Goodwill amortization definition
/What is Goodwill Amortization?
Goodwill amortization refers to the gradual and systematic reduction in the amount of the goodwill asset by recording a periodic amortization charge. The accounting standards allow for this amortization to be conducted on a straight-line basis over a ten-year period. Or, if one can prove that a different useful life is more appropriate, the amortization can be over a smaller number of years. The goodwill amortization alternative only applies to privately held entities.
If a business elects to amortize goodwill, it has to keep doing so for all existing goodwill, and also for any new goodwill related to future transactions. That means an organization cannot selectively apply amortization to the goodwill arising from just specific acquisitions. Thus, company management needs to commit to the amortization concept entirely, which many organizations may be reluctant to do.
If this option is chosen, there will be a large amortization charge that offsets profits for a long time. This means that the users of a company's financial statements should be educated about the impact of amortization on reported results. Otherwise, the company will appear to be reporting worse results than its competitors.
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Advantages of Goodwill Amortization
There are two key advantages to using goodwill amortization, which are as follows:
Reduced impairment testing. Since the ongoing amortization of goodwill is going to keep dropping the carrying amount of the entity over time, this means the likelihood of an impairment test is going to decline as time goes by. And since impairment testing is only at the entity level, there’s even less work involved in whatever amount of residual impairment testing there might be.
Reliability of financial position. The reported financial position of a business that uses goodwill amortization is less skewed by the presence of a goodwill asset on its balance sheet. Over time, the goodwill asset will disappear entirely, leaving a balance sheet that contains the normal proportions of assets, liabilities, and equity.
Problems with Goodwill Amortization
The one catch to using goodwill amortization is that a business must also conduct impairment testing, but only if there’s a triggering event indicating that the fair value of the entity has dropped below its carrying amount. And, you can choose to test for impairment only at the entity level, not for individual reporting units.
Reporting of Goodwill Amortization
There are reporting requirements associated with goodwill amortization. On the balance sheet, the amount of goodwill net of any accumulated amortization and impairment charges must be presented. This is the same logic we use in presenting fixed assets. And in the income statement, goodwill amortization is presented within continuing operations, unless it is associated with a discontinued operation – and in that case, it is presented with the results of the discontinued operation.