets company
or certain key shareholders or employee from reentering the same line of business
for a specified period of time.

Goodwill is now tax deductible (effective August 1993), This built in incentive
favoring the assignment of part of the purchase price to covenants not to compete
instead of goodwill no longer exist. Furthermore both goodwill and covenants not to
compete are tax deductible over 15 years.

Where the locality of the business makes the trade, goodwill as a disposable
asset represents the advantage derived from the chance that customers will continue
to frequent the premise in which the business has been carried on.

Where the business is one which depends upon the reputation of a firm,
goodwill consists of the advantage which the owner derives from being allowed to
repL~sent himself as such; and where value of the business depends on its business

6
Fisher, ibid p. 81
7
FASB, APB Opinion No. 18, par 91
8
FASB ibid, p. 4817

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connection, the goodwill on sale consist of the right to be properly introduced to
those connection.

Recently, the "importance of goodwill and the necessity of preventing

improper appropriations have been fully recognized."

B. The conceptual frame work approach

To determine which accounting premises and techniques for goodwill requires
a certain set of characteristics as a guideline in the examination, and evaluation of
recognition and measurement of goodwill.

1. An historical cost basis.

Cost is defined by Sprouse and Moonitz as a foregoing a specific made to
secure benefits and is measured by an exchange price.1

At any point in time, resources and benefits belonging to the organization (to
the entity) could have been acquired through an exchange transaction or through
other means such as evolutionary processes which are currently and commonly
perceived to arise.

Even so subjective an evolution as the importance of goodwill may be viewed

and the significance of goodwill is evident. Whenever an exchange price for such
assets and benefits exists, it is used as the basis of the original recording and all
subsequent allocations, reallocations, and recording so long as such benefits are still
in the possession of the said organization. It is the historical cost basis.

2. Cost allocation
When the term "goodwill" is used to describe the entire excess of cost over
book value of assets acquired, without regard to the nature of the excess, a problem
of allocation may arise whether it is recognized as such or not.

The generally accepted accounting practice of acc"ounting for assets at cost

involves the use of fair value of that which is given in exchange or the fair value of
that which is acquired, whichever ISSN more readily determinable, as the
appropriate measure of cost. Nothing in the concept requires that the excess of cost
of properties acquired over the book value there of be labelled or described as
goodwill. In all cases, this excess should be allocated according to the factor or factor
which created it.

Several accountants state that the excess which would arise in some business
combination transactions could not be allocated on a reasonable basis to any
accounts other than goodwill.2

3. Accounting for a profit oriented organization

The basic objective of the conceptual organization under consideration is to
earn profit. Making a positive profit is taken to be one of the critical factors affecting
the viability, continuity, and survival of the organization.

Closely associated with the foregoing is the characteristic that goodwill

represents an above -average to make a profit. Whatever may be said of a firm's

1
Hugh P. Hughes, ibid p. 8
2
Hugh P. Hughes, ibid p.12

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contribution to a stable livelihood or service ability of its products. Thus, goodwill
ultimately ISSN perceived in terms of profits although of course service ability may
affect profitability and therefore, goodwill as well.

Because goodwill is commercially valuable, it is commonly regarded as an

asset. Whatever the reason, goodwill like all assets, ISSN capitalized according to its
assumed ability to contribute to profitability.

Arm's length prices or their equivalent

If a basis for allocation of the excess exists, it will generally be evident from
an analysis of the combination transaction itself. These transactions often result from
arm's-length bargaining between two managements or stock holder groups
frequently only after a considerable pericd of negotiation.

When agreement of a combination plan is reached, the terms of the

agreement are commonly stated explicitly. When the final price ISSN determined,
which are known to both parties, the acquiring company has knowledge of what the
combination is to cost them.

If the price paid to effect the combination is in excess of the underlying book
value of the assets acquired, the officials of the buying company know why they pay
the excess. In most combinations, the data available from the combination
negotiations and from the terms of the final settlement will provide a fair basis for
allocating the excess paid.

C. The allocation of goodwill

In allocating the purchase price of a business between depreciable and non-
depreciable assets for tax reporting purposes, the amount allocated to goodwill must
be calculated in a residual manner. This goodwill is determined in the same manner
for both financial reporting and tax reporting.

Accounting Research Bulletin No. 43 revised two features of the accepted

accounting for intangibles. 1) First, the immediate write-off of intangibles by charges
against earned surplus was opposed, and second, the adoption of an amortization
policy with respect to goodwill are present.1

The opposition to immediate write off developed in the late 1940's in

accounting for business combinations. Immediately after recording the
combination.transaction, however, any excess of the cost recorded over the
underlying book value of the assets acquired was charged off to surplus. During the
1949 -'52 period, there was a high degree of direct write off to earned surplus
(retained earnings). A direct write off to earned surplus has the effect of accounting
for the assets or properties received at their previous book value. The excess of book
value is not carried forward as goodwill.

Chapter 7c of Accounting Research Bulletin No.4 is quite clear in its objection

to direct write-off of excesses arising in this manner. By 1958 -60 AICPA and security
exchange commission disapproved of this direct write off. One effect of the absence
of direct write off was to clarify the distinction between a purchase and a pooling in
accounting for assets.

1
Arthur R Wyatt, ibid p. 59

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 A second point of interest is the absence of any trend in the allocation of the
excess where the excess was recorded on the book of the surviving company.
Through out the period the excess was assigned to specific tangible assets about as
frequently as it was assigned to goodwill. The problem of allocating the excess
among specific assets was apparently solved satisfactorily.

A third point is the adoption of a policy of amortization. The amortization of

the excess classified as goodwill appears to reflect the influence of the policy of
amortization set forth in Chapter 5, "Intangibles Assets" of Accounting Research
Bulletin No. 43.

Goodwill is a residually determinant amount. Goodwill is reported in the

financial statements as an asset of the enlarged combined business. The amount
allocated to goodwill must be calculate in a residual manner (termed the residual
method of allocation).

Thus, goodwill is determinant in the same manner for both financial reporting
and tax reporting.

Chapter 5 of Accounting Research Bulletin No. 43 (issued in 1953) involved a

significant change from a position taken earlier by the committee in Accounting
Research Bulletin no. 24 (issued in 1944). The principal significance of this new
position of the committee was that the excess of cost over book value of a
company's stock acquired would charges to income rather than to surplus. ARB No.
43 was accepted by the Security and Exchange Commission as being appropriate
accounting for intangibles.

D. The amortization of goodwill

If all or part of the difference between the fair value and the book value is
assigned initially to goodwill, it should be amortized if it has a limited life. The
problem of disposing of this difference has a dual impact, once at the initial recording
of the transaction and again at the end of each subsequent accounting period. Any
amortization will, of course, reduce reported income below the amount which would
be reported without amortization.

The question about capitalizing of goodwill has been debated for several
decades. The decision of whether to capitalize goodwill ISSN usually supported by a
theoretical discussion of goodwill is an asset. In 1974, FASB was against
capitalization of R & D expenditures because of the uncertainty of future benefits.
One of the basis for the decision was that R & D expenditures are so difficult to
measure. As mentioned earlier, goodwill appears to consist of many factors and
elements and each transaction creating goodwill may involve a unique mix of these.
It is necessary to identify the useful life and the dollar value of goodwill.1

The failure to identify and measure the value of goodwill creates problems
with capitalizing goodwill both at the acquisition date and after the date of
acquisition. At the date of acquisition, a premium is being paid for synergism based
upon the judgment of the management of the acquiring firm. The estimate used in
the computation of the price paid are the only evidential matter available and an
independent appraiser enjoyed by the auditor with probably arrive at a different
amount for the excess if it did not have future benefit, especially when the amount is

1
Higher. Hugh.P, ibid p.24

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determined through negotiations between a willing buyer and a willing seller.
Therefore, regardless of the nature of the excess, FASB may decide to capitalize the
residual under the caption of goodwill and the price paid for investment indicate the
existence of some future benefits. If the residual is capitalized as goodwill, then an
amortization period or useful life must be determined.

Cally & Valkan proposed a two step approach to accounting for goodwill. First,
all intangible and tangible assets that form the basis for the excess payment over fair
values of net assets acquired must be identified, capitalized and amortized over their
useful lives. Second, any remaining unidentifiable portion of the i excess must be
written off against equity on date of acquisition.2

Alternative accounting principle for goodwill are required or permitted

depending on when the assets were acquired.3 1. The cost of intangibles assets
acquired prior to Nov 1, 1970, shall be either: a. accounted for as an asset and not
amortized if the asset has no evident limited life or b. Amortized by systematic
charges in the income statement over the period benefit if the asset does have a
limited life. The cost of intangible assets acquired after October 31,1970 from the
enterprise or individual shall be recorded as an asset and shall be amortized over the
period of its estimated useful life, but the period of amortization shall not exceed 40
years. Cost of developing, maintaining or restoring intangible assets that are not
specifically identifiable shall pe recorded as expenses when incurred.

The cost of unidentifiable intangible assets is measure by the difference

between the cost of the group of assets or enterprise acquired and the sum of the
assigned cost of individual tangible and identifiable tangible assets acquired less
liabilities assumed.

The recorded cost of intangible assets shall be amortized by systematic

charges to income over the period estimated to be benefited. Factors that shall be
considered in estimating the useful lives of intangibles assets include: 4
a. Legal regulatory or contractual provision
b. Provision for renewal or extension
c. Effect of absolecense, demand, competition and other economic
factors
d. A useful life, service life expectations of individual or group of employee.
e. Expected actions of competitors and others
f. Unlimited useful life may be indefinite and benefit cannot be reasonably projected
g. Varying effective lives.

A reasonable estimate of the useful life may often be based on upper and
lower limits even though a fixed existence is not determinable. The period of
amortization shall not, however exceed 40 years. The straight line method of
amortization, equal annual mounts shall be applied unless an enterprise
demonstrates that another systematic method is more appropriate.

Goodwill and similar intangible assets cannot be disposed of apart from the
enterprise as a whole. If an enterprise is sold or liquidated, all or a portion of the

2
J Ron Colley & Ara Volkan, Accounting for goodwill, from Accounting Horizon (June
1988), American Accounting Association
3
FASB, Current Text Accounting Standard, ibid p. 2635
4
FASB, ibid p.2637

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unamortization cost of goodwill recognized in the acquisition shall be excluded in the
cost of the assets sold.

The cost of intangible assets which has a limited life shall be i written off
when it becomes reasonably evident that they have became worthless.5

In determining whether the intangible became worthless, consideration shall

be given to the fact that in some cases intangible asset acquired by purchase may
merge with or be replaced by intangibles acquired or developed with respect to other
products or lines of business and in such circumstances the discontinuance of a
product or line of business may not in fact indicate loss of value.

According to accounting standards, General Standard volume 1, A deferred

tax liability or asset is not recognizei for a difference between the reported amount
and the tax basis of goodwill, Unallocated "negative" goodwill and leveraged leases.6

II. International accounting treatment for goodwill

A. The fluctuation of goodwill

There has been a dramatic growth in the significance of intangible assets
relative to the intangible assets of MNE's. This is due to continuing wave of
international mergers, the pursuit of global market leadership often through the
development or acquisition of famous brand names, the world wide expansion of the
service sector, the speed and extent of technological change and the growing
sophistication and integration of international financial market. As a result, the
problem of how corporations should account for intangibles including goodwill, brand,
patents and research and development, and so on, have arisen and could
considerable controversy. There is currently a variety of accounting treatments that
are considered acceptable in the interJlational corporate context.

Accordingly, it is currently a matter of some considerable controversy as to

whether goodwill should be created as an asset for accounting purposes and if so,
whether or not it should be amortized against future earnings1.This is an important
issue because profits are used as a significant indicator of business performance.

The value of goodwill is relevant in contrast to the traditional emphasis on the

existence and cost of intangible assets.

The International Accounting Standards Committee (IASC) in its IAS No.22,

"Accounting for business combinations", deals with the goodwill issue but
recommends a flexible approach (i.e., either to capitalize goodwill as an asset and
amortize it over its useful economic life or to immediately write off goodwill against
equity). No Amortization period is recommended.2

More recently however, the IASC proposal published in January 1989,

recommend elimination of the immediate write off method and adopts the required
treatment of recognizing goodwill as an asset to be systematically amortized against

5
Colley & Volkan, ibid, p. 41
6
FASB, ibid p.158
1
P.A Taylor, consolidated financial statement, Harper & Row, 1987
2
International Accounting Standard Committee, IAS 22 Accounting for business
combination, London : IAS, January

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earnings over its useful economic life. The maximum amortization period is five years
unless a longer period can be justified, which should not, in any case, exceed 20
years.

B.The recognition of goodwill

Since intangible assets tend to lack physical substance, an important criteria
influencing recognition is that intangibles can be identified as resources that indicate
the financial strength of a company and its ability to meet its obligations. In this
contex, the "separability" of the asset would seem likely to weigh heavily in the
identification decision as this would indicate the potential for realization without
threatening the viability of the business as a going concern.

Goodwill would not seem to qualify as an asset in the conventional accounting

context given that goodwill is the difference between the value of a business taken
as a whole and its net assets. The problem with goodwill is that it cannot be
unbundled from the business and disposed of as a separate asset. Further, since
goodwill is a cost incurred with the expectation of future economic benefits, it does
appear to meet the "relevance" criterion for asset recognition.

C. The valuation of goodwill

Although goodwill may have legally separable property rights attached such
as trade marks, patents, brands and designs, variety of alternative valuation
methods can be used including historical cost, market valuation, current cost, the
allocation of purchase cost of goodwill, discounted cash flow, and the use of earning
multiples, all of which involve varying degrees of subjective judgment.

According to Financial Accounting Concept No.5, the statement requires that

four fundamental criteria should be met in order for an item to be recognized in the
financial statements. One of this criteria is measurability. To be recognized, an item
must be " ...measurable with sufficient reliability."3

Thus, in order to be capitalized, goodwill must meet the measurability

criterion established by the FASB which requires that a verifiable (reliable) estimate
of the dollar value of the asset be known.

In capitalizing goodwill, both at the acquisition date and after the date of
acquisition, the problem exists in identifying and measuring the value underlying the
residual, goodwill. As an example of the latter, assume that a premium is paid for a
firm partly because of contracts the firm possess which give exclusive access to a
customer base.

If the contracts are separately capitalized and for some reason, the contracts
are unexpectedly terminated and their value lost, the unamortized cost of the
contracts should immediately be written off.

However, if the contracts are not separately identified and thus are included
as part of goodwill, it is unlikely that a portion of goodwill will be written off upon the
termination of the contracts. This is one of the major problems with the current
method of accounting for goodwill. Thus, the impairment of the asset is next to
impossible to determine.

3
FASB, Statement of Accounting Cincept No. 5 (Stanford : FASB 1975), par.63

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 There are also problems with measurement at the acquisition date. If the
investors are willing to pay a substantially higher price for the firm than was
determined by market forces, they must expect that the value of the acquired firm is
more to their company than its value as a stand-alone firm. Thus premium is being
paid for the synergism based upon the judgment of the management of the acquiring
firm. However, the verification of the value of the premium included in the purchase
price is not possible since the only source of goodwill measurement is management
presentation. That is, the estimate used in the computation of the price paid ISSN
the only evidential matter available and an independent appraiser engaged by the
auditor would probably arrive at a different amount for the excess payment.

D. The choice of accounting method

1. Assets without amortization

If the FASB agreed with the contention that the amount presently cannot be
capitalized because the auditor cannot attest to its f measured amount, known as
goodwill management will have to prove Ithe validity of its assumptions, and
amounts that do not belong on the balance sheet will be written off.

However, there will be an impact on total assets (decrease), total equity

(decrease), and net income (increase slightly), reported in the financial statements.
It is worthwhile to examine the magnitude of the impact of such an accounting policy
change in the risk (debt- to equity) and performance (return on investment) ratios.
These ratios are extensively used by financial analysts to determine the credit
rating's and stock prices of a company.

2. Assets with amortization

However, the FASB may decide that in the case of business acquisitions, the
measurement process is sufficiently objective and the measurement amount itself is
verifiable and reliable. Management would not have paid for the excess if it did not
have a future benefit, especially when the amount is determined through
negotiations between a willing buyer and a willing seller.

If amortization is appropriate, then it should be over the useful economic life

of the asset, not an arbitrary period. While goodwill may be viewed as assets
embodying future economic benefits, they are a cost incurred to be used up in
generating future earnings, such costs should be systematically amortized against
earnings consistent with the accrual accounting concept.

However, the IASC subsequently proposed (July 1990) to incorporate the

capitalization of development costs as a preferred treatment provided that certain
recognition criteria are satisfied.4

3. The immediate write-off

The immediate write off approach is supported by the arguments that
goodwill and related intangibles are not assets for balance sheet purposes because
they are not separable from other associated assets, nor independently realizable. It
is not possible to asses the future economic benefits of goodwill with a reasonable
degree of certainty. It is argued, therefore, that "prudence", should govern the
"recognition" decision. Accordingly, the cost of goodwill should be written off

4
International accounting standard committee, E 32, Statement of intend on
comparability of financial statement, London : IASC 1990

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immediately against equity or earnings consistent with the treatment of goodwill.
Opponent of this method however, argue that goodwill is indeed an asset and should
be recognized as such with or without amortization. It ISSN argued that a valuation
approach is desirable because it is morerelevant to users in provjding information
about the substance of the business.

International Accounting Standard No.9 deals with Accounting for Research

and Developments Activities and recommends the immediate write-off against
earnings of research and development expenditures.5

More recently, the IASC proposed in its exposure draft "Comparability of

Financial Statements" (E 32), published in January 1989, that the preferred
treatment for research and development expenditures should be the immediate write
off method.6

This recommendation was based on the view that asset recognition in this
context is very uncertain and that the majority of companies f appear to accept such
an approach.

III. Comparative national practice

A. Accounting treatment for goodwill in Australia

1. The recognition of goodwill

The Australian Accounting Research Foundation (AARF) is the most powerful
accounting agency in Australia which operates among other departments, an
Accounting Standard Board (AASB) and a Public Sector Accounting Standard Board.
Eventually, AARF published accounting research studies, accounting t}leory
monographs, discussion papers, and auciit guides.

Australians have a deep-seated distrust of government regulation and

bureaucratic reach. The private sector dominates the Australian economic system.
Company law governs business affairs. Each Australian state has a company code
identical to the company Act of 1981, which standardized company laws throughout
all states and territories.

The two major Australian professional accounting bodies are the Institute of
Chartered Accountants in Australia (ICAA) and the Australia Society of Accountants
(ASA). ICAA has a membership of approximately twenty thousand and is closely
identified with auditing and public practice. ASA's membership approximates sixty
thousand with significant representation of public sector employees.

The Australian Accounting Research Foundation was establish by those two

accounting bodies for developing financial accounting concepts and standards.

5
Lee H Radebaugh & Sidney J Gray, International accounting and Multinational
enterprises. Third edition, John Wiley & Sons, Inc 1992. p.233
6
Lee H Radebaugh, ibid p.241

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 The Australian Accounting research Foundation issued exposure Draft 49 in
August 1989, which proposed that acquired identifiable intangible assets should be
recognized as assets and stated at their cost of acquisition.1

Goodwill would also qualify for recognition, the systematic amortization

approach is proposed for all intangibles assets basec on the criterion of useful
economic life, through it is suggestec that 20 years would be expected to be the
maximum.

2. The valuation of goodwill

In general, Australian financial Accounting measurement conforms to the
Genre of Anglo practice. However, Australian companies are allowed the option of
revaluing non-current assets.Revaluatio increments are credited to an asset
revaluation reserve.2
Gains from revaluations cannot be included in operating income.
However, periodic revaluation is also required. All valuation would be carried out by
an independent professional expert. This has arisen from the recent practice of some
large companies in Australia to value licenses, copyrights, and publishing rights for
some time now. Usually, the valuation of those intangible assets ISSN determine by
allocating an appropriate proportion of the cost of goodwill.

The valuation approach used here was apparently based on a "current cost"
approach. The rules do not permit a market valuation to be used. Where current cost
is the valuation basis, then annual, revaluation are necessary.

The capitalization of homegrown brands and other intangibles except goodwill

is also permitted. Brand valuations would not be systematically amortized but would
be reviewed annually. While a valuation approach seems more relevant, one problem
is that the companies concerned have provided very little information about the
valuation process involved.

This make the valuations very difficult to interpret, with resulting uncertainty
likely to undermine confidence from a securities market perspective.

3. The choice of accounting method.

Under the Companies Act in Australia, only companies can be consolidated.
The pooling of interest method of accounting for business combination is not allowed.
Companies are prohibited from dealing in their own shares. Therefore, there are no
treasury stock transaction.

In Australia, the method of immediate write-off against equity ISSN not

permitted. Financial reporting in Australia is comparatively permissive. This is
primarily due to limited enforcement resources rather than the presence of
legislation or a comprehensive set of financial accounting standards. The central
disclosure concept ISSN that financial statements must "give a true and fair view"
which ISSN not specifically defined in the professional literature. Directors of
Australian companies have rather onerous statutory disclosure requirements.
Company size and status determine the extent of necessary disclosures. The

1
Lee H Radenbaugh & Sidney J Gray, International Accounting and Multinational
enterprise, John Wiley & Sons Inc, 1992, p.247
2
Frederick D.S.Choi & Gerhard F. Mueller, International accounting, Prentice Hall,
1993, p.87

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directors must state why the application of legal requirements and approved
accounting standards fail to yield a true and fair value. If alternative disclosures
and/or accounting measurement rules are employed so as to achieve a true and fair
view, the directors must report accordingly. The directors' report is a separate
document. It is not subjected to an independent audit.

B. Accounting treatment for goodwill in Japan

1. The recognition of goodwill

In many ways, Japan is a rather traditional society with a strong cultural and
religious roots. Most recently, American and International dimensions have entered
the Japanese Accounting , envoirement. Cultural change occur in almost single steps.
All of Japan is very business oriented. The accounting profession in Japan is small
and lacks influence in the accounting standard setting, process, but provides
recommendations on the practice application of legal accounting regulations. The
Japanese Institute of Certified Public Accountants was established by law in 1948,
although an earlier body had been in existence since 1927. The AICPA summary of
Japanese accounting (1988) notes that inter corporate purchase are rare in Japan.1
Japanese firms' release little information about goodwill resulting from acquisitions.

Another important factor impacting accounting in Japan is the extensive cross

ownership among Japanese companies. Firms hold equity interests in each other and
generally jointly own other firms. This intercorporate investment yield giant industrial
conglomerates-especially the nine major Japanese trading companies. Banks are
often a part of these industrial groups. Life time employment in a company is still the
order of the day. Japanese workers and managers are "members" of companies.
They do not consider themselves employees.

The Japanese Institute of Certified Public Accountants (JICPA) ISSN organized

and operates much along the line of the American Institute of Certified Public
Accountants. In 1990, the JICPA had approximately eleven thousand members.
About two thousand of these were junior CPA'S.2

In Japan, they used the nature of historical cost based accounting

measurement. Current cost accounting is taboo. Depreciation expense is invariably
measured on a tax basis, this typically understates reported earning of Japanese
corporations.

Consolidated financial statements are now required in Japan even though

significant subsidiaries are excluded. Mergers and acquisitions seldom occur in Japan
and accordingly, no authorative literature exist in this respect. Case by case
treatment prevails with regard to the previously mentioned cross holding among
Japanese corporations, which, for accounting purpose might be regarded as the
equivalent of treasury stock.

The accounting profession in Japan is small and lacks influence in the

accounting standard setting process, but provides reconunendations on the practical
application of the legal accounting regulations. A special interest in the International

1
Colley & Volkan, ibid, p. 345
2
Choi & Mueller, ibid, p. 102

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qspects of accounting regulations appears to be an important motivation for this new
development.

2. The valuation of goodwill

Japanese firms must capitalize and must account for goodwill on a consistent
basis for financial reporting purposes. While acquisitions within Japan may be rare,
Japanese acquisitions of US Firms are increasing.

Goodwill arising from these acquisitions was estimated by reviewing the firms
financial statements prepared for the SEC, Form 20-K, like Sony followed U.S. GAAP.

Although the Japanese may not have addressed the specific question of
goodwill, they are focusing more on US GAAP. The Japanese finance ministry
recently postponed the effort to require "American-style" consolidated financial
statements. As part of the structural impediments initiative talks, the Japanese are
being encouraged to produce statements in conformity with SEC requirements.

In Japan, goodwill, organizational expenses and R & D expenses, and pre

operating expenses must be amortized within five years.

3. The choice of accounting method

Similar to the situation in France, Germany and elsewhere, an i expense is
allowed for tax purposes only if it is fully booked. Goodwill may be written off
immediately against earning in the income statement and a write-off against
reserves is not permitted. Goodwill is also a tax deductible expense .Naturally, this
policy has a very conservative impact on earnings. Thus, the effects of accelerated
intangiable amortization, permissive foreign exchange translation procedures, and
similar other advantageous taxation provisions are utilized for tax and book purposes
alike.

Consolidate financial statements are now required in Japan even hough

significant subsidiaries are excluded. If a company has one more 50 percent plus
owned subsidiaries, it must consolidated the subsidiaries financial statements and
must also use the equity method of measuring investments in other companies
wherein they had 20 to 50 percent of equity. However, if a company does not own
50 percent or more of any other company, the equity method of accounting is not
required.

The lower cost or market measurement typically applies to inventories and

marketable securities. Capitalization of interest eost is not permissible, and inter-
period income tax allocation Seldom occurs due to the congruence between book and
taxable period income. Deferred income tax accounting arises only in connection 'lth
the preparation of consolidated financial statements.

C. Accounting treatment for goodwill in Indonesia

1. The recognition of goodwill

Dutch traditions and practices characterize Indonesia to a significant extent-
with a recent tilt toward the American ways of doing things. Prior to 1970,
Indonesian legal requirements for accounting, auditing, and financial reporting were
few in number, very general in nature, and by and large economically insignificant.
After 1970, the Act on Annual Accounts changed all of that. This Act laid down the
United state basis for accounting systems because the stock market was open for the

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first time in Indonesia. At that time, Indonesia government decided to adopt
American Accounting Standards and translate them to the Indonesian language.
After some modification which related to conditions in Indonesia, America Accounting
Standards (General Accepted Accounting Principles) became Prinsip Akuntansi
Indonesia (PAI) in 1973.

Prior to 1970, there was a virtual absence of legislation on accounting. This

gap was filled by the influenticll Dutch accounting profession, since Indonesia was
influence by tlle Dutch since the World war. Despite the currently fairly detailed
provision of the Prinsip Akkuntansi Indonesia, the over-r.iding criterion is the
application of "Generally Acceptable Accounting Principles," which is more or less
equivalent to the "true and fair view".

There are no legal provisions or authoritative accounting recommendations

regarding business mergers and acquisitions in Indonesia. Goodwill is an intangible
asset which has future benefits and includes patents, copy rights, and Franchises.1

Wit regard to accounting for business combinations, Indonesia practices

permit the use of either the purchase method or the the pooling of interests method.
There is a flexible approach to goodwill similar to the Dutch in that goodwill may
either be written off immediately against reserves or amortized over its useful
economic life.

Company law and the accounting profession are the major influences, and
although the number of companies listed on the stock exchange is relatively small,
there is a tradition of public ownership of shares and an international business
outlook compared to many other continental European countries.

However, the influence of company law has grown steadily since 1970, with
the Act on the Annual Account of Enterprises and the implementation of Prinsip
Akuntansi Indonesia.

2. The valuation of goodwill

According to Prinsip Akuntansi Indonesia (PAI), purchased goodwill should be
amortized over its useful life and has no limited life.2 If the amortization period is
shorter than its useful life, it can be revised for the next period.

Most firms amortize purchased goodwill over five years. The value of goodwill
is equal to expenses which are included in the acquisition of this goodwill.
Management can use judgment to analyze the useful life of this goodwill and
amortize this goodwill over this period. The value of goodwill should be related to
future benefits and decreases in goodwill value can be charged to profit and loss or
written-off immediately if this goodwill already has no future benefit.

The main valuation base in Indonesia is still historical cost. However, and in
fact, intangible assets must be valued at historical cost irrespective of which
valuation basis is adopted for the main account. Depreciation is usually based on the
straight line approach, but each company can choose an alternative depreciation
method with which they are comfortable. For tax purposes, the only depreciation
method that can be used in financial statements is the double declining method.

1
Ikatan Akuntansi Indonesia, Prinsip Akuntansi Indonesia, Rineka Cipta, 1984, p. 29
2
IAI, ibid, p. 35

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3. Choice of accounting method
Companies in Indonesia mainly use full consolidation for controlled
subsidiaries and equity method accounting for entities not fc:ontrolled but having an
equity participation. Proportional consolidation is permissible for joint ventures. By
law, controlled companies can be excluded from consolidation due to goodwill/
negative goodwill paid or received in the acquisition of participating interest.

The taxation treatment in Indonesia is similar to the United states, and United
Kingdom in that taxation rules differ from accounting rules in a number of respects,
giving rise to deferred taxes.

BIBLIOGRAPHY

1. Arthur R Wyatt Phd, Cpa, Critical study of accounting for business

combination, Accounting Reseasrch Study No.5, AICPA 1963.
2. APB No. 17: Intangiable Assets, NY: AICPA
3. APB, 1970. Opin Graw Hill 1994.
4. Accounting Standard Committee. 1990. Exposure Draft6 47: Accounting for
goodwill, London: Institute of Chartered Accountants in England and Wales,
February.
5. Bazley/Nikolai, Intermidiate Accounting, Cincinati OH, College division South-
western Publishing Co, 1990.
6. Dicksee Lawrence R, Tillyard Frank, Goodwill and its treatment in account,
NY, Arno Press, 1976.
7. Fredrick D.S, Choi & Gerhard G Mueller, International Accounting, Mc
Accounting for goodwill, 1984, London: Institute of Chartered Accountant in
England and Wales.
8. FASB, Statement of accounting concept No.5, Stanford, 1975.
9. FASB, Current text Accounting standard, general standard, Homewood,
Illinois 60430, 1991/1992
10. FASB, Current tex accounting standard, industry standard, Homewood
Illinois 60430, 1992/1993
11. George R Catlett & Norman O Olson, Accounting Research study No. 10, NY,
AICPA 1968.
12. Higher, Hugh. P, Goodwill in Accounting : A history of the issues and
problems. College of business administration Georgia State University,
Atlanta, Georgia, 1982.
13. Hastle, S. 1990, "Goodwill are we really making progress?", Accountancy,
October 28.
14. Ikatan Akuntansi Indonesia, Prinsip Akuntansi Indonesia, Reneka Cipta,
1984.
15. J Ron Colley & Ara G Volkan, Accounting for goodwill, from accounting
Horizon, June 1988, AAA, 1988
16. Lee H Radebough & Sidney J Gray, International Accounting and
multinational enterprises, John Wiley & son, Inc 1992.
17. AICPA, Management service technical study No,5. Analysis for purchase or
sale of a business. NY, AICPA 1976
18. Stepehn A Zeff & Bola G Dharan, Reading and notes on financial accounting
issues and controversies, Mc Graw Hill 1994.
19. R.H. Nelson, The momentum theory of goodwill Accounting review
(October 1953), p. 493

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