Question

How do you amortize goodwill? provide an example.

Answer 1

Amortization is similar to that of depreciation. The difference is that depriciation is for tangible assets and amortization is for intangible assets. Amortization is basically, reduction in the value of an intangible asset, example- goodwill, patent, copyright. over the useful life of an intangible asset in the systematic manner, means every year amortization expense is recorded and the reduced value of an intangible asset is shown in the balance sheet.

Goodwill is the excess of the amount paid over the purchase value of the asset or business.

Example - X Limited purchased asset from H Limited for $20000 having purchase value of $10000.

Difference of $10000 ($20000- $10000) is goodwill.

In the books of H Limited -

Generally, useful life of intangible asset is considered to be of 10 years, unless other estimate of useful life is available with evidence.

Amortization expense to be recorded every year -

Cost of goodwill / useful life

= $10000 / 10

= $1000

Now, in 1st year, amortization expense is recorded for $1000. The balance of goodwill for 1st year is =

$10000 - $1000 = $9000

This $9000 will be shown in Balance sheet ending for 1st year.

Journal entry to record amortization =

Amortization expense $1000

Intangible asset $1000

Amortization is an expense and every expense is a debit account. And goodwill is an asset and asset is also a debit account. When expense is made, it is debited and it reduces the value of an intangible asset by the corresponding amount, so reduction in value of an asset leads to credit of asset account.

Note -

It is to be noted that under IFRS and US GAAP does not allow for amortization of goodwill, because these standards assume goodwill for indefinite life period.