Explanation of Goodwill and Accounting Treatment

This memorandum explains the nature of goodwill and its accounting treatment. It discusses the difference between tangible and intangible assets, the recognition of goodwill in books, and the accounting treatment of internally generated and acquired goodwill.

Solution-1
MEMORANDUM
Date: 11th May, 2019
To: Ms Picos, The Chief Financial Officer
From: The accountant
Subject: Explanation regarding nature of goodwill and accounting treatment
Nature of Goodwill
There assets are two types of assets in any business. First one is ‘tangible assets’ and another is
‘intangible assets’. Tangible assets are those assets which can be seen and touched. For example,
machinery, furniture, etc. Intangible assets are those assets which has no physical substance and
which can’t be seen or touched, but they have some future economic benefits for the entity. One
such type of intangible asset is goodwill. In layman words, goodwill refers to the reputation
which business has earned over a period of time. This goodwill results in the increase in market
value of the entity.
Recognition of goodwill in books
As per accounting standards, goodwill can be of two types, one is internally-generated goodwill
and other is acquired goodwill. The goodwill that is earned by the company on its own is known
as internally generated goodwill, for instance, due to selling of good quality products, the
company has made a special value for itself in the market. Due to this, the market value of the
company has increased. The other type of goodwill is acquired goodwill. It means acquiring
another company by paying consideration more than its fair value of net assets undertaken. In
other words, excess of consideration paid over the net book value of the assets and liabilities
acquired.
Accounting treatment of goodwill
As per accounting standards, the company should not account for the internally generated
goodwill in its books, however, the acquired goodwill should be recorded as an intangible asset

in the books of Investor Company. Further, this recorded goodwill should be checked for
impairment at each reporting period end and should be amortized if required.
So, the Patagonia Ltd should record $50,000 (i.e. the excess amount paid over the net book value
of the asset) in its books as goodwill.

Solution-2
(a) Acquisition analysis in the books of Padda Ltd. as on 1 July, 2014
Amount
Share Capital $180,000
General reserve $34,800
Retained Earnings $66,000
FV: Inventories ((28,500-22,500)*(1-30%)) $4,200
FV: Plant & equipment ((264,600-(300,000-38,400))*(1-30%)) $2,100
FV: Patent (15,000*(1-30%)) $10,500
Recorded Goodwill -$7,200 $9,600
Net fair value of assets acquired $290,400
Consideration transferred
Equity shares of Padda Ltd $150,000
Artworks $90,000
Cash $60,000
Dividend receivable -$12,000 $288,000
Gain on bargain purchase $2,400
(b) Consolidation journal entries for Padda Ltd group
At 1 July 2014
Account titles Dr. Cr.
Share Capital $180,000
General reserve $34,800
Retained Earnings $66,000
Business combination valuation reserve $9,600
Gain on bargain purchase $2,400

Investment in Slang Ltd. $288,000
(Pre-acquisition entry recorded)
Dividend payable $12,000
Dividend receivable $12,000
(Elimination of dividend)
Inventories (28,500-22,500) $6,000
Deferred tax asset (6,000*30%) $1,800
Business combination valuation reserve $4,200
(Inventories recorded at fair value)
Accumulated Depreciation - Plant & Equipment $38,400
Plant & Equipment (38,400-3,000) $35,400
Deferred tax asset (3,000*30%) $900
Business combination valuation reserve $2,100
(Plant & equipment recorded at fair value)
Patent $15,000
Deferred tax asset (15,000*30%) $4,500
Business combination valuation reserve $10,500
(Patent recognition)
Business combination valuation reserve $7,200
Goodwill $7,200
(Goodwill transferred)

At 30 June, 2019
Account titles Dr. Cr.
Share Capital $240,000
General reserve $34,800
Retained Earnings (1 July 18) * $600
Business combination valuation reserve $12,600
Shares in Slang Ltd. $288,000
(Pre-acquisition entry recorded)
*RE = 66,000+4,200-7,200-60,000-2,400
Accumulated Depreciation - Plant & Equipment $38,400
Plant & Equipment (38,400-3,000) $35,400
Deferred tax asset (3,000*30%) $900
Business combination valuation reserve $2,100
(Plant & equipment recorded at fair value)
Depreciation expense (3,000/10) $300
Retained Earnings (1 July 18) (3,000/10*4*70%) $840
Deferred tax asset (1,500*30%) $450
Income tax expense (300*30%) $90
Accumulated depreciation - Plant & Equipment $1,500
(Depreciation on fair valuation)
Amortization expense (15,000/5) $3,000
Retained Earnings (1 July 18) (15,000/5*4*70%) $8,400
Income tax expense (3,000*30%) $900

Transfer from business combination valuation reserve $10,500
(Amortization expense of patent recorded)
Transfer from business combination valuation reserve $10,500
Business combination valuation reserve $10,500
(Transfer of amount)