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The Evolution of Goodwill Accounting: 1970-2005 and The Lesson Learned

By: Ersa Tri Wahyuni

This piece was written back in 2006 where I am still fascinated by Goodwill Accounting. My research interest has been developed, but goodwill accounting is always an interesting issue to follow… occasionally…

I love history… and I love accounting… please enjoy the goodwill accounting from a humble accounting historian perspective.


Goodwill appears in the balance sheet of a company when a business purchases another business and pays for more than the fair value of the specifically identified net assets of the acquiree. In United States, where accounting standards are more advanced than in most other countries, goodwill has been reported for more than 100 years, but before the 1970s there was no single accounting and financial treatment for goodwill (Kintzele et.al, 2005).

Below are some popular accounting methods for goodwill before 1970s:

1. Capitalization and indefinite retention of purchased goodwill as an asset.
One of the early methods of accounting and reporting for goodwill before the 1970s was to record it as an intangible asset with an indefinite useful life. Under this approach, purchased goodwill was recognized as an asset but rarely recognized as an expense. Goodwill was assumed to be an asset with a fixed value of the life of the business, similar to other fixed assets.
The key area of debate was whether goodwill fit in to definition of asset, especially to satisfy the requirements of asset that the entity had control over the benefits. Although many studies argued that the core component of goodwill is an asset (Johnson and Petrone, 1998) many articles also challenged that idea. One of the important studies by Henning et.al, (2000), showed that their study was consistent with the concern that some components of goodwill were assets while others are not. The results suggested that investors did not review the residual components of goodwill as an asset. Therefore perceived goodwill entirely as an asset was not encouraged by this research.

2. Immediate write-off of purchased goodwill against reserves.
Before the 1970s, this is also a popular alternative to account goodwill. Until the end of 1998, this alternative was recommended to UK firms under Statament of Standard Accounting Practice (SSAP) No. 22, “Accounting for goodwill” (Henning et.al, 2004).
The argument for this policy was that goodwill was not an asset because it could not be sold separately from the acquired business. FASB, the standard setter of United States challenged this argument. The viewpoint of FASB, as written by Johnson & Petrone (1999), stated that the Board believes that goodwill meets the criteria of assets. The Board concluded that goodwill provides future economic benefits because it possesses the capacity to produce cash flow in conjunction with other assets.
Under the treatment, purchased goodwill was treated consistently with internally generated goodwill on the Balance Sheet (no asset shown). On the other hand, goodwill was treated inconsistently in the profit and loss statement (no expense for purchased goodwill, while the amounts spent in building up the goodwill of existing businesses are expensed). Miller (1995) argued that this inconsistently caused incompatibility in reported results between companies growing by acquisition and companies with internal growth policies. Also, immediate write-off of goodwill reduced accountability, depleted the amount reported to shareholder’s equity and distorted rate-of-return measures.
However, this method had the advantage of accounting for the negative attributes of goodwill all at one time in the year of acquisition. This way the company can have a clean start the year following the acquisition. Nevertheless, this method ignored the common realistic situation that the value of goodwill would be more likely to exist after the year of acquisition.

Goodwill Accounting After 1970s.

In the year 1970, The United States had a new standard for intangible assets (APB No.17) which required that all goodwill be amortised in a systematic manner not to exceed a period of 40 years. The preference method of amotization was by the straight-line method. APB No.17 also stated that goodwill was a subject to a test of impairment and required that the firm tested goodwill impairment at the “enterprise level”. However the standard did not require goodwill to be tested annually nor prescribed a certain methodology on how firm should run the impairment test.
Amortization of goodwill waspopular method in some countries at that time (see table 1). Under this approach, purchased goodwill is reported as an asset and systematically expensed. Nevertheless, given that the life of purchased goodwill was often indeterminate, its forced amortization may have been far removed from any real-world economic value. This raised questions about the usefulness of the information (Miller, 1995).

Why Shift to Impairment?

Another accounting method for goodwill that has been developed recently is to capitalize goodwill and test it for impairment on rigorous annual review. The method is canvassed in a discussion paper issued in December 1993 by the UK Accounting Standard Board (Wagner, 1994). In 1995, the United States issued FAS No.121 which required goodwill be tested annually for impairment. At this time, goodwill in the US was subject to both amortization and annual impairment test.
Starting 2001, FASB issued FAS No.142 which mandated that goodwill should no longer be amortized, but should be tested for impairment annually. Any firm in the United States suddenly needed to conduct an initial impairment test and for most companies, the 2002 annual report was the year in which the standard was implemented.
On January 1, 2005, the International Accounting Standard Board (IASB) completed the first phase of business combination project, which is an on going project between IASB and FASB, and issues IFRS 3, Business Combination. Starting in 2005, IASB also adopted an annual impairment test and prohibited amortization of goodwill, which was previously prescribed at IAS 22. Other countries that adopted IFRS then follow IASB, such as Australia also adopted the IFRS in 2005. Clearly there is a major shift all over the world from amortization of goodwill in to impairment of goodwill. In the very near future, countries all over the world will reach a common goal of accounting harmonization and will need to adopt the impairment of goodwill and prohibit amortization of goodwill.

One of the main questions raised in this paper is why the world would be interested in impairment instead of amortization? There are two possible answers to this question. Impairment of goodwill provides a better accounting treatment for the nature of goodwill thus it can satisfy many parties debated about the nature of goodwill. The second reason is goodwill amortization had failed to provide a relevant information to the users, thus in attempt to improve the relevancy of goodwill information, standard setters chose impairment.

1. Goodwill impairment is a better accounting method than direct write-offs and amortization.

The difference between annual impairment value with amortization is this method ensures that goodwill is expensed when appropriate. It can be argued that, goodwill impairment is better than other alternatives in four areas:
• Purchased goodwill is treated consistently with internally generated goodwill. With the write-off method, the companies that grow from business combination (mergers and acquisition) will be disadvantaged compared to companies that grow without business combination.
• Purchased goodwill is recognized as an asset, but it is expensed when appropriate.
• The value of goodwill will be more representative of the real value. While the amortization method systematically decreases the value of goodwill, impairment method enables the retention of the value of goodwill if the value is not decreasing.
• The impairment method acknowledges that goodwill may have indefinite useful life.

Although the method seems superior compared to the other accounting methods, annual impairment has a high compliance cost arising from the need for comprehensive valuation of business segments with purchased goodwill. The test required by IASB is far more rigorous than the test required by FASB. However, the debate about goodwill now is no longer whether goodwill is an asset or not, but rather than how should firm test goodwill for impairment.

2. Goodwill amortization has failed to provide relevant information to users.
Under the amortization method, the value of goodwill is systematically decreased despite the fact that it may not actually decrease. Unlike amortization, the impairment method enables the value of goodwill to remain the same if the recoverable amount is greater than the carrying amount. FASB does not presume that goodwill and other intangible assets that have indefinite useful lives will not be amortized but rather will be tested at least annually for impairment. (FASB, 2001)
There must be a good reason that standard setters all over the world now are more interested in goodwill impairment than amortization. FASB has already changed their goodwill accounting, while other standard setters such as AASB and IASB are moving in the same direction. The reason for the change was probably because of some research findings showed that goodwill amortization disclosure was not decision-useful information for the user of financial statement.
Ever since 1992, researchers had recognized some problems with goodwill amortization disclosure in the United States. APB No.17 required the amortization method for goodwill accounting. However, compliance rate to that standard was actually very low (Duval, et.al, 1992). Duval, et.al (1992) conducted a survey in 1988 among 621 firms of New York and American Stock Exchange. Twenty-one percent did not disclosure net goodwill, 58 percent did not disclose accumulated goodwill amortization and 76 percent did not disclose goodwill amortization expense.
Duval et al. (1992) research investigated whether goodwill disclosures by publicly traded firms were sufficient to enable investors to determine the financial statement impact of APB No.17. The results suggested that investors could not easily identify the financial statement effects of goodwill accounting rules at the time for a substantial number of firms with material goodwill. Duval et al. (1992) then argued that the more complete and uniform goodwill disclosures were needed.
More and more research studies were done to investigate the usefulness of goodwill amortization disclosure. Greg Clinch (1995), in his literature review concluded that there is no consistent association between reported goodwill amortization and either share price or returns. Also there was only a little firm evidence that goodwill amortization expense reflected information that was used by investors in setting share prices and return. Clich (1995) then proposed two reasons for that: 1. goodwill amortization was less importance to investors than other components of net income or 2. goodwill may not be viewed as an amortizable asset by investors.

It is important to note Clinch second argument in this context. If investors did not view goodwill as something that should be amortized, then probably standard setters need to consider another method. Hopefully, the other method wiould increase the usefulness of goodwill disclosure information to the investors. FASB monitored the research progress before they argued that goodwill amortization disclosures were not decision-useful to investors and they would like to change to method of impairment.
The research done by Moehrlre, et.al (2001) also supports the FASB argument that goodwill amortization disclosures are not desion-useful to investors. The results of the study support FASB’s conclusion in that earnings excluding goodwill amortization disclosures provide decision-useful financial information equivalent to that contained in net income. Moehrle et.al. (2001) research provided results that support the FASB decision to adopt impaired goodwill.

Additional conclusive research by Jennings, et.al, (2001) reported that goodwill amortization information does not improve the quality of earning information for investors to predict share values. The study reviewed 2,918 observations (firm years) in the US listed company from 1993-1998 to investigate which one could explain the share values better; earnings before goodwill amortization or earnings after goodwill amortization. The study found that earning before goodwill amortization explained significantly more of the share price than the earnings after goodwill amortization. Jennings, et.al also suggested that making the earnings impact of goodwill accounting more transparent would benefit investor and analysis.

To sum up, from the previous research findings, most were conducted in the United States and suggest that new rules needed to be set up for goodwill accounting. Goodwill amortization does not represent faithful and decision-useful information. Better information is needed, as intangible assets (including goodwill) are an increasingly important economic resource for many entities. Goodwill also becomes an increasing proportion of the assets acquired in many transactions.

The Possibility of Goodwill Impairment in Indonesia

The Possible Impact and consequences on Indonesia if Adopting Goodwill Impairment
Currently in Indonesia, the requirement for goodwill disclosure is to disclose net goodwill on the face of the balance sheet. In 2005, from 324 listed companies on the Jakarta Stock Exchange (JSX), goodwill was reported on the face of balance sheet by 60 companies. Of the 60 companies, 36 companies has relatively small amount of goodwill- less than one percent of their total assets. Only seven companies have goodwill more than 5% from their total asset (attachment 1).

Accounting standards for goodwill in Indonesia are different when compared to US GAAP or IFRS. In PSAK 22 (Indonesian GAAP) Accounting for Business Combination, goodwill should be amortized using straight-line basis, unless other amortization method is more appropriate in other circumstances. The amortization period should not exceed five years, unless a longer period can be justified and the justification should be disclosed. The maximum period of amortization should not exceed than 20 years from the date of acquisition. PSAK 22 was harmonized with IAS 22 (revised 1993) which has similar regulation for goodwill. IAS 22 was revised in 1998 and superseded by IFRS 3 in 2005.

However in PSAK 19 (revised 2000), Accounting for intangibles, goodwill is also a subject of the annual impairment test. Although in PSAK 19, the standard does not specifically describe the impairment test for goodwill from acquisition, considering PSAK 19 was harmonized with IAS 38 (revised 1998), the practice should be similar to IFRS. IAS 38 Accounting for intangibles was revised in 2004, and as the revision of IFRS/IAS were quite rapid in the past five years, it is hard for the Indonesia Accounting Standard Body (DSAK) to catch up with the new revised standard.
In regards to negative goodwill, both IFRS and US GAAP have similar standards where the excess of negative goodwill (after reassessing the acquiree identifiable asset) should be recognized in profit or loss (US GAAP as extraordinary gain) immediately. In Indonesia, the excess of negative goodwill should be recognized as deferred income (liability) and recognized as income over a period of not less than 20 years.
The condition of goodwill accounting in Indonesia is similar to the condition in the US around 1995 where goodwill was amortized but also was tested for impairment annually. Observing the harmonization effort by Indonesian standard setter with IFRS since 1994, Indonesia will need to adopt impairment of goodwill sooner or later. The information on when exactly Indonesian GAAP is going to adopt goodwill impairment remains unknown at the time this article was written.

Indonesian Standard Setter should\ had realized that the world consensus on impaired goodwill is very strong. Currently nearly 7,000 public companies in the 25 EU countries will be required to use IFRS for the first time in 2005 (Shoaf & Zaldifar, 2005). Indonesian Institute of Accountants (IAI) in many occasion stated that they aim to harmonize with IFRS by 2008. But considering there are still so many IFRS that have not been adopted yet, and IFRS about business combination will likely to change in the future anyway, business combination probably is not a major priority of Indonesian Standard Setter now or even in five more years.

It is interesting to analyze what would be the possible impact to Indonesia if Indonesia adopt impairment of accounting and prohibit goodwill amortization? As Indonesia is about ten years behind the US in this issue, it would be imperative to look at what happened in the US after they issued SFAS 142 in 2001. Some lesson learns below can become considerations, not only the standard setters but also to investors:

1. Major Write-Off of Goodwill by listed companies in the first year.
One important lesson was learned from the US who was the first to adopt impairment for goodwill accounting. Before 2001, US companies with weak performance can delay goodwill impairment to protect their asset value in the balance sheet. In fact this has been a major criticism prior SFAS 142 that the rule gave too much discretion to the firms as to the amount of write-off and the timing of the write-off.
The FASB adopted SFAS 142 in July 2001. Companies using US GAAP had time until June 30, 2002 to complete the first part of the impairment test and until the end of the year to complete the balance sheet. Any write-off that resulted from the initial impairment test was reported in a favorable manner, as a change in accounting standard. Any write-offs that occured after the transitional period had to be reported as income from continuing operations. If companies waited until after the first quarter to start, they would have to go back and restate numbers for the first quarter (Gilpin,2002)
Due to the incentives to clear up the matter in the first quarter, some analysts predicted that some companies would take substantial write offs of their goodwill in 2002. The new rule would possibly weakening companies’ balance sheets, especially those, which built through acquisition. Some companies have a huge proportion of goodwill in their balance sheets. The write-down of an asset reflects reduced future expectations of cash flow and earnings. If it is proven that it will weaken the balance sheet, sureties bonds are more likely to be concerned.
An important research by Henning et,al (2004), concerned 1,482 sample US firms that wrote off their goodwill during the transitional period. Ninety-three percent of the transition firms with significant abnormal returns decided to recognize goodwill impairment. In contrast only 12 percent of the transition firms with positive abnormal returns decided to impair. This result was consistent with hypothesis that “weak performance” companies may have delayed their goodwill impairment and maximized the goodwill impairment during the transition year. The study also showed that these weak firms impaired a greater proportion of their market-adjusted goodwill, had higher debt-to-capital ratios and had older goodwill compared to “good performance” firms.

2. Impairment test it too complicated.
Another concern is the complexities of the impairment test. Calculating impairment is complicated. Impairment tests are based on the future cash flow that an asset is expected to produce, but goodwill alone does not produce cash flows. It only produces cash flows in conjunction with the other assets or groups of assets. Associating goodwill with these assets for purposes of impairment testing is problematic, particularly when the operations and activities of once-separate companies are combined. Goodwill may have to be assessed on an enterprise-wide basis, which also is problematic (Johson & Petrone, 1999)
Even if Indonesia decided to adopt impairment, the model to do the impairment test both prescribed by FASB or IFRS is complicated. The model is so complicated it can make the compliance cost too high for some companies in Indonesia which their goodwill mostly comprised of less than 5 percent of their total asset.
FASB model needs two steps of calculating impairment while IFRS only one step. However IFRS requires goodwill to be tested in CGU level (Cash Generating Unit), while FASB allowed goodwill is tested in reporting entity’s level. IASB initially was also interested to prescribe two-step test, but significant concern of IASB constituents about the practicality and complexity of the test made IASB then prescribed only one step test.

Asking companies to test their goodwill annually would probably too expensive and is something that need to be considered by the companies as well. There would be many other issues beside the testing which may include: how do companies define a cash generating unit, what are the tax implication of the write downs, and after the extensive and possible expensive testing, would it increase the relevance of financial statement at all?

3. Impairment test increases possibility for subjectivity and manipulation.

IAS 36 Impairment of asset requires the firm to compare carrying amount of goodwill with its recoverable amount. IASB used the term of recoverable amount instead of fair value because in deciding the recoverable amount, one should choose which ever is higher; fair value less cost to sell or value in use. Due to the nature of goodwill and other intangible asset that do not have an active market, to determine its market value would be problematic. Most of the firms then use the estimated fair value and compare it with the carrying value. However the use of estimation can opens more opportunity for manipulation.
Research by Kintzele et al. showed that most of the companies use present value or discounted cash flow in their impairment test. They investigated S&P 100 listed companies in United States and check their annual report of 2002. From the 100 companies, 35 percent of the companies had an initial impairment and discussed the method of determining the impairment loss. From that 35 companies, twenty-nine companies used present value or discounted cash flows, three companies used discounted cash flows, and three companies used market-based fair-value determination without further elaboration on how they determine that value.
There are many different methods used in calculating the “fair value” of goodwill and the distinctive accounting method compared to other intangible assets, this would increase internal inconsistency in the financial reporting. The use of cash flow estimates, the selection of discount rates and the use of appraisal values are all fraught with subjectivity and the manipulation issues inherent in such a process (Kintzele, et.al, 2005). This research even suggested that the combination of goodwill amortization and impairment testing is probably a better way to account goodwill.


Now, October 2012, EFRAG and Italian accounting standard is pushing IASB to review IFRS 3, especially on the prohibition of goodwill systematic amortization. Should we go abandon goodwill impairment just because it is too difficult?

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