In order to understand the accounting alternative for amortizing goodwill, it first makes sense to define goodwill and explain how it is created.
Goodwill is an asset representing future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.[1] In other words, goodwill is the amount by which the purchase price, or consideration paid, exceeds the net identifiable tangible and intangible assets acquired.
How is goodwill generated?
- To record goodwill, a company must make an acquisition; a company cannot internally create goodwill from an accounting perspective.[2]
How is goodwill initially measured in a transaction?
- In order to calculate the amount of goodwill recorded on the acquiring company’s financial statements, the acquiring company must perform a purchase price allocation consistent with ASC 805.
Who can elect the accounting alternative for amortizing goodwill?
- Only private companies and not-for-profit entities can make this election.
What Does the Accounting Alternative Election Mean?
As mentioned above, an acquiring company must perform a purchase price allocation in order to record the identifiable and unidentifiable (i.e., goodwill) net assets acquired on its financial statements. Two common identifiable intangible assets acquired in a transaction are customer-related assets and non-competition agreements (“NCAs”).
In a purchase price allocation, it is common for customer-related intangible assets to be valued using the multi-period excess earnings method (“MPEEM”). However, when the accounting alternative election is made, customer-related intangible assets that are not capable of being sold separately from the rest of the business do not have to be valued separately.[3] NCAs are also not required to be valued.
Further, if the accounting alternative election is made, goodwill is required to be amortized over ten years and only tested for impairment if the company thinks a triggering event has occurred.[4]
What Are the Benefits of Electing the Accounting Alternative?
Electing the accounting alternative can potentially lower the likelihood of a goodwill impairment charge.[5] This is because the carrying value of the company would automatically decrease each year due to the amortization of goodwill, all other things being equal.
Electing the accounting alternative also potentially lowers the cost of the purchase price allocation analysis. Since the analysis is much simpler without valuing customer-related intangibles or NCAs, the overall process likely reduces the reporting costs for the acquiring company.
Conclusion
Private companies should consider the accounting alternative for amortizing goodwill if the customer-related intangible asset in their planned acquisition is not capable of being sold separately. This allows the company to amortize a larger goodwill asset as the customer-related intangible asset (and any NCAs) are subsumed into the total goodwill value and therefore creates a lower likelihood of a future goodwill impairment charge.
In addition, overall reporting costs are less for the acquiring company as the purchase price allocation analysis is simplified.
[1] FASB Master Glossary: Goodwill.
[2] FASB No. 2021-03, Intangibles – Goodwill and Other (Topic 350) 350-20-05-4A: Costs of developing, maintaining, or restoring internally generated goodwill should not be capitalized.
[3] FASB No. 2014-18, 805-20-25-30.
[4] If the accounting alternative election is not made, goodwill is tested annually for impairment.
[5] A goodwill impairment charge occurs where the Fair Value of the company is less than the Carrying Value of the company.
