Accounting for goodwill: a historical review.

AuthorFeleaga, Liliana

    The development of industrial mass production has lead to a major change in the business world. The property function assumed by investors has gradually been entirely separated from the leadership function assumed by the managers. Additionally, the development of goodwill paralleled the development of business enterprise (Hughes, 1982). As the form of businesses changed from individual enterprises to corporations, goodwill was no longer attached to its owner's personality and became potentially transferable to other entities (Garcia).

    The treatment of goodwill has also evolved in line with global institutional changes. For example, in the US, the Dominion Companies Act was amended in 1917 to force companies to issue shares only after the capital has been fully paid in. Therefore, the difference between the fair value of the shares involved in the transaction and the fair value of the net assets in the case of business combinations has been capitalized under the term of goodwill. The recognition of goodwill has created a lot of controversy in the accounting world, and its measurement has been the object of numerous debates. Hughes' review (1982) goes as far as saying that "the accounting literature on goodwill appeared in periodicals or newspapers, such as The Accountant starting with 1874".

    The purpose of the present study is to propose a historical review of accounting for goodwill, seeking to identify the recognition and measurement methods with may eventually find their place in the international generally accepted accounting principles (GAAP). The remainder of this paper is structured as follows: the next section analyses the notion of goodwill; this is followed by a description of the controversies regarding its recognition and evaluation; the fourth section presents the evolution of the accounting policies regarding goodwill in the international standards; the last section offers the conclusions of this paper and some recommendations for future research.


    The issue of goodwill has been fiercely debated for many decades. In spite of numerous academic and practitioner efforts, there is still not widely accepted definition and recording method for goodwill. To clarify this notion, the scientific literature (Epingard, 1999) usually presents different methods regarding the measurement of goodwill, of which we acknowledge the following:

    * Goodwill is calculated as the difference between the global real value of an enterprise and the fair value of the identifiable elements as net assets. This subtractive method is preferred by professionals because it is straightforward, but it also has a major drawback since it does not account specifically for intellectual capital.

    * Goodwill can be determined on an additive procedure, by aggregating the value of its components (patents, licenses, trademarks, distribution networks etc.). The main drawback is that the additive method ignores the interdependence between the components of goodwill and its effects on the financial performance of the enterprise, thus being the least used method of calculation.

    * Goodwill can also be determined based on the estimation of managers regarding the capacity of the enterprise to produce a return superior to that from a riskless investment of capital. From a practical standpoint, this method entails the identification of future cash flows, of outflows to shareholders in the form of dividends and of the surplus from selling the control in the company.

    Within the limits of the International Financial Reporting Standards (IFRS), goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized (IFRS 3, 2007). The definition effectively confirms that the value of the business overall is more than the sum of the accountable and identifiable net assets.


    A widely discussed aspect in the literature is whether goodwill is really an asset in the full sense of the word. According to Spacek (1964), goodwill is not an asset, but a cost to the buyer of earnings in excess of the cost of the assets required to produce those earnings. Catlett & Olson (1968) add that basing the valuation of goodwill on shares' price represents nothing but the stock market's speculation about the company's future. Moreover, Schuetze (2001) considers that goodwill cannot be recognized as an asset because it does not comply with the definition of IAS 38 for intangible assets, i.e. goodwill cannot be sold separately from the enterprise acquired, thus being an accounting residual in nature.

    These aforementioned ideas start from the fact that the accrual of an expense does not necessarily lead to the creation of an asset. However, the following definition must be brought into the discussion, according to the IFRS Conceptual Framework: an asset is a resource under the company's control, coming from past operations and expected to generate future economic benefits. Therefore, goodwill can be seen as an asset controlled by an entity as long it will generate future economic benefits because of its capacity to interact with other assets in an enterprise, as a result of a past event, i.e. the business combination. On the same note, Paton (1968) highlights that assets are not inherently tangible or physical. An asset is an economic quantum and the distinction between tangibles, so-called, and intangibles, so-called, is not a fundamental line of cleavage. In principle, the intangible asset is just as admissible to the respectable, recognizable company of business property as something you can stub your toe on.

    Goodwill can be created in the context of economic activity or can emerge as the results of an acquisition of an entity, the latter situation being called "purchased goodwill". To prevent the situation in which some companies may obtain an unlawful advantage by valuing their own assets and thus producing more favourable balance sheet, goodwill is recognized by accounting standards only when it is purchased. One of the issues crucial...

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