Goodwill Arising on Amalgamation and Its Amortisation

In one line

Goodwill on amalgamation is the excess of the consideration over the net assets acquired, and it must be amortised to income over its useful life, not exceeding five years unless a longer period can be justified.

Where it comes from

Paragraph 37, worked in the last two chapters: any excess of the consideration over the value of the net assets acquired is recognised as goodwill arising on amalgamation.

It arises only under the purchase method. Pooling cannot produce it.

What paragraph 19 says it is

Goodwill arising on amalgamation represents a payment made in anticipation of future income and it is appropriate to treat it as an asset to be amortised to income on a systematic basis over its useful life.

That sentence contains the justification for everything that follows. It is a payment for income not yet earned. As the income arrives, the payment is written off against it.

Paragraph 19 also records the practical difficulty: it is frequently difficult to estimate the useful life of goodwill with reliability, and such estimation is therefore made on a prudent basis.

Paragraph 38: the rule

The goodwill arising on amalgamation should be amortised to income on a systematic basis over its useful life. The amortisation period should not exceed five years unless a somewhat longer period can be justified.

Three things to say precisely.

It is amortised to income, meaning charged to the Profit and Loss Account. It is not written off against reserves and not left standing.

Five years is a ceiling, not a term. A useful life of three years means three years. The standard does not permit five where three is the honest estimate.

A longer period is possible but must be justified, and the standard's word is "somewhat" longer, which does not invite twenty.

Paragraph 20: the factors

Paragraph 20 lists what may be considered in estimating the useful life of goodwill arising on amalgamation:

• the foreseeable life of the business or industry;
• the effects of product obsolescence, changes in demand and other economic factors;
• the service life expectancies of key individuals or groups of employees;
• expected actions by competitors or potential competitors; and
• legal, regulatory or contractual provisions affecting the useful life.

A question asking why goodwill should be amortised over a longer or shorter period is asking for these.

The entry

On goodwill of Rs 45,000 amortised over five years:

Repeated for five years, the Goodwill Account closes.