CHAPTER ONE

INTRODUCTION

1.1

Background of Study

For decades Accounting for goodwill has been a subject of debate in Accounting between accountants, practitioners and within the arena of accounting decision making bodies.

Although these problems seems to have been settled by the Accounting principles Board Opinion 16 & 17 on business mergers and amortizations. In about a century and a half ago, the first definition of goodwill reflected it as the difference between the purchase price and the fair value of an acquired companys assets. This definition has evolved since that time and may be defined in two different ways today. The residuum and the excess profits approach.

In the residuum approach, goodwill is defined as the difference between the purchase price and the fair market value of an acquired company's assets. Goodwill is a leftover amount that cannot be identified, after a thorough investigation, as any other tangible or intangible asset. In the excess profits approach, goodwill is the difference between the combined company's profits over normal earnings for a similar business.

Under this definition, the present value of the projected future excess earnings is determined and recorded as goodwill. (Johnson, Jeannie D. April 93)

Business executives used the name Goodwill in a variety of ways before it became part of accounting terminology. One of the most common meanings of Goodwill in a non-accounting sense concerns the benefits derived from a favourable reputation among customers. To accountants, however, Goodwill has a very specific meaning not necessarily limited to customer relations.

Goodwill, in law and accounting, an intangible asset constituting a value over and above the valuation of the tangible assets of the business, and representing all benefits derived from the distinctive location, trade name, credit rating, reputation, and patronage of the business. On the sale of a business, a charge usually is made for the goodwill as one of the assets. Sometimes goodwill may be sold by itself without the transfer of any other assets; for example, a business that is moving to another locality may sell the right to use its name and to occupy its former premises. (Encarta encyclopaedia standard, 2005)

Historical cost which states that economic resources be recorded in terms of the amounts of money exchanged, when a transaction occurs the exchange price by its nature a measure of the value of the economic resources that are exchanged serves as the cause of misunderstanding, thus it does not reflect the innate worth of a company.

Arriving at a fair value for the Goodwill of a business is a difficult and subjective process. Any estimate of Goodwill is in large part a matter of personal opinion.

In the absence of any definitive accounting standard on goodwill, accounting treatments are likely to be diverse. Among the practices that have been adopted include: y y y Capitalize goodwill as an asset and treat it as a permanent item; Capitalize goodwill as an asset and amortize it systematically in income; Write off goodwill immediately it arises against reserves;

Goodwill shown as a dangling debit against shareholders funds Amortize goodwill through reserves, not necessarily on a systematic basis; and amortize goodwill as an extraordinary item. (Tan 2001)

However studies have indicated that companies in Malaysia frequently adopt the 3 main methods mentioned below; y y y Immediate write-off, Capitalization as a permanent item; and Capitalization with systematic amortization.

The MIA and MACPA took an initiative to formalize an accounting standard on goodwill in 1987. In 1991 they issued a revised joint discussion paper on goodwill accounting proposing that purchased goodwill should be recognized as an asset while inherent goodwill should not be recognized. This paper identified treatment of purchased goodwill as follows:

In 1992, an exposure draft, MAS 6 Accounting for Goodwill, was issued by the two bodies and was intended to make MAS 6 to be a compulsory standard. However, MACPA has deferred the implementation of MAS 6 due to further developments on this contentious subject by the IASC. (Tan, 2001)

[IAS 22.20] also defines Goodwill as the difference between the cost of the acquisition and the acquiring enterprise's share of the fair values of the identifiable assets acquired less liabilities assumed.

Different definitions given to goodwill have given it different treatment in various quarters, firms, companies and industries internationally and Malaysia in particular.

Researcher is therefore conducting this research to analyze the various methods under which companies treat goodwill to suit their financial statements, and to come out with a more preferable method to serve the advantage of all companies to achieve harmonization and uniformity regardless of size of a company.

1.2

Problem Statement

Research is aimed; 1. To identify the various elements, that causes or influence companies to select different accounting treatments for goodwill.

2. It is also to find out the reason companies prefer or select different methods to others in the treatment for goodwill in Malaysia.

1.3.1 Research Questions

Which of these methods: Capitalization as a permanent item, Capitalization and amortization or Immediate write-off is frequently adopted by Malaysia companies and why?

What are the factors that cause the preponderance for companies in Malaysia to adopt different accounting treatment for goodwill?

1.4

Objectives of the Study

The objective of this study is to establish equality and consistency in the treatment of goodwill and to provide Accountants and Stakeholders with a method which will help them to reflect a free and fair view of financial statements globally and Malaysia in particular.

Also to come up with a standard method for goodwill accounting in financial reporting, and to let accountants and practitioners know the impact each method, when selected will have on the financial statement. This is to prevent them from choosing any method as and when they think is appropriate.

1.5

Definition of Terms

The inability of Directors to indicate Goodwill in their financial statements does not help in the maximization of shareholders wealth. Hence the link between write offs and true financial performance.

1.5.1

Purchased Goodwill

Purchased goodwill arises when a business acquires another as a going concern and the combination is accounted for as an acquisition. This includes goodwill arising on consolidation and on the acquisition of an incorporated business.(Tan, 308, 2001)

1.5.2

Positive Purchased Goodwill

IFRS 3 defines positive purchased goodwill thus: Any excess of the cost of the acquisition over the acquirers interest in the fair value of the identifiable assets, liabilities and contingent liabilities acquired as at the date of the exchange transaction should be described as goodwill and recognized as an asset.

1.5.3 Negative Purchased Goodwill.

FRS 10 defines negative purchased goodwill as any aggregate fair values of the identifiable assets and liabilities of the entity exceed the acquisition cost.

IAS 22 also defines negative purchased goodwill as any excess, as at the date of the exchange transaction, of the acquirers interest in the fair values of the identifiable assets and liabilities acquired over the cost of the acquisition.

1.5.4 Non Purchased Goodwill

Inherent goodwill (non-purchased goodwill) can be referred to as, an entity that generates on its own accounts a goodwill by means of hard work , good name , good services and reputation, other than gaining it from acquisition etc. This is not to be recognized in the entitys financial statements.

(Tan 2001) stated that inherent or non-purchased goodwill attributable to businesses are not the subject of an acquisition. All businesses have an element of inherent goodwill in that, as going concerns, they are worth more (positive goodwill) or less (negative goodwill) than the sum of the fair values of their respective separable net assets.

1.6

Scope of Limitation of Study

Due to the fact that researcher is using only secondary data for this study, all information are gathered from search engines, text books mainly relating to accounting treatment of Goodwill, accounting journals and magazines, and state libraries.

Because the study is related the practices in Malaysia all information are gathered within Malaysia.

Information was gathered from the annual reports of a total of 100 companies listed on the main board of the Bursa Malaysia.

The outcome may however differ from various studies conducted by other researchers, because of the difference in the companies selected.

1.7

Organization of Chapters

This dissertation involves 5 main chapters Chapter 1 is the introduction chapter and it consists of background information, research problem, research question, conceptual framework and definition of terms. Chapter 2 is the literature review and will consist of various literatures of researches done on this study, theories and arguments related to this research. Research methodology would be placed in chapter 3. Chapter 4 will emphasize on the analysis and summary of findings. Chapter 5 would be recommendation and conclusion. earlier