In this session we shall look at how goodwill is calculated for inclusion as a non-current assets in the Statement of Financial Position. We shall look at how it is initially calculated and then and calculated subsequently.
Goodwill
When the parent company of a subsidiary company prepares its consolidated financial statements it will calculate the value of any goodwill that should be included in the consolidated statement of financial position.
Note that only purchased goodwill should be recorded in a set of financial statements. Internally generated goodwill, that is, the goodwill created by a company itself, should not be recorded as a company asset.
Goodwill at the end of a financial period is calculated as follows:
Goodwill on acquisition less accumulated impairments of goodwill
Calculating goodwill on acquisition
IFRS 3 tells us that goodwill on acquisition should be calculated as follows:
The above is the formula we will use in all the examples below. We will also however, use an alternative method that many find easier to remember (in truth this alternative is simply a rearrangement of the above formula). This alternative is as follows.
Goodwill equals the amount paid by the parent for its investment less the parent’s share of the fair value of the subsidiaries’ identifiable net assets
Illustration 1: Where the parent has purchased all of the subsidiary and the carrying values of the subsidiary’s assets and liabilities is the same as their fair values
Pi Ltd paid £1,000,000 for 100% of Chi Ltd’s shares. The carrying value of Chi Ltd’s identifiable assets and liabilities are the same as their fair value. Chi Ltd’s statement of financial position as at the date of its acquisition by Pi Ltd is shown below.
Note that there are no non-controlling interests in this example as the parent owns all of the subsidiary’s shares. As a result the non-controlling interest’s share of the fair value of the assets acquired less the liabilities assumed is £nil.
The calculation of goodwill is as follows:
Alternative calculation: (amount paid less fair value of parent’s share of net assets). That is, £1,000,000 – £888,000 x 100% = £112,000
Question
Parent Ltd has purchased all the share capital of Subsidiary Ltd for £825,000. At the date of acquisition Subsidiary Ltd had identifiable assets with a carrying value of £920,000 and identifiable liabilities with a carrying value of £290,000. The fair values of Subsidiary Ltd’s assets and liabilities is the same as their carrying values.
Calculate the goodwill on acquisition
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- Amount paid was £825,000
- Non-controlling interest’s share was £0 (nb. there are no non-controlling interests as Parent Ltd owns all the share capital of Subsidiary Ltd)
- Fair value of Subsidiary Ltd’s net identifiable assets was £630,000 (i.e. £920,000-£290,000)
- Goodwill at acquisition was £195,000 (i.e. £825,000 – £630,000)
Illustration 2: Where the parent has purchased a majority of the subsidiary and the carrying values of the subsidiary’s assets and liabilities is the same as their fair values
Rho Ltd paid £350,000 for 80% of Nu Ltd’s shares. The carrying value of Nu Ltd’s identifiable assets and liabilities are the same as their fair value. Nu Ltd’s statement of financial position at the date of acquisition is shown below.
The calculation of goodwill is shown below.
Alternative calculation: (amount paid less fair value of parent’s share of net assets). That is, £350,000 – £304,815 x 80% = £106,148
Question
Ma Ltd has acquired 85% of the total share capital of Son Ltd for £205,000. Son Ltd has identifiable net assets with a carrying value of £182,500. The fair value of these net assets is the same as their carrying value.
Calculate the goodwill on acquisition
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- Amount paid was £205,000
- Non-controlling interest’s share was £27,375 (i.e. £182,500 x 15%)
- Fair value of Son Ltd’s net identifiable assets was £182,500
- Goodwill at acquisition was £49,875 (i.e. £205,000 + £27,375 – £182,500)
Illustration 3: Where the parent has purchased a majority of the subsidiary and where the carrying values of the subsidiary’s identifiable assets and liabilities is the same as their fair values with one exception
Omicron Ltd paid £175,000 for 60% of Psi Ltd’s shares. The carrying value of Psi Ltd’s identifiable assets and liabilities are the same as their fair value with the exception of a property that has a carrying value of £50,000 and a fair value of £120,000 (an increase of £70,000).
Omicron Ltd’s statement of financial position as at the date of acquisition is shown below.
When calculating goodwill we must use the fair value of the subsidiaries’ assets and liabilities rather than their carrying value. We will therefore have to add £70,000 to their value to take into account the higher value of the property
Alternative calculation: (amount paid less fair value of parent’s share of net assets). That is, £175,000 – (£173,660 + £70,000) x 60% = £28,804
Question
Da Ltd has purchased 70% of the shares in Kid Ltd for £150,000. At the acquisition date, Kid Ltd had identifiable assets with a carrying value of £390,000 and liabilities of £260,000. The assets include a piece of land that had a carrying value of £30,000 but a fair value of £80,000. The fair value of all other assets and liabilities were the same as their carrying value.
Calculate the goodwill on acquisition
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- Amount paid was £150,000
- Non-controlling interest’s share was £54,000 [i.e. £180,000 x 30% (see below)]
- Fair value of Kid Ltd’s net identifiable assets was £180,000
- Goodwill at acquisition was £24,000 (i.e. £150,000 + £54,000 – £180,000)
Note. The fair value of the identifiable assets less the liabilities assumed is £180,000 which is calculated as £390,000 – £260,000 – £30,000 + £80,000
Illustration 4: A further example where the parent company has bought a majority of the subsidiary and the carrying values of assets and liabilities equals their fair values
Upsilon Ltd paid £100,000 for 90% of Eta Ltd’s shares. The carrying value of Eta Ltd’s assets and liabilities are the same as their fair value. Eta Ltd’s statement of financial position at the date of acquisition is shown below.
This time when we calculate goodwill we end up with a negative number. This tells us that we are not actually dealing with goodwill but with a Bargain Purchase.
Alternative calculation: (amount paid less fair value of parent’s share of net assets). That is, £100,000 – £119,650 x 90% = £(7,685); i.e. a bargain purchase
Unlike goodwill, a bargain purchase is treated as a gain and will be added to the group’s retained earnings.
Question
Papa Ltd has purchased 55% of the shares of Baby Ltd for £410,000. The fair value of the identifiable assets acquired less the liabilities assumed is £780,000.
Calculate the bargain purchase on acquisition
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- Amount paid was £410,000
- Non-controlling interest’s share was £351,000 (i.e. £780,000 x 45%)
- Fair value of Baby Ltd’s net identifiable assets was £780,000
- Bargain purchase on acquisition was £19,000 (i.e. £410,000 + £351,000 – £780,000)
Illustration 5: Where the parent company has purchased a majority of the subsidiary and the carrying value of the subsidiary’s identifiable assets and liabilities is the same as their fair values with one exception
[Note: the difference with this and the above examples is that we are not given the subsidiary’s statement of financial position at the date of acquisition but are told what the subsidiary’s capital and reserves are at that date. This information is enough for goodwill to be calculated as the total of a company’s capital and reserves is the company’s equity and the accounting equation tell us that equity equals assets less liabilities (i.e. its net assets).]
Zeta Ltd purchased 75% of the shares in Sigma Ltd for £150,000. At the date of acquisition the share capital and reserves of Sigma Ltd were:
- Share capital £1,000
- Reserves £118,000
At the date of acquisition the carrying value of Sigma Ltd’s identifiable assets and liabilities are the same as their fair values with the exception of a property. The property has a carrying value of £46,000 and a fair value of £100,000 (a difference of £54,000).
The calculation of goodwill is shown below.
Alternative calculation: (amount paid less fair value of parent’s share of net assets). That is, £150,000 – (£1,000 + £118,000 + £54,000) x 75% = £20,250
Question
Mater Ltd has purchased 90% of the shares in Filium Ltd for £995,000. At that date Filium Ltd’s equity consisted of share capital of £250,000 and retained earnings of £620,000. The fair values of Filium Ltd’s identifiable assets and liabilities at that date was the same as their carrying values.
Calculate the goodwill on acquisition
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- Amount paid was £995,000
- Non-controlling interest’s share was £87,000 [i.e. (250,000 + 620,000) x 10%)
- Fair value of Filium Ltd’s net identifiable assets was £870,000 (i.e. 250,000 + 620,000)
- Goodwill at acquisition was £212,000 (i.e. £995,000 + £87,000 – £870,000)
Question
Pater Ltd has purchased 75% of the shares in Filia Ltd for £1,100,000. At that date Filia Ltd’s equity consisted of share capital of £500,000 and retained earnings of £450,000. The assets of Filia Ltd at the acquisition date included a property with a carrying value of £40,000 that had a fair value of £120,000.
Calculate the goodwill on acquisition
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- Amount paid was £1,100,000
- Non-controlling interest’s share was £257,500 [i.e. 1,030,000 x 25% see note below]
- Fair value of Filia Ltd’s net identifiable assets was £1,030,000 (see note below)
- Goodwill at acquisition was £327,500 (i.e. £1,100,000 + £257,500 – £1,030,000)
Fair value of Filia Ltd’s identifiable net assets was £1,030,000 which has been calculated as £500,000 + £450,000 – £40,000 + £120,000
Valuing Goodwill subsequently
Goodwill that has been recorded in the consolidated statement of financial position should be reviewed annually for impairment.
If goodwill is not impaired, it will continue to be recorded as a non-current asset at the same value.
If however, goodwill is impaired, an impairment loss should be recorded. This impairment loss will reduce the value of goodwill in the statement of financial position and will also be recorded as an expense in the statement of profit or loss.
Question
Mum Ltd has purchased 60% of the share capital of Child Ltd for £80,000. At the date of acquisition Child Ltd’s equity totalled £100,000 and on that date the fair values of Child Ltd’s assets and liabilities was the same as their carrying values.
At the end of Mum Ltd’s financial year, its directors identified that goodwill in Child Ltd had been impaired by £5,000.
a) Calculate the goodwill at acquisition
b) Calculate the goodwill at the financial year-end
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a) The goodwill at acquisition was £20,000 [i.e. 80,000 + (100,000 x 40%) – 100,000]
b) The goodwill at the financial year-end was £15,000 [i.e. £20,000 – £5,000]
