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Goodwill can be described as the additional value obtained from an acquisition over and above the value of the net assets acquired. This additional value does not last for ever. Like other non-current assets, its value erodes over time. It is therefore appropriate to depreciate or amortise goodwill over a number of years after a subsidiary has been acquired.

When goodwill is amortised:

• The charge for amortisation each year is treated as an expense in the consolidated income statement.
• The value of goodwill in the consolidated balance sheet is its original value minus accumulated amortisation.

The goodwill arising at acquisition must be amortised (depreciated) over its estimated economic life, through the income statement. In the example of goodwill on consolidation, the goodwill on acquisition amounted to $1,000.

Example

A was incorporated on 1 January 20X5. On 1 January 20X7 it acquired 100% of the ordinary shares in B which was incorporated on that day. Two years later, on 31 December 20X9, the balance sheet of the two companies were as follow.

If we assume a life of ten years for this goodwill. Prepare a consolidated balance sheet at 31 December 20X9 for A and its subsidiary.

Solution

• The amoritisation is: $1000/10*3 = $300. The amoritisation through the income statement at $100 per year has reduced the accumulated profit balance.
• Non-current assets: $15,000 + (1000 – 300) = $15,700
• Accumulated profits: $10,000 + 3,000 – 300 = $12,700

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If the parent pays more for the investment in the subsidiary than the value of the subsidiary’s net assets, the difference represents the amount paid for the unrecorded goodwill in the subsidiary.

Example

• A: the investment in B is $6,000
• B: the share capital is $5,000.

The calculation shows that A paid $1,000 more than their value for the assets of B. The difference is goodwill, defined as the difference between the cost of an entity and the fair values of that entity’s net assets.

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Example

A was incorporated on 1 January 20X5. On 1 January 20X7 it acquired 100% of the ordinary shares in B which was incorporated on that day. Two years later, on 31 December 20X9, the balance sheet of the two companies were as follow.

Prepare a consolidated balance sheet at 31 December 20X9 for A and its subsidiary.

Solution

• Non-current assets: $10,000 + $5,000 = $15,000
• Net current assets: $5,000 + $3,000 = $8,000
• Share capital: $10,000. The $5,000 investment in B appearing in the A balance sheet is cancelled by the $5,000 share capital in the balance sheet of A.
• Accumulated profits: $10,000 + $3,000 = $13,000.

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When one company invests in another, the investment appears as an asset in the investor’s balance sheet, and dividends received are credited to the income statement. To reflect the ture nature of the relationship between the parent company and the subsidiary, the two companies can be recognised as a single entity because the subsidiary is controlled by the parent.

Consolidated accounts is the name given to the accounting techniques which seek to reflect the ture position, as regards both profits and assets, when one company controls another. The parent company prepares consolidated accounts incorporating the results of the whole group.

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The financial statements should disclose the following for capitalised development costs:

• the amortisation method used and the expected period of amortisation
• a reconciliation fo the carrying amounts at the beginning and end of the period, showing new expenditure incurred, amortisation and amounts written off because a project no longer qualifies for capitalisation
• amortisation during the period.

In addition, the financial statements should also disclose the total amount of research and development expenditure recognised as an expense during the period.

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Research is original and planned investigation undertaken with the prospect of gaining new knowledge and understanding.

Development is the application of research findings.

Research expenditure

No intangible asset arising from research should be recognised.

Development expenditure

An intangibel asset arising from development should be recognised if, and only if, an enterprise can demonstrate all of the following:

• the technical feasibility of completing the intangible asset so that it will be available for use or sale
• its intention to complete the intangible asset and use or sell it
• its ability to use or sell the intangible asset
• how the intangible asset will generate probable future economic benefits. Among other things, the enterprise should demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.
• the availability of adequate technical, financial and other resources to coplete the deveplopment and to use or sell the intangible asset
• its ability to measure reliably the expenditure attributable to the intangible asset during its development.

The amount to be includeed is the cost of the development. Note that expenditure once treated as an expense can’t be reinstated as an asset.

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In the balance sheet accounts payable, “Cr” insteads increasing and “Dr” insteads decreasing. The accounts payable are liabilities in the balance sheet. They are shown like this:

• Liabilities
• Non-current liabilities
• Long-term borrowings
• Deferred tax
• Long-term provision
• Current liabilities
• Trade and other payables
• Short-term borrowings
• Current portion of long-term borrowings
• Current tax payable
• Short-term provisions

Liabilities are the financial obligations of an enterpeise. They may arise as a result of a trading transaction or may represent the obligation to repay monies borrowed by the enterprise.

Examples are trade account payable, loans from a bank, and accruals made at the year end before an invoice has been received.

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There is a possible situation where a debt is written off as bad in one accounting period, perhaps because the debtor has been declared bankrupt, and the money, or part of the money, due is then unexpectedly received in a subsequent accounting period.

When a debt is written off, the double entry is:

The full doube entry for the cash being received is:

and

These can be simplified to:

As the debit and crdit to the receivables account cancel each other out. However, it may be useful to pass the transaction through the customer’s account so that the fact that the debt was eventually paid, or paryly paid, is recorded there.

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A bad debt written off is considered to be uncollectable, a doubtful debt allowance is some doubt as to its collectability.

As known, a bad debt written off is as an expense shown in the income statement. It is considered to be uncollectable. A doubtful debt allowance is an amount owing to the business concerning which there is some doubt as to its collectability. It’s for purdent and reasonable and shown under the accounts receiable.

When a bad debt ocurred, the expense is written off in the bad debts expense account but this time the debt is not removed from receivables. Instead, an allowance is set up which is a credit balance. This is netted off against trade receivables in the balance sheet to give a net figure for receivables that are probably recoverable.

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Example to explain and analyse the allowance for doubtful debt.

Aspring has accounts receivable of $11,200 at his year end of 31 May 20X9. Of these he decides that there is some doubt as to whether or not he will receive a sum of $500 from B and he also wishes to allow for the possibility of not receiving 2% of his remaining receivables.

At 1 June 20X9 Aspring had a balance on his allowance for doubtful debts account of $230.

Solution:

Step1

Calcuate the allowance for doubtful debts required at 31 May 20X9.

Step2

Write up the allowance for doubtful debts account, putting in the opening balance of $230 and the closing balance required of $714. The difference is the expense to the bad debts expense account and subsequently to the income statement.