Goodwill is an intangible asset that normally arise at the time of acquisition of one company by another at a price higher than the investee company’s fair value of its net assets. The value of goodwill is usually determined by the intrinsic value of brand name, customer base, patents, proprietary technology and the like.
Once the value of goodwill is determined and accounted for in the company that acquired it, as a rule of thumb it must be assessed annually for any impairment at the balance sheet date to ensure they are carried at fair values as per the provisions of Australian Accounting standards. The value attributed to goodwill may not only affect the financial position but also the performance reported.
Business need to ensure that financial statement assertion of “valuation” is properly evaluated to avoid any material misstatement while carrying value of goodwill in the books. Goodwill once recorded in the financial statements cannot be revalued upwards in majority of the cases.
As owners/directors of the company, we are our best judge when it comes to valuation of “goodwill” as this will involve a fair bit of estimation and judgement which should always be in line with prudent market and economic conditions.
Key aspect of a proper goodwill valuation / impairment testing is getting right the variables used in the value calculation. Basic inputs include:
- Current year results
- Capital expenditure budgets for the projected years
- Company’s cost of capital
- Growth rate in company’s profits
- Discount rates
Depending on the size of the organisation cost of equity would include apart from the risk-free rate, a market risk premium/small company premium and market risk. The debt to equity ratio will also have an impact on the final numbers. Growth rates to the company’s profitability need to be realistic and justifiable which should be determined on the trend of past performance of the company and take into consideration the current market and economic conditions surrounding the company’s line of business/field of operations. Given the subjectivity of elements of impairment calculations, all assumptions and key uncertainties are required to be part of the disclosures in the financial statements.
Impairment assessments generally require expert assistance from an accountant and we encourage all directors and management to utilise such expertise when determining the value of goodwill and when undertaking impairment assessments. We are experienced in establishing robust impairment models utilising management knowledge of the market in which it operates and information on goodwill impairment is also available on the ASIC website. Just search for ‘Impairment of non-financial assets: Materials for directors’.
Detailed information on goodwill impairment available at the below website of ASIC:
ASIC guidance on impairment of non-financial assets
Written by the Audit team at DFK Collins