Accounting for Goodwill: An Alternative

The accounting for a business combination is outlined in chapter 11. The calculation of goodwill is strange. It is a plug, the difference between the price paid by the acquirer and the total of the fair value of acquired tangible assets and the identified intangible assets acquired. This is the only time in accounting where something is valued with a plug number rather than with attribution. What is the acquirer buying when buying goodwill? There are fundamentals behind the plug to be recognized.

There are other issues with the accounting. The total of the fair value of individual assets acquired comes into the calculation, but we understand that, in business, values come from using assets together; fair value of assets is not the sum of their fair values. Yet is another issue: Acquirers pay a premium over the stand-alone price of the target, but this is not recognized in the accounting even though that is usually deemed to be the value added in the merger.

Here is an alternative accounting. Your will recognize it as applying the valuations in this book.

1. Record the acquired assets at their book value in the target’s balance sheet. This is the first component of the building block diagram in chapter 4.
2. Record the additional fair value that those assets generate jointly based on the earnings those assets generate. This is the value added to book value in the no-growth value in chapter 4, the second component of the building block diagram.
3. Record the difference between the no-growth value and the stand-alone price of the target before the acquisition offer as the value of growth in the target that is purchased. This is the third component of the building block diagram.
4. Recognize the difference between the stand-alone price of the target^2Mthe price premium paid^2Mas the added value of the combination.

Components 1‒3 are just the calculation of what an investor is buying, as in chapter 4. Component 4 is the value of the so-called synergies. Components 3 and 4, the excess of fair value of net assets acquired (jointly) and the purchase price can be called goodwill. But now the economic value behind the goodwill is identified.

That identification also guides the impairment of goodwill, for now we see what is to be impaired: Is the growth value in (3) lower than what was paid for? Has the value of the combination not been realized?

See Oh, H. and S. Penman. 2025. A Proposal for Goodwill Accounting, forthcoming, Abacus.