An acquisition is a process through which one company acquires another company. It usually occurs when the buyer purchases over 50% of the shares in another company. Sometimes, this percentage may vary based on the voting rights that come with the obtained stock. In most cases, the buyer pays more than the worth of those shares to complete the acquisition.
Accounting standards require companies to recognize goodwill on acquisition. Usually, it equals the premium paid for the shares purchased.
What is Goodwill on Acquisition?
Goodwill on acquisition is an intangible asset that arises when one company acquires another company. Its value comes from the difference between the fair value of the acquired company’s identifiable net assets and the price paid by the seller. In other words, goodwill represents the value of the synergies, reputation, customer base, and other intangible factors that the acquiring company believes it will gain from the acquisition.
In accounting, goodwill is an intangible asset that comes with strict standards. Companies cannot recognize it unless it is measurable and separately identifiable. However, an acquisition allows companies to meet these requirements. Goodwill on acquisition becomes a part of the consolidation process. It can have a significant impact on the company’s assets and reputation.
What is the accounting treatment for Goodwill on Acquisition?
The accounting treatment for goodwill on acquisition may differ between the IFRS and GAAP. Typically, companies must calculate goodwill based on the two values mentioned above. The net identifiable assets for a company come from its balance sheet. Usually, it equals the equity of the subsidiary. On the other hand, the purchase price is the sale proceeds. It may include various forms of compensation, including cash, shares, future payments, etc.
Once companies calculate the value of goodwill, they must identify it as an intangible asset. The accounting treatment for goodwill on acquisition also dictates companies check it for impairment at the end of each reporting period. Unlike other intangible assets, goodwill does not require amortization. If the parent company disposes of the other company, the residual goodwill becomes a gain or loss.
What is the journal entry for Goodwill on Acquisition?
The journal entry for goodwill on acquisition is part of a complex accounting treatment. As mentioned above, it is the difference between the purchase price and net identifiable assets for the transaction. The difference between these two constitutes the goodwill portion of the journal entry. Overall, the journal entry for goodwill on acquisition is as follows.
| Dr | Net identifiable assets |
| Dr | Goodwill |
| Cr | Sale proceeds |
In the above entry, goodwill is an asset since the parent company pays more than the net identifiable assets. Sometimes, it may also be a credit if the opposite is true.
Example
A company, Red Co., acquires another company’s 60% shares for $500,000. At the time of the transaction, the net identifiable assets of the subsidiary were $400,000. Based on the above information, the goodwill on acquisition will be $100,000 ($500,000 – $400,000). Red Co. uses the following journal entry to record this amount.
| Dr | Net identifiable assets | $400,000 |
| Dr | Goodwill | $100,000 |
| Cr | Sale proceeds | $500,000 |
Conclusion
Goodwill is the value of the synergies, reputation, customer base, and other intangible factors in company acquisitions. It comes from the difference between the amount the parent company pays and the net identifiable assets of the subsidiary. Typically, companies record this amount when the acquisition occurs and must check it for impairment regularly.
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