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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.