Commentary: Is Goodwill an Asset?

Abstract

The accounting for purchased goodwill generates greater interest whenever merger and acquisition activity is robust, as it has been recently. Standard setters have been active, too. The United Kingdom's Accounting Standards Board (ASB) has issued a new standard on goodwill accounting, the International Accounting Standards Committee (IASC) has issued standards (approved but not yet released) on both business combinations and intangible assets and the Financial Accounting Standards Board (FASB) has undertaken a project on accounting for business combinations, including goodwill accounting.

In the United States, the amount paid for goodwill in a purchase business combination currently must be amortized over a period not to exceed 40 years. To avoid the resulting drag on reported earnings, many companies seek to account for their combinations as poolings of interests so that purchased goodwill is not recorded and amortized. Not surprisingly, the vast majority of large combinations in the United States are recorded as poolings, although that treatment is much less common in other parts of the world. For example, poolings are prohibited under Australian standards, and under Canadian, U.K. and IASC standards they are restricted to combinations in which an acquirer cannot be identified.

The growing globalization of capital markets is reducing the tolerance for continued differences in accounting standards, including those for business combinations. Since the United States is perceived as being out of step with other countries, that raises the question of whether U.S. standards should be revised, which has, in turn, placed the spotlight on goodwill accounting.

Some believe that goodwill should be recognized as an asset, while others argue that it should not be. The question of whether goodwill is an asset has not been addressed in the context of the conceptual definition of assets in FASB (1985) Concepts Statement No. 6, Elements of Financial Statements.1 Determining whether goodwill is an asset, entails considering the nature of goodwill in order to ascertain whether it possesses the essential characteristics of an asset under the FASB's definition.

At its November 19, 1997, board meeting, the Board decided that goodwill meets the assets definition in Concepts Statement No. 6 and this commentary presents the reasoning behind that decision. Whether goodwill is an asset is the first of many issues the Board must address in its business combinations project. However, it is one of the most fundamental issues because the Board must have a common understanding of what goodwill is before it can address how to account for goodwill. If the Board had decided that goodwill did not meet the assets definition, the ensuing discussions in its business combinations project would have been markedly different.

Although the FASB had a project on business combinations on its agenda two decades ago, it did not complete the project nor did it address that question in the context of the assets definition because the definitions were in the process of being developed and had not been finalized.

JEL Classification: M41, M44, M47