Explaining nature of goodwill and its accounting

This memorandum explains the nature of goodwill and its relevant accounting treatment. It discusses the types of goodwill, accounting treatment for internally generated and acquired goodwill, and the recognition and impairment testing of goodwill in a business combination.

Solution-1
MEMORANDUM
Date: 9th May, 2019
To: Ms Picos, The Chief Financial Officer
From: The accountant
Subject: Explaining nature of goodwill and its accounting
This memorandum is prepared to explain the nature of goodwill and its relevant accounting treatment.
The details are as below:
Nature of Goodwill
Goodwill is an intangible asset, which has no physical substance or presence, but some future economic
benefits to the entity. Since, it is an intangible item, hence determining its cost is very difficult. The
goodwill can be of two type, one is internally generated goodwill, and another is acquired goodwill.
Accounting treatment of goodwill
According to accounting standards, internally generated goodwill can only be recorded in the financial
statements, if it has future economic benefits for the entity and its cost can be reliably measured. On the
other hand, acquired goodwill arises when a company purchases another company paying consideration
more than its fair value of net assets acquired.
Hence, during a business combination, the goodwill is the excess of consideration paid over the net book
value of the assets acquired. This excess or goodwill represents the future economic benefits that an entity
will be getting due to acquisition of other assets in the business combination. In other words, the benefit
of synergy can be called as goodwill. As in the given case, Patagonia Ltd acquired Salto Ltd. and has paid
excess consideration of $50,000 as compared to net book value of the assets of Salto Ltd. This excess will
be shown as goodwill on the asset side of the statement of financial position. Goodwill is a non-current
asset and is shown under the heading of intangible asset on the Assets side.
Hence, upon acquisition of Salto Ltd, the goodwill of $50,000 will be recognized in the books of
Patagonia Ltd. and going forward at each reporting period end, the company need to conduct an
impairment testing according to AASB 136. If upon the impairment testing, company finds that the

recoverable amount is less than the carrying amount, then the impairment loss on goodwill needs to be
book and to be charged off in the P&L against the goodwill.
The Accountant

Solution-2
(a) Acquisition analysis as on 1 July, 2014
Account titles Amount
Share Capital $180,000
General reserve $34,800
Retained Earnings $66,000
Fair valuation: Inventories $4,200
Fair valuation: Plant & equipment $2,100
Fair valuation: Patent $10,500
Goodwill already recorded -$7,200
Net fair value of assets acquired $290,400
Consideration paid
- in the form of equity shares of Padda Ltd $150,000
- in cash $60,000
- in artworks $90,000
Less: Dividend receivable -$12,000
Gain on bargain purchase/ negative goodwill $2,400
(b) Consolidation journal entries for Padda Ltd’s group at 1 July 2014
Particulars Debit Credit
Share Capital A/c $180,000
General reserve A/c $34,800
Retained Earnings A/c $66,000
Business combination valuation reserve A/c $9,600
Gain on bargain purchase A/c $2,400
Investment in Slang Ltd. A/c $288,000
(Being pre-acquisition entry recorded)
Dividend payable A/c $12,000
Dividend receivable A/c $12,000
(Being elimination of dividend recorded)
Inventories A/c $6,000
Deferred tax asset A/c $1,800
Business combination valuation reserve A/c $4,200

(Being inventories recorded at fair value)
Accumulated Depreciation - Plant & Equipment A/c $38,400
Plant & Equipment A/c $35,400
Deferred tax asset A/c $900
Business combination valuation reserve A/c $2,100
(Being plant & equipment recorded at fair value)
Patent A/c $15,000
Deferred tax asset A/c $4,500
Business combination valuation reserve A/c $10,500
(Being patent recognised in books)
Business combination valuation reserve A/c $7,200
Goodwill A/c $7,200
(Being adjustment passed in Goodwill)
Consolidation journal entries for Padda Ltd’s group at 30 June 2019
Particulars Debit ($) Credit ($)
Share Capital A/c $240,000
General reserve A/c $34,800
Retained Earnings (1/7/18) A/c * $600
Business combination valuation reserve A/c $12,600
Investment in Slang Ltd. A/c $288,000
(Being pre acquisition entry recorded)
* Retained earnings = 66,000+4,200-7,200-60,000-2,400
Accumulated Depreciation - Plant & Equipment A/c $38,400
Plant & Equipment A/c $35,400
Deferred tax asset A/c $900
Business combination valuation reserve A/c $2,100
(Being plant & equipment recorded at fair value)
Depreciation expense A/c $300
Retained Earnings (1/7/18) A/c $840
Deferred tax asset A/c $450
Income tax expense A/c $90
Accumulated depreciation - Plant & Equipment A/c $1,500
(Being depreciation on fair valuation recorded)
Amortisation expense A/c $3,000

Retained Earnings (1/7/18) A/c $8,400
Income tax expense A/c $900
Transfer from business combination valuation reserve A/c $10,500
(Being patent amortisation expense recorded)
Transfer from business combination valuation reserve A/c $10,500
Business combination valuation reserve A/c $10,500
(Being amount transferred)