Final Output

Nina Rica P. Sabulao

March 2015
Table of Contents

1. Executive Summary 1

1.1 Overview of Goodwill Accounting 1

1.2 Summary of Issues and Recommendation 2

1.3 Acknowledgements 3

2. Background 4

2.1 Certified Public Accountants’ Interest in Accounting for Goodwill 5

2.2 Objectives of this Position Paper 6

2.3 Underlying Assumptions 7

2.4 Features and Benefits of Goodwill 9

2.5 The Need for a Uniform Goodwill Accounting Standard 13

3. Goodwill Accounting Issues 15

3.1 Introduction 15

3.2 Our Reporting Approach 19

3.3 Accounting Issues Addressed in this Position Paper 19

4. Detailed Discussion, Analysis of and Recommendation on Accounting Issues 20

5. Appendices 31

5.1 Available Sources of Accounting Guidance 31

5.2 References 31

1
1. Executive Summary

1.1 Overview of Goodwill Accounting

Amortization of goodwill is not allowed according to IFRS 3. Instead, goodwill

should be tested for impairment periodically. Impairments become the only

method for the subsequent accounting treatment of goodwill.

“But, is the periodic review on impairment the only and best way for subsequent

accounting treatment of goodwill?”

We agree with the legislate point of IFRS 3 that the amortization of goodwill

could distort the financial information, because the periods and patterns in which

economic benefit from goodwill is consumed is hardly estimated.

However, we noted that some companies who perform the impairment test of

goodwill and some researches raise many issues on the subsequent accounting

treatment of goodwill, “impairment test”.

The key points of issues on accounting treatment of goodwill in IFRS 3 that

require only review on impairment are as follows:

1) Various assumptions and estimations used in verifying recoverable amount

may bring up doubt on the reliability in impairment test of goodwill and financial

information. In addition, due to given difficulty in verifying fair value estimates

for goodwill, it is possible that management may use this discretion to avoid or

delay the impairment of goodwill

2) Although goodwill consists of various components, impairment test is

performed as a whole, without considering various components and natures of

2
goodwill. Therefore, impairment of goodwill may not reflect the economic

substance.

3) Generally, impairment of goodwill is influenced by the economic fluctuation.

That is, the risk of impairment of goodwill can be underestimated at the time of

economic expansion while it can be overestimated at the time of economic

recession. Accordingly, it is apprehended that impairment of goodwill expands

volatility of earnings in sympathy with the economic cycle.

There have been a number of disputes regarding the subsequent accounting

treatment of goodwill e.g., amortization or impairment. However it has been

hardly decided which would be superior, because each method has both merit and

demerit.

Generally, goodwill is accounted for as an asset.

1.2 Summary of Issues and Recommendations

Up to date, there are still ongoing debates as to the recognition of goodwill as an

asset. Some argue that goodwill should be limited to the definition of property

because it cannot be controlled by an entity, it cannot be sold independently or

rented, its character cannot be changed, and it cannot independently generate rent

in contrast to the definition of an asset(right) which states that “assets are

resources controlled by the entity…” and that right of ownership includes the

right to use an article, to change its character, transfer some or all of the property

rights to others through sale or rental and to share in profits or losses from its use

3
 (Furuboton and Pejovich 19721). Even so, goodwill is still considered a specific

intangible asset, an intellectual capital, because it is expected to result into an

inflow of resources into the entity embodying economic benefits.

Another point given consideration in this paper is the subsequent valuation of

goodwill. Countries around the globe have differing approach regarding this topic,

depending on the standards they have adopted. Countries like Canada and

Australia have the choice between amortization or impairment because they are

following US GAAP. The Philippines, on the other hand, can only exercise the

impairment of goodwill as goodwill amortization has been prohibited as per 2013

IFRS update.

1.3 Acknowledgement

Short as this paper may be, this sure was made not lacking of attention and gusto.

This paper would’ve remained abstract if not for the help and encouragement of

the wonderful people around her. Her heartfelt thanks to:

Glenda Buena- Tupaz, for the input on the basics of paper writing;

Her instructor, Timoleon S. Lianza, MM, CPA, for giving her yet another

unforgettable experience with cramming and deadlines, and of course the chance

to search for new horizons and learn new things;

Her parents, for unfailingly supporting her in all her ventures;

And God Almighty, for guiding her all throughout this journey.

1
Furuboton, E. and S. Pejovich. 1972. “Property rights and economic theory: a survey of recent
literature,” The Journal of Economic Literature. Vol. X No.4 Dec. 1137-1162.
4
 2. Background

The first printed article about goodwill was published in the year 1884 by Harriss

(1884) although its term and concept can be traced to the manorial times. The first

debate for the accounting of goodwill was started in 1891 by Francis More1

and since then, it has not ceased. The debate on accounting for goodwill is one of

the longest running debates in accounting history (Hughes, 1982). International

accounting standard board (hereinafter “IASB”) has been issuing new

interpretations continuously in an effort to improve the quality of financial

information. The manifestations of this undertaking would be IFRS 3 and IAS 36.

This new interpretations changed the subsequent accounting treatment of

goodwill significantly by not allowing the amortization of goodwill instead,

subjecting goodwill for impairment annually. IASB took away the amortization of

goodwill from the subsequent accounting treatment of goodwill,because it

believes that the amortization of goodwill could trigger arbitrary accounting.

IASB believes the removal of this arbitrary accounting could improve the quality

of accounting information of goodwill- which was doubted by recent empirical

studies.2

2.1 Certified Public Accountants' Interest in Accounting for Goodwill

2
“Proposal of Alternatives for Goodwill Accounting.”IFRS 19Jan.2015.
<http://www.ifrs.org/Theorganisation/Advisorybodies/EEG/Documents/AP2%20Accoun
ting%20 for%20Goodwill.pdf>

5
 It is probably because of its abstract nature that goodwill is considered as one of

the most difficult accounts to deal with. All throughout the 20th century

accountants have tried to promote a shared vision of accounting- partly codified in

principles or accounting frameworks- in order to reconcile the conflicting

interests of different stakeholders. There is yet to be promulgated a standard that

will minimize, if not eliminate issues concerning the accounting for goodwill.

What makes this an issue of interest, is not only the disparity in its accounting,

but that which concerns goodwill being used as a device in committing fraud as in

the case of Caterpillar, Inc., which paid for goodwill in the amount of $580

million to acquire ERA Mining Machinery Limited (ERA) and later found out

that goodwill did not even exist.3

CPAs acknowledge “the need for reliable and supportable goodwill analysis and

disclosure…while regions and countries are at different stages of maturity with

respect to valuation, goodwill impairment accounting, and auditing practices,

more can be done” (Forsythe, 2014). More than just the need to reconcile

accounting and cross- border accounting differences for goodwill is the need to

intensify CPAs knowledge about goodwill accounting to avoid incidents similar

to Caterpillar, Inc., where inadequate understanding of goodwill translates to

being preyed on and a victim of fraud.

2.2. Objectives of this Position Paper

3
Selling, Tom.”Caterpillar: Another Sad Example of Bad Goodwill Accounting.”Accounting Onion.
Feb.2013.19Jan.2015.<http://accountingonion.com/2013/02/caterpillar-another-unfortunate-case-
of-bad-goodwill- accounting.html>

6
The main objective of this position paper is to rediscover goodwill. This position

paper is designed to present the history, current status and issues surrounding

the accounting for goodwill in the most comprehensive manner. This paper

will start by introducing the first published book about goodwill and trace its

subsequent development. The discussions will talk largely about the following:

 First printed material about goodwill

 Its early definitions

 How it was recognized as an asset

 Present comparisons between internally generated and purchased goodwill

 Accounting for internally generated goodwill

 Accounting for purchased goodwill

 Explain why cross-border differences in goodwill accounting exist

 Discuss point of advantages and disadvantages between goodwill

amortization and impairment

After a thorough discussion on the abovementioned topics, the researcher ensures

that any interested party who looks into the matter will gain a better

understanding of the complex nature of goodwill and be able to form a conclusion

on whether to amortize or impair goodwill.

2.3 Underlying Assumptions

7
 Support

GAAP

Illustration 1. Standard Setting Process4

A large number of stakeholders influence the standard setting process. In this

paper, the interpretation is focused on the influence of underlying assumptions on

alternative proposals. The hypothesis is that theoretical support provided by

accounting principle is the key element in the credibility of alternative proposals.

Their likeliness to be accepted does not only depend upon stakeholders (social

actors) in an institutionalized process but also on their accordance with

underlying theories as investigated in this paper.

In the field of goodwill issues, acquired goodwill is probably the most

representative because of its longevity. Debates about internally generated

goodwill and intangibles also reveal different views of accounting but they are

usually considered as a margin of a central goodwill issue. There is, as proposed

by Clemence Garcia (2007), a simplified classification for accounting of

purchased goodwill.

To what information should accounting give priority?

4
Garcia, Clemencia. How Accounting for Goodwill Relies on Underlying Assumptios; A Historical Approach.
Tokyo, Japan. 2007
8
 ASSUMPTIONS FLOWS (P/L) STOCKS (B/S)
Does ASSET Valuation at cost Market Value
Goodwill (Less Conservative) Amortization over Useful life No Amortization
NOT ASSET Valuation at cost Liquidation Value
Meet the
(More Conservative) Immediate write-off against Rapid Expensing
Definitio
reserve
n of an
Asset?
Illustration 2. Classification of Accounting for Purchased Goodwill5

Two basic assumptions were used to distinguish the different treatments of

goodwill. The first one is whether accounting should be primarily focused on the

representation of flows- annual income- or the representation of the stock- net

worth. From these basic views derive the two usual acceptations of goodwill as

mentioned above: an excess earning power. The second one is whether goodwill

meets or not the definition of an asset.

In short, this classification provides a framework to analyze the four alternatives

usually mentioned in accounting literature(Ding et al., 2005):

Alternative 1: Recognition as an asset at cost and amortization over useful life

Alternative 2: No recognition as an asset or immediate write-off against reserve

Alternative 3`: Recognition as an asset and permanent retention in the balance

sheet, possible adjustment of value

Alternative 4: Immediate or Rapid Expensing6

2.4 Features and Benefits of Goodwill

5
Ding, Y., J. Richard and H. Stolowy (2005). “Accounting Regulation and Social Actors: An International
Study Goodwill”, Working Paper, CEREG, Universite Paris Dauphine.

6
Garcia, Clemencia. How Accounting for goodwillrelies on Underlying Assumptions: A Historical Approach.
Tokyo,Japan,2007.
9
 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.7

Many accounting theoreticians8 have tried to define and standardize the concept

of goodwill accounting, but until today, the approach used still differ from one

country to another. Perhaps the one constant in all definitions and discussions of

goodwill is that it is classified as intangible, rather than tangible. As discussed in

the article “Accounting Treatment of Goodwill: Yesterday, Todayand Tomorrow”

(Seetharaman, Balachandran, Saravanan), USA, Canada, Australia and UK treat

goodwill differently.

USA. The goodwill issue was being debated in the American literature and courts
in the early 1900s. However, the first official pronouncement by the American
accounting profession was only release on December 1944. The Accounting
Research Bulletin No. 24 (Committee on Accounting Procedure, 1944) adopted a
traditional historical approach to the intangible, including goodwill,
establishing costs as the valuation basis. In those days, internally generated goodwill
wasnot discussed. The Bulletin recognised two types of purchased
goodwill. It recommended that goodwill with a limited term of existence be
amortised systematically to income. If there is no indication on the limited term,
then goodwill will either be retained at cost until evidence indicated limited
existence, or amortised to income on some systematic basis. Another way of
treating goodwill is to write-off the goodwill against capital immediately.
7
"Goodwill." Microsoft® Student 2009 [DVD]. Redmond, WA: Microsoft Corporation, 2008.
8
Among others, Bithell 1882, Hughes 1882, Yang 1927.
10
 However, this approach was not recommended by the Bulletin although that it is
permitted on the ground that the practice had been long established and widely
approved (Committee on Accounting Procedure,1944). In 1953, the ARB No. 43
Restatement and Revision of Accounting Research Bulletins (Committee on
Accounting Procedure, 1953) prohibited the option of immediate write-off of
goodwill against capital. In August 1970, the Accounting Principles
Board (APB) of the American Institute of Certified Practicing Accountants released
APB Opinions 16 Business Combinations(APB, 1970a) and 17 Intangible Assets
(APB, 1970b). Opinion No. 17, operative in respect of intangible assets
including goodwill acquired after 31 October 1970, retains the traditional
historic posture adopted in ARB No.24. Purchased goodwill is to be recorded at
cost with the amount to be calculated by reference to the fair value of the
identifiable net assets acquired and the fair value of the purchase consideration.
The purchase consideration may be measured either “by the fair value of the
consideration given or the fair value of the property acquired whichever is
the more clearly evident.” Opinion No. 17 requires purchased goodwill to be
capitalised and amortised against income over a maximum period of 40 years.
The immediate write-off of goodwill in the year of acquisition is specifically
prohibited, as is the recognition of internally generated goodwill.

Canada. The Canadians followed the Americans and in December 1973 the
Canadian Institute of Chartered Accountants (CICA) issued CICA Section 1580
“Business Combinations” to apply from 3 March 1974. This document based on
the ED (CICA, 1973) issued a year earlier, is very similar to the US
pronouncement in requiring purchased goodwill to be capitalised and amortised
over a period of 40 years. However, the Canadian document is silent on the issue
of internally generated goodwill.

New Zealand. Statement of Standard Accounting Practice No. 8 (SSAP 8)

Consolidated Financial Statements (New Zealand Society of Accountants, 1978)
was issued by the New Zealand Society of Accountants in August 1978. The
statement required that under the purchase method of accounting for business
combinations the cost of purchase be recorded at the fair value of the
consideration given and any excess of the cost of purchase over the fair
values of the net assets be recorded as goodwill. SSAP 8 did not require to amortise
goodwill. Goodwill was required to be shown as an intangible asset in the
balance sheet to the extent that it had not been amortised or written down. In
addition the unamortised portion of goodwill was to be written down where
there had been a permanent impairment in value. SSAP 8 and SSAP 2 Accounting
for Associated Companies [Equity Accounting] were subsequently
replaced by SSAP 8 Accounting for Business Combinations issued in October

11
1987 to apply from 1 January 1988. One of the major changes from the earlier SSAP 8
is the requirement that goodwill be amortised to the profit and loss over the period of
expected benefit. No maximum amortisation period is specified in the standard.
However in the discussion paper, it states that the period over which goodwill
should be amortised “would be unlikely to exceed ten years and should in no case
exceed 20 years”.

Australia. In Australia, as in other parts of the world, a variety of accounting

practices were used to account for goodwill in the absence of an accounting
standard. This is evidenced by studies specifically related to goodwill on
consolidation, undertaken by Gibson and Francis (1975) and Goodwin (1986),
and other general surveys of financial reporting practices conducted by Standish
(1972) and Ryan and Tibbits (1996). The goodwill project was placedon the
Australian Accounting Research Foundation (AARF) agenda in late 1977 and in
December of that year a goodwill discussion paper was commissioned. The
AARF received the first draft of the paper from Ernst and Whinney in August
1978 and a revised paper in May 1980. The first goodwill exposure draft was
issued selectively by the Accounting Standards Board of the AARF 13 months
later, and in May 1983, five-and-a-half years after the commencement of
the goodwill project, the amended draft was issued for public comment. Statement of
Accounting Standards AAS 18 Accounting for Goodwill (Australian Accounting
Bodies, 1984) was issued by the Australian Accounting Bodies in March 1984 to
apply from 31 March 1985. AAS18 requires that purchased goodwill, measured
as the excess of the purchase consideration over the fair values of theidentifiable
net assets acquired, be recognised as an asset, and systematically amortised
over a maximum period of 20 years. The amortisation of goodwill through the
profit and loss is consistent with the all-inclusive concept of income which was
adopted in AAS1 in an attempt to eliminate the practice of writing off items such
as goodwill against reserves or retained profits.

UK. A discussion paper Accounting for Goodwill (ASC, 1980) issued by the UK
Accounting Standards Committee (ASC) in June 1980 suggested that
purchased goodwill be systematically written off over its useful life. Reactions to
the discussion paper was mixed. The method used widely at the time was to
write off in the year of acquisition. However, strong support was also shown for
the capitalisation / amortisation approach. ED30 Accounting for Goodwill issued
in October 1982 allowed companies either to write off goodwill in the year of
acquisition, or capitalize and amortise goodwill over a recommended period of
20 years or less. The recognition of internally generated goodwill was not
permitted. Statement of Standard Accounting Practice No. 22, SSAP 22,
Accounting for Goodwill was issued in December 1984. Although permitting the

12
 amortization of goodwill over its useful economic life, the statement
recommends the direct write off of goodwill against reserves. This
recommendation is justified on the basis that the treatment is consistent with
not recognising internally generated goodwill. International. The
International Accounting Standards Committee was founded in June 1973 to
foster the improvement and world-wide harmonization of accountingregulation,
standards and procedures. In September 1981, the Committee issued ED22
Accounting for Business Combinations (International Accounting Standards
Committee, 1981). The exposure draft recommended that goodwill arising on
acquisition, defined as the excess of the purchase price over the assigned
values of the net identifiable assets acquired, be amortised to income on a
systematic basis over its useful life. However, International Accounting
Standard 22 (IAS 22) Accounting for Business Combinations
(International Accounting Standards Committee, 1983), published in November 1983
reflects the current international disharmony of goodwill accounting
regulation. The Standard allows any difference between the cost of acquisition
and the fair value of net identifiable assets acquired to be either recognised as an
asset and amortised to income on a systematic basis over its useful life, or
immediately adjusted against shareholders interests. IAS 22 does not indicate a
preferred approach. However, there are moves to amend this standard by the
International Accounting Standards Committee in 1989.

According to Grinyer et al (1990) “...a root cause of apparent confusion

concerning the treatment of goodwill, as in many other accounting matters, arises

because of a failure to identify what the accounts are trying to measure and the

purpose that they serve.”

The increasing number of business combinations has made goodwill a subject of

great importance. The large differences between the purchase consideration paid

in acquiring a business and the fair value of the net tangible assets acquired

which give rise to so called goodwill lead to a great difficulty and differences in

opinions among the accountants in accounting for the "item". However, most

accountants have agreed that goodwill because of its intangible and vague nature

should be excluded from the balance sheet unless it has been purchased.
13
2.5 The Need for a Uniform Goodwill Accounting Standard

The problem with having two permitted standard in the accounting for goodwill is

that it results to lack of comparability between accounts, thereby undermining

the fundamental purpose of the standard. As a minimum, if two methods were to

be permitted, a few respondents recommended that clear guidelines should be laid

down as to which method should be used under what circumstances.

The accounting method for goodwill is so flexible that interested parties

sometimes tend to question on the validity of this flexibility, particularly on the

terms of attaining comparability of financial statements. This resulted in abused

goodwill accounting, which is the “polluted purchase” (Kam, 1990) employed

for business combinations. Many companies used the lower book values of net

assets instead of using the fair values of the net assets acquired in the allocation of

the purchase consideration, resulting in large balancing goodwill figure. This

enables the corporation to lower its depreciation charges and the absence of

goodwill amortisation. The basic problems in both the treatment of the accounting

for goodwill is that using the immediate write-off method, could adversely

deplete the equity base of the reporting entity, thereby distorting its gearing

position. The amortisation method on the other side would severely reduce the

reported profits and earnings per share, in which they are the important market

indicators for the companies.

“…Dealing with inconsistencies from market to market can be even more

perplexing especially for publicly traded markets. Whatever the situation,

14
 companies operating across the global economy continue to face the challenge of

differing application of valuation methodologies and accounting principles

regarding goodwill accounting.”9This topic is more than just accounting

differences. As indicated in its Public Statement, ESMA “would like to stress the

need for transparency and the importance of appropriate and consistent

application of the recognition, measurement, and disclosure principles provided

for in IFRS in order to ensure the proper functioning of financial markets.”10

3. Accounting Issues

3.1 Introduction

The most comprehensive review of the long and complex history of goodwill

examined in the research process was compiled by Hughes11. A part of the

foreword of his book reads:

When I first began this project in 1969, I believed that I would come up with the
intrinsic nature of goodwill - maybe even define the asset for all time. Perhaps all
of those writers were arguing and struggling toward some unforeseen Truth, and
it was for me to chart the direction, extract the essence of their works, and obtain
the ultimate answer that maybe all were moving unconsciously toward. My own
personal exuberant and intellectual Charge of the Light Brigade was rewarded

9
Forsythe, Greg.”The Goodwill Impairment Dilemma: What happens when US GAAP and IFRSs
Clash?”Deloitte Development LLC.2013.Pg3.
10
"European common enforcement priorities for 2012 financial statements," European Securities and
Markets +Authority Public Statement 725, p1, November 12, 2012.
11
Hughes (1982)
15
 with frustration, disappointment, and – finally - relief. I at last came to accept
fully that all of those unfortunate souls who
struggled with goodwill's nature and treatment did so, not in some possibly great
movement toward Truth, but because there was no one Truth and never will be.
The origin of goodwill can be revealed through history, but its nature is a matter
of personal interpretation.12

The notion of goodwill as a residual amount is well established. For example, the

glossary of the IASC defines goodwill, in the context of an acquisition, as ‘any

excess of the cost of the acquisition over the acquirer’s interest in the fair value of

the identifiable assets and liabilities acquired as at the date of the exchange

transaction’. Thus, goodwill is defined, not in terms of its attributes, but in terms

of the calculation by which its supposed “worth” is established.

The UK definition contained in FRS 10: “Goodwill and Intangible Assets” (“FRS

10”) is

similar. Purchased goodwill is ‘the difference between the cost of an acquired

entity and the aggregate of the fair values of that entity’s identifiable assets and

liabilities.’ In this definition, it is almost implied that the calculation brings

goodwill into existence.

The business world of the 20th and 21st centuries is one that has become more

and more susceptible to mergers and acquisitions. As a result of the industrial

revolution, and the more recent technological revolution, some firms were, and

continue to be, able to gain the competitive advantage over competitors, leading

to their acquisition (Hughes 16). With the increase of business acquisitions, there

was a need to reexamine old accounting principles in order for the transactions to
12
Hughes, Hugh P. Goodwill in Accounting: a History of the Issues and Problems. Atlanta: Business Pub.
Division, College of Business Administration, Georgia State University, 1982. Print.
16
 be properly recorded; this accounting is known as goodwill accounting. Goodwill

accounting has undergone recent revision by the FASB, specifically in the area of

goodwill impairment. Without proper accounting for goodwill impairment,

several firms would have the ability to overstate their net earnings and destroy the

reliability of the financial statements in the eyes of investors. To understand the

history and need for goodwill accounting and impairment, one must start with a

definition of the concept. According to the Intermediate Accounting text by Stice,

“goodwill is best thought of as a residual amount, the amount of the purchase

prices of a business that is left over after all other tangible and intangible assets

have been identified (Stice 577).”13 This definition dictates that goodwill is

another intangible asset that accounts for the business working as a whole

compared to the individual components. Another definition of goodwill as

provided by Hughes states that, “goodwill may be thought of as the differential

ability of one business, in comparison with another or an assumed average firm,

to make a profit (Hughes 7).” These definitions are, in short, describing the

presence of a synergy that a business possesses which allows it to earn more

extensive profits compared to another.

The need for revised accounting for acquisitions and business combinations arose

in 1970 in response to an outbreak of acquisitions during the 60’s (Davis) 14.

Initially, there were two methods for this accounting known as the pooling of

interest method and the purchase method. The first of these basically combined
13
Stice, Earl K., James D. Stice, and K. Fred Skousen. Intermediate Accounting. 17th ed. Mason: South-
Western Cengage Learning, 2010. Print.
14
Davis, Michael. "Goodwill Accounting: Time for an Overhaul." Journal of Accountancy 173 (1992).
Questia. 1992. Web. 27 Nov. 2011. <http://www.questia.com/googleScholar.qst?
docId=5000139844>.
17
the ledgers of the two companies. The latter method required all assets to be

recorded on the books at their fair values as of the acquisition date. This purchase

method often inflated some of the assets because fair value was often greater than

book value; this discrepancy led to inflated depreciation and amortization charges

which reduced a company’s retained earnings. In 2001, Statement No. 141 was

issued by the FASB, eliminating the use of the pooling method. This was only

able to pass because the FASB worked to compromise with businesses on the

amortization issues with goodwill; the resulting compromise came to be known as

goodwill impairment (Stice 577).

While different standard setting bodies have lack of correspondence as to the

recognition and subsequent valuation of goodwill, they are in consensus as to the

treatment of internally generated and purchased goodwill. According to FRS 10,

Goodwill and Intangibles, on initial recognition “Purchased goodwill and

intangible assets should be capitalized as assets. Internally generated goodwill

should not be capitalized and internally generated intangible assets should be

capitalized only where they have a readily ascertainable market value.”

Developed goodwill is that goodwill which is generated internally because of

good name, capable staff and personnel, superior quality of products, favorable

location and high credit standing. PAS 38, paragraph 48, explicitly provides that

internally generated goodwill shall not be recognized as an asset. Purchased

goodwill, on the other hand, is the one that is paid for and arises when a business

is acquired.

If the purchase price or consideration transferred is less than the net amount of the

18
 identifiable assets acquired and liabilities assumed, the difference is negative

goodwill. PFRS 3, paragraph 34, provides that such negative goodwill is

recognized in profit or loss as “gain on bargain purchase”. The standard has

already dropped the term negative goodwill.15

3.2 Reporting Approach

For a clearer interpretation and easier understanding, this paper utilized the

traditional reporting approach. Issues were discussed and analyzed thoroughly

before recommendations were formulated. Given the sensitivity of the issue,

parallel and contradicting views were critically reviewed so as to be precise with

the findings and give appropriate recommendations. Each pros and cons were

given consideration and attention thus coming up with a sound interpretation and

judgment.

3.3 Accounting Issues Addressed in this Position Paper

Below are the two major accounting issues addressed in this position paper.

Issue 1: Is goodwill really an asset?

Issue 2: Should goodwill be subjected to amortization or impairment?

15
Valix, Conrado and Christian Aris Valix. Theory of Accounts Vol.1. 2019 C.M. Recto, Manila, Philippines:
GIC ENTERPRISES & CO., INC. 2012
19
 These two issues are the most debated in the field of goodwill accounting, all

other topics such as the nature and definition of goodwill, internally generated,

purchased and negative goodwill have been discussed in Chapter 3.1

(Introduction) of this paper.

4. Detailed Discussion, Analysis of and Recommendation on Accounting Issues

Issue 1: Is goodwill really an asset?

Is goodwill a plug figure or does it represent unrecorded value? Research has

focused on whether the value of goodwill is reflected in market capitalization.

However, from an economic perspective goodwill is an asset only if it generates

rent.

To test whether goodwill is an asset, return on assets is analyzed by industry for

companies with and without goodwill over a ten year period. In most industries,

companies with goodwill performed as well as those without it.

Goodwill is the difference between the purchase price of a company and the fair

value of its assets. This difference is booked as an asset under authority of

Financial Accounting Standards Board (FASB) Statement of Accounting Standard

(SFAS) No. 141 Business Combinations (2001).16

16
Accounting Principals Board (APB) Opinion No. 16. 1970. “Business Combinations”
20
 Some argue that assets should be limited to the definition of property (Fisher

190617; Samuelson 1996).18 From a legal prospective, property is a bundle of

rights. A right of ownership includes the right to use an article, to change its

character, transfer some or all of the property rights to others through sale or

rental and to share in profits or losses from its use (Furuboton and Pejovich

197219). Goodwill cannot be sold independently or rented, its character cannot be

changed, and it cannot independently generate rent. It might be true that an entity

can not control goodwill, it can at least control the factors affecting goodwill such

as upholding the reputation of the company and continuous monitoring of the

quality of products and services that it provides.

On the other hand, goodwill has not been universally recognized as an asset.

Accounting Research Study No. 10, “Accounting for Goodwill” (1968) suggests

that goodwill should be immediately written off. The argument is that goodwill is

simply the result of the subjective evaluation of purchasers, and such subjective

evaluations can vary widely. For example, the offer price of a firm can rise

dramatically when there are two or three bidders (Johnson and Petrone 198820)

In theory, goodwill is more like intellectual capital than it is like physical assets.

Since some industries, like coal mining, rely more on physical assets than other

industries, such as business services, it is possible that goodwill generates rent in

some industries and not in others.

17
Fisher, I. 1906. The Nature of Capital and Income. New York: Reprints of Economic Classics, Augustus M.
Kelley, Publisher.
18
Samuelson, R. A. 1996. “The concept of assets in accounting theory,” Accounting Horizons. Sept. Vol.10
Iss.3. 147-157.
19
Furuboton, E. and S. Pejovich. 1972. “Property rights and economic theory: a survey of recent
literature,” The Journal of Economic Literature. Vol. X No.4 Dec. 1137-1162.
20
Johnson, T. L. and K. R. Petrone. 1998. “Is goodwill an asset?” Accounting Horizons Sept. 1998 Vol. 12
Iss. 3. 293- 304.
21
 The Coal, Gold, and Smoke industries were eliminated from the study because,

over a ten year period, they had less than twenty years of operations with

goodwill, the minimum number deemed necessary to draw statistically reliable

conclusions. Of the remaining forty five industries(number of industries subjected

to the research), companies without goodwill outperformed companies with

goodwill in six industries on a statistically significant basis. Such findings tend to

support the notion that goodwill is simply a plug figure rather than an asset as

claimed by the FASB. However, in twenty one industries, there was no

statistically significant difference in the performance of companies with and

without goodwill. This finding tends to support the assumption underlying SFAS

141 (2001)21 that goodwill represents intellectual capital not captured by

traditional accounting means, but which is recognized in the price acquiring

companies pay for a target firm. The more surprising finding is that companies

with goodwill outperformed those without goodwill in eighteen of forty five

industries. This indicates that goodwill provides a return superior to that of

traditional assets in many industries and is consistent with the argument of Barber

and Strack (2005)22 that performance depends more on people than assets.

The answer to research question of whether there is a difference in the rent

generating power of high goodwill companies and companies without goodwill on

an industry by industry basis, is that there is a statistically significant difference.

However, the fact that thirty two of the thirty eight industries with high goodwill

performed as well as or better than companies without goodwill tends to refute the
21
“Statement of Financial Accounting Standards No. 141 Business Combinations,” (SFAS 141) Financial
Accounting Standards Board. June 2001
22
Barber, F. and R. Strack. Harvard Business Review June 2005, Vol.83. Iss. 6. 80-91.
22
 theory that goodwill is simply a plug number and not a rent generating asset.

The results of this study broadly support the implicit assumption underlying

FASB 141 (2001) that goodwill is a rent generating asset. While this assumption

is not supported for every industry it is supported in thirty nine of the forty five

industries in this study or about 87%. To determine whether this phenomenon was

the result of comparing firms with no goodwill to those with slightly more than

one percent goodwill, a second analysis was done to compare the performance of

companies with no goodwill to those with high goodwill, that is 20% or more of

their assets in goodwill. The data show that companies with high goodwill

generate rent on total assets at least as great as that of no goodwill companies in

thirty two of thirty eight industries or about 84%.

Issue 2: Should goodwill be subjected to amortization or impairment?

For many years, goodwill was accounted for similarly to other intangible assets. A

company would estimate the useful life of the goodwill it incurred, which could

be as much as 40 years, and would amortize the goodwill over the estimated life.

In June of 200 l, the Financial Accounting Standards Board (FASB) issued SFAS

14223. This new statement on Accounting for Goodwill and Other Intangibles no

longer allows companies to amortize their goodwill. Companies are now required

to test goodwill on an annual basis for impairment. Impairment tests are familiar

to the accounting industry. They are used for the write-downs of accounts

receivable to net realizable value, of inventory to lower of cost or market value, of

23
Dennis, M. C. (2003, January). More new accounting rules--FASB 142. Business Credit, 105, 56-57.
Retrieved November 28, 2003, from the ABIINFORM database.
23
 property plant and equipment to

current market value (Massoud and Raibom, 2003) 24. Other intangible assets that

are determined to have a finite useful life will continue to be amortized. The new

accounting approach for goodwill is a two-step process. In the first step, a

company must estimate the fair value of the reporting unit that the goodwill is

attached to and then compare the fair value to the carrying value (including the

goodwill) of that reporting unit. If the fair value is greater than the carrying value,

then goodwill is not impaired and should not be reduced. Companies are not

allowed to record a gain to goodwill if the fair value is determined to be greater

than the carrying value. If the fair value is less than the carrying value, then the

company must continue to the second step. In the second step, a company would

apply the fair value it had calculated to the assets and liabilities of the reporting

unit. The remaining balance of the fair value is the new value of goodwill and the

carrying value of goodwill should be reduced to the new value. Initial impairment

charges in December 2001 and in 2002 could be reported as extraordinary losses,

however impairment charges in subsequent periods should be recorded as an

operating expense. The impairment test may be performed at any time during the

year, so long as date is consistent from year to year. Additionally, companies must

perform an interim test if a triggering event occurs. Examples of triggering events

include market decline, regulatory action, new competition or a loss of key

personnel (Moehrle and Reynolds-Moehrle, 2001)25. Companies will also have to

perform an interim measurement if they plan on selling or disposing of a reporting

24
Massoud, M. F., & Raiborn, C. A. (2003, April I). Accounting for goodwill: Are we better off. Review of
Business, 26, 26-32. Retrieved November 28, 2003, from the ABIINFORM database.

24
 unit or a material portion of one. Goodwill cannot have a fair market value as a

stand alone asset because it represents an intangible value created by a

combination of other tangible and identifiable intangible assets. Because of the

nature of goodwill, the definition of a reporting unit is vital to assessing its value.

A reporting unit is described as the level of a business that management reviews

and assesses as a separate segment. Reporting units can be distinct business lines,

geographic segments, or even the company as a whole if no reporting unit exists

(Moehrle and Reynolds-Moehrle, 200126). A company can also use a level of

operation within the reporting unit if financial data of the functions of that level

are available.

FAS 142 radically changes the accounting for goodwill and related intangible

assets that are deemed to have ‘indefinite’ lives. It eliminates the periodic

amortization over an estimated life not to exceed 40 years, and instead institutes a

periodic impairment test. FAS 142 embodies the FASB’s march toward ‘fair

value’ accounting, whereby management are charged with recording periodic

changes in the fair values of operating assets rather than trying to systematically

match the cost of such assets to the benefits that they are expected to generate.

The FASB claims that the new standard “improves financial reporting because the

financial statements of entities that acquire goodwill and other intangible assets

will better reflect the underlying economics of those assets” (FAS 142, p7).

25
Moehrle, S. R., & Reynolds-Moehrle, J. A. (2001, September). Say good-bye to pooling and goodwill
amortization. Journal of Accountancy, 192, 3 t-38. Retrieved November 28, 2003, from the
ABIINFORM database.
26
Moehrle, S. R., & Reynolds-Moehrle, J. A. (2001, September). Say good-bye to pooling and goodwill
amortization. Journal of Accountancy, 192, 3 t-38. Retrieved November 28, 2003, from the
ABIINFORM database.
25
Assuming that management make unbiased forecasts of the future benefits from

intangible assets and incorporate these forecasts into impairment estimates on a

timely basis, the standard would achieve its intended objective. However, such

improvements hinge critically on the role of management in recording impairment

charges on a timely basis. Given the inherent unverifiability of fair values for

intangibles and management’s incentives to inflate assets and earnings, it is

possible that management will use this new discretion to delay impairments

(Watts, 2003; Ramanna, 2008; Ramanna and Watts, 2009). If this were the case,

FAS 142 would simply result in the aggressive application of historical cost

accounting, whereby assets are initially capitalized at cost and then only written

down in the face of overwhelming evidence of impairment. Such accounting

causes the initial overstatement of assets and earnings, and the later

understatement of earnings when the aggressive accounting is reversed through

large and untimely ‘big bath’ impairments. Moreover, it is possible that investors

could temporarily overvalue companies with inflated asset balances, leading to

poor resource allocation and lower returns to investors. A recent report from Bear,

Stearns & Co. indicates that the transition from goodwill amortization to the new

SFAS 142 rules may take up to 21 months and may cause considerable market

confusion in the meantime.

The evidence indicates that the application of goodwill accounting under FAS 142

produces accounting numbers that deviate from economic reality and results in

the delayed recognition and pricing of declines in the fair value of goodwill. If

management is able to estimate the timing and magnitude of future cash flows

26
 associated with goodwill, then goodwill impairments should be relatively large

during periods when the cash flows generated are relatively high, suggesting that

goodwill impairments should be greatest when pre-impairment margins are

relatively high. The evidence instead suggests that management only take

impairments once it becomes obvious that significant benefits from the goodwill

have expired. We note that this evidence is inconsistent with the stated objective

of FAS 142 in providing better information about goodwill. For the accounting to

provide better information, it is critical that management can forecast the future

benefits and match the impairments to the expiration of the benefits. Instead, our

evidence suggests that management only report impairments after it is obvious

that most of the benefits have expired. This results in systematically overstated

goodwill and earnings in the periods following acquisitions.

Consequently, firms with deteriorating operating performance and overstated

goodwill have temporarily inflated stock prices. Collectively, this evidence

suggests that the goodwill impairments contain little new information and that

management use the discretion afforded by FAS 142 to delay the recognition and

pricing of declines in the fair value of goodwill. This is inconsistent with FASB’s

claim that FAS 142 will provide users of financial statements “with a better

understanding of the expectations about and changes in [goodwill and intangible

assets] over time, thereby improving their ability to assess future profitability and

cash flows” (FAS 142, p.7)27.

27
Financial Accounting Standards Board (2001B). “Goodwill and Other Intangible Assets”, Statement of
Financial Accounting Standards No. 142, Norwalk: Financial Accounting Standards Board.
27
There have been a number of disputes regarding the subsequent accounting

treatment of goodwill e.g., amortization or impairment. However it has been

hardly decided which would be superior, because each method has both merit and

demerit.

Dennis J. Chamber argued in his empirical studies in 2007 that either permitting

both impairment and amortization in parallel or liberal choice for companies to

select their own accounting treatment for goodwill considering their own

characteristics could enhance the quality of accounting information rather than

using only one accounting treatment between impairment and amortization.

It may seem to be early to determine whether IASB’s objective has been achieved

to improve quality of accounting information as of now, especially, at a point that

a new accounting treatment for goodwill has been implemented just 10 years ago.

Especially, it has been only 2 years for Korea to adopt this new accounting

treatment.

The researcher, on the other hand, believes that the goodwill accounting as laid

down by IFRS is more appropriate as it is in accordance with the matching

principle, holding true the presumption that businessmen, especially accountants,

uphold the values of honesty and integrity.

Presented on the next page is the chronology of requirements for goodwill

accounting.

28
 Year Category Key Developments
1970 U.S. GAAP The APB issued Opinion No. 17, which required the
amortisation of goodwill over a period not exceeding 40
years.

1983 IASs The IASC issued IAS 22 Business Combinations, which

permitted systematic amortisation of acquired goodwill
over its useful life not exceeding 20 years while also
allowed goodwill to be immediately charged to equity on
the acquisition date.

1993 IASs The IASB revised IAS 22, to eliminate the option to
immediately charge acquired goodwill to equity on the
acquisition date.

1999 U.S. GAAP The FASB issued an Exposure Draft, proposing to shorten
the maximum amortisation period of goodwill from 40
years to 20 years.

2001 U.S. GAAP The FASB issued SFAS 141/1423, which prohibited
amortisation of goodwill and required regular impairment
testing, coupled with the abolition of the pooling-of-
interest method.

2004 IFRSs The IASB issued IFRS 3 and its related standards, through
which the accounting requirements relating to goodwill
were generally aligned with those in U.S. GAAP4.

2013 U.S. GAAP The FASB voted to permit amortisation of goodwill for
private companies, and directed its staff to explore
whether to permit the same approach for public business
entities.
Illustration 3. Chronology of Requirements for goodwill Accounting28

The Philippine’s Financial Reporting Standards Council issues its standards in a

28
Fabi, Tomaso, Marco Mattei, Fillippo Poli,Tomo Sekiguchi. “Should Goodwill Still Not Be Amortised?”
Accounting and Discussion for Goodwill” (2014). 2 Feb (2015).
<http:discussion_20140722_enin.pdf>
29
 series of pronouncements called “Philippine Financial Reporting Standards” or

PFRS that corresponds to IFRS, IAS and IFRIC. Since in the above table of the

chronology of accounting goodwill, the last accounting body to update is the

IASB(the body that publishes IFRS), it is safe to assume that we follow the most

recent update it has issued which is prohibition of the amortization of goodwill

and requirement for impairment testing coupled with the abolition of the pooling

of interest method.

However, as Dennis J. Chamber stated in his studies of 2007, we believe there are

alternatives which is more useful to accounting treatment of goodwill. Therefore,

prior to IASB’s post implementation review of Business Combination, we would

like to present various alternatives for impairment of goodwill; 1) permitting both

impairment and amortization in parallel 2) liberal choice for companies to select

their own accounting treatment for goodwill considering their own characteristics

or 3) recognition of either impairment loss or amortization through other

comprehensive income to improve the periodic comparability of earnings.29

29
Choi, FDS and Cee Lee (2012). “Differences in Accounting for Goodwill”. Journal of International
Accouting. No.3
30
5. Appendices

5.1 Available Sources of Accounting Guidance

The researcher based her work largely on the following standards:

Philippines Financial Reporting Standards (PFRS)

International Financial Reporting Standards (IFRS)

US Generally Accepted Accounting Principles (US GAAP)

International Accounting Standards (IAS)

5.2 References

Accounting Onion. Feb.2013.19Jan.2015.

<http://accountingonion.com/2013/02/caterpillar-another-unfortunate-case-of-bad

goodwill- accounting.html>

Accounting Principals Board (APB) Opinion No.16.1970.“Business

Combinations”

"European common enforcement priorities for 2012 financial statements,"

European Securities and Markets Authority Public Statement 725, p1,
November 12, 2012.

Financial Accounting Standards Board (2001B). “Goodwill and Other Intangible

Assets”, Statement of Financial Accounting Standards No. 142, Norwalk:
Financial Accounting Standards Board.

"Goodwill." Microsoft® Student 2009 [DVD]. Redmond, WA: Microsoft

Corporation, 2008.

“Proposal of Alternatives for Goodwill Accounting.”IFRS 19Jan.2015.

<http://www.ifrs.org/Theorganisation/Advisorybodies/EEG/Documents/AP2%20
Accounting%20for%20Goodwill.pdf>

“Statement of Financial Accounting Standards No. 141 Business Combinations,”

(SFAS 141) Financial Accounting Standards Board. June 2001

31
Barber, F. and R. Strack. Harvard Business Review June 2005, Vol.83. Iss. 6. 80-
91.

Choi, FDS and Cee Lee (2012). “Differences in Accounting for Goodwill”.
Journal of International Accouting. No.3

Davis, Michael. "Goodwill Accounting: Time for an Overhaul." Journal of

Accountancy 173 (1992). Questia. 1992. Web. 27 Nov. 2011.
<http://www.questia.com/googleScholar.qst?docId=5000139844>.

Dennis, M. C. (2003, January). More new accounting rules--FASB 142. Business

Credit, 105, 56-57. Retrieved November 28, 2003, from the ABIINFORM
database.

Ding, Y., J. Richard and H. Stolowy (2005). “Accounting Regulation and Social
Actors: An International Study Goodwill”, Working Paper, CEREG, Universite
Paris Dauphine.

Fabi, Tomaso, Marco Mattei, Fillippo Poli,Tomo Sekiguchi. “Should Goodwill

Still Not Be Amortised?” Accounting and Discussion for Goodwill” (2014). 2
Feb (2015). <http:discussion_20140722_enin.pdf>

Fisher, I. 1906. The Nature of Capital and Income. New York: Reprints of
Economic Classics, Augustus M. Kelley, Publisher.

Forsythe, Greg.”The Goodwill Impairment Dilemma: What happens when US

GAAP and IFRSs Clash?”Deloitte Development LLC.2013.Pg3.

Furuboton, E. and S. Pejovich. 1972. “Property rights and economic theory: a

survey of recent literature,” The Journal of Economic Literature. Vol. X No.4
Dec. 1137-1162.

Furuboton, E. and S. Pejovich. 1972. “Property rights and economic theory: a

survey of recent literature,” The Journal of Economic Literature. Vol. X No.4
Dec. 1137-1162.

Garcia, Clemencia. How Accounting for goodwillrelies on Underlying

Assumptions: A Historical Approach. Tokyo,Japan,2007.

Hughes, Hugh P. Goodwill in Accounting: a History of the Issues and Problems.

Atlanta: Business Pub. Division, College of Business Administration, Georgia
State University, 1982. Print.

Johnson, T. L. and K. R. Petrone. 1998. “Is goodwill an asset?” Accounting

Horizons Sept. 1998 Vol. 12 Iss. 3. 293-304.
32
Massoud, M. F., & Raiborn, C. A. (2003, April I). Accounting for goodwill: Are
we better off. Review of Business, 26, 26-32. Retrieved November 28, 2003, from
the ABIINFORM database.

Moehrle, S. R., & Reynolds-Moehrle, J. A. (2001, September). Say good-bye to

pooling and goodwill amortization. Journal of Accountancy, 192, 3 t-38.
Retrieved November 28, 2003, from the ABIINFORM database.

Samuelson, R. A. 1996. “The concept of assets in accounting theory,” Accounting

Horizons. Sept. Vol.10 Iss.3. 147-157.

Selling, Tom.”Caterpillar: Another Sad Example of Bad Goodwill Accounting.”

Stice, Earl K., James D. Stice, and K. Fred Skousen. Intermediate Accounting.
17th ed. Mason: South-Western Cengage Learning, 2010. Print.

Valix, Conrado and Christian Aris Valix. Theory of Accounts Vol.1. 2019 C.M.
Recto, Manila, Philippines: GIC ENTERPRISES & CO., INC. 2012

33
NINA RICA P. SABULAO
Balite, Kawayan, Biliran
09156503686
ninaricasabulao@yahoo.com

EDUCATION
Eastern Visayas State University
Bachelor of Science in Accountancy
Salazar St., Quarry District, Tacloban City

Kawayan National High School

Poblacion Kawayan, Biliran
2010

SKILLS

ACHIEVEMENTS/AWARDS RECEIVED
Diploma in Bookkeeping NCIII
TESDA
March 2013
(arranged from current to past)
*you can include jpia and non jpia contests
*academic/non-academic contests/awards

AFFILIATIONS

WORK EXPERIENCE/ SPECIAL TRAININGS

Name of Company
Address
Position
Job description
(Arranged from current to past)

34
SEMINARS ATTENDED
Basic Orientation Seminar on Leadership
Participant
EVSU ORPES Hall
July 26, 2013

Seminar on Taxation
Participant
Ritz Tower, Tacloban City

PFRS for SMEs

Participant
EVSU GS Function Hall

REFERENCES
Timoleon S. Lianza, MM, CPA
EVSU College of Business and Entrepreneurship
OIC Dean, Concurrent , Accountancy Department
09164788045

Michelle Ayles
Machica Firm
Auditor
09483933039

Aivee Cabueñas
Machica Firm
Auditor
09159875305

35