Question

 

Goodwill and Reported Net Income

An income statement is a report on a company’s financial performance over a period of time. The measure of an amount that a company has earned during a period of time is known as net income.

The income statement is the financial representation of the operating activities of a company during a period of time. Net income is the measure of an amount that a company has earned during a period of time. In an income statement the line items of revenues, expenses, gains, and losses in a bid provide an explanation of how a firm earned its net income.

Instructions

1. What is goodwill?

2. When should a firm measure it and how does it affect that firm’s reported net income, if at all?

Answer 1

1) Goodwill is an intangible asset that is associated with the purchase of one company by another. Specifically, goodwill is the portion of the purchase price that is higher than the sum of the net fair value of all of the assets purchased in the acquisition and the liabilities assumed in the process.

2) A company should measure goodwill when it buys another firm.Goodwill on the balance sheet ordinarily doesn't have any effect on net income. But each year, companies must analyze the current value of their acquisitions. This is called "testing for impairment." If they conclude that the acquisitions are worth at least as much as the value assigned to them on the balance sheet, there's no problem. But if their market value has fallen below the "book value," the value on the balance sheet must be written down. If the company decides it has too much goodwill, then goodwill is impaired. The company writes down goodwill by reporting an impairment expense. The amount of the expense directly reduces net income for the year. So a $10,000 goodwill impairment expense means a $10,000 reduction in net income.