Explaining nature of goodwill and its accounting

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