Goodwill is a company’s intangible asset that arises when one company acquires another. Goodwill exists in the company’s brand image, brand name, ethical business practices, customer relations, patents, employee relations and advanced technology (Zanoni, 2009). Goodwill is an asset but is intangible because it does not exist in physical form like land, machinery and buildings among others. Goodwill is recorded in the assets section of the balance sheet. However, during the process of business creation, goodwill does not show up in the parent company’s trial balance. The reason for this is that goodwill is implied as an investment in subsidiary account. When the accounts are consolidated, this investment account is broken down into different components. Goodwill then appears separately as part of the consolidated financial statement balances (Hoyle, Schaefer & Doupnik, 2011).
There are some investors who are not very keen on goodwill. However, goodwill is an indication of the success of a company. If the acquiring company has to continually adjust the goodwill, then it means that it probably overpaid for the goodwill and is therefore not receiving the return on investments from the goodwill.
The revised Financial Accounting Standards Board (FASB) statement No. 141 retains the requirement that the accounting method should be used for all business combinations. This SFAS 141(R) Business Combinations is designed to improve relevance and allow for easy comparability of accounting information. An acquirer is defined as the person or entity that purchases control of a business; acquirer was not defined in the previous statement, even though it had guidelines on how an acquirer may be identified. There are significant changes that have been made in the new statement and which are described below.
The first is that an acquirer must recognize the assets acquired, together with the assumed liabilities and any other interest at the acquisition date. These are measured at fair values. This is a departure from the previous cost-allocation process that required that the costs of acquisition to be allotted to the assets acquired and liabilities assumed. Cost-allocation projects focused on cost objects like sales region, customer base and products. The costs are to be considered separately for the acquisition. The acquisition related costs are also included in the incurred costs by the acquirer. The statement also requires that the acquirer restructure the costs that it expected to incur during the acquisition but which it did not incur. These costs are considered as liabilities on the acquisition. This shows how the SFAS 141(R) Business Combinations improves the relevance and representation faithfulness of accounting statements and information.
The second departure is that step acquisitions should recognize all identifiable assets and liabilities at the full amounts of the fair values. Previously, an entity that acquired another through step acquisition identified the investment costs, fair value of identifiable assets that were required and the goodwill needed at each and every step.
The third departure is that the statement provides guidance for measuring minority interest’ share of the consolidated assets and liabilities at the time the acquisition is made. This practice was less relevant and did not consider the practical business situations at the time of acquisition.
The equity method of accounting is used by corporations to determine the profits accrued from their investment in other companies. The equity method is based on the assumption that if a company has more than 20% stake in another, then this stake gives it the power to exercise influence on the other company. On the other hand, if the invested equity is less than 20%, then it is assumed that the investor does not have considerable influence on the other company. The income earned from this investment is reported in the income statement with the reported value being determined by the proportional investment in the other company. When equity method of accounting is used, the investor records the initial investment made in the other company at cost. This value is then periodically adjusted to reflect the additional investment or any divestment in the other company. In the event that the investee company makes a loss, the investor company calculates its share of the loss based on its percentage stake in the investee company. This is recorded as loss of investments thereby reducing the value of the investment. The equity method requires that the investor company records the carrying value of the investment without considering any fair value changes that have occurred in the market. This means that the value of investment changes based on the profits or losses because it is known that the investor company influences the operational and business strategy of the investee company (Hoyle, Schaefer & Doupnik, 2011).
Yes, Wolf Pack should recognize the decline in the value of holdings in the current financial year statements. Since Wolf Pack bought 25% stake in the company, it has significant stakes to influence the operating strategies of MVD. There is increased competition in the transit warehousing industry and there are competitors who have opened facilities in more convenient locations. This made MVD to lose 30% of its customers. The other challenge is that the price for warehousing service has had to reduce due to increase supply of the services. According to the equity method, this loss should be recognized because it is not temporary. The business environment has made MVD to record a large loss; there is a permanent change in the market, they have lost some customers and the operating environment may be more difficult for MVD. This is because competitors may be more competitive in technology and human resource investments, something which MVD may not find easy to invest in. Globalization creates increased competition and being in a negative position will make it difficult for the company to deploy successful strategies. There are instances when the account may be reduced to zero. This happens when the investee has suffered immense losses. When this happens, the investor company should stop using the equity method and eliminate the original cost of acquisition from the balance sheet. Once the investment has been removed from the balance sheet, no other costs in form of losses may be accrued by the investing company. This will help in accurately reporting the true position of the company.
An impairment test is a measure to determine whether an item in the balance sheet is worth the amount that has been stated in the balance sheet. From the case scenario, Wolf Pack should not test for the impairment of the value that had already been assigned in the balance sheet. This is because the operating environment has been so harsh and the assets have experienced erosion in their value to the extent that the decrease in the value of the stock is much greater than the original investment that they input in the company. The FASB regulations do not require an equity investor to test an investee for asset impairment. In addition, the regulations also state that there should not be a separate attempt to test goodwill. It is difficult to separate goodwill from the original investment meaning that it should not be tested for impairment (Zanoni, 2009). By not testing goodwill, Wolf Pack would be complying with the regulatory requirements in accounting reporting.
- Hoyle. J.B., Schaefer, T.F., & Doupnik, T.S. (2011). Advanced accounting. New York: McGraw Hill Publications.
- Zanoni, A.B. (2009). Accounting for goodwill. New York: Routledge.