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How Good Will Goodwill be? The diamond mining companies, the and sightholders, the manufacturers and retailers have all invested heavily in building up brands. These brands are intangible assets, but after spending millions of dollars developing a brand, what have you got to show for it, or what are you allowed to show on your balance sheet? These brands are classified under goodwill, a word which has a lot of definitions, such as
In fact, all are correct. If a company builds up a brand or reputation then that can be classified as goodwill. If ABC Ltd has a good reputation in the market, the book value of the company is $4m and it is bought for $5m, then the extra $1m is also goodwill. The rule of thumb is that goodwill generated internally is expensed as it is incurred. But goodwill that is purchased is recorded in the balance sheet. IFRS 3 para 51 states: Goodwill is recognised by the acquirer as an asset from the acquisition date and is initially measured as the excess of the cost of the business combination over the acquirer's share of the net fair values of the acquiree's identifiable assets, liabilities and contingent liabilities. Paragraph 54 of IFRS 3 prohibits the amortisation, or depreciation, of goodwill. Instead goodwill must be tested for impairment at least annually in accordance with IAS 36 Impairment of Assets And, the goodwill has to be attributed to the cash generating entity at which the goodwill is monitored for internal management purposes. A cash-generating unit to which goodwill has been allocated shall be tested for impairment at least annually by comparing the carrying amount of the unit, including the goodwill, with the recoverable amount of the unit: [IAS 36.90]
If the value of the goodwill has been impaired then the loss should be recognised immediately in the profit and loss account, first for the cash generating entity and if there is balance pro rata over the rest of the company. Relevance for the diamond industry. As mentioned in the introduction, a lot of money has been invested in brand building, but which has been expensed as it was incurred. However, if a sightholder buys a company at a premium in order to obtain the rights to a brand, then that premium can be recognised as an asset, or CAPEX in DTCtalk. Careful structuring of the company in which a brand is going to be developed, which is then purchased will create the intangible asset that can be capitalised on the balance sheet of the acquiring company. Negative Goodwill As mentioned previously, when a company is purchased at a premium, the premium can be recorded as an intangible asset in the balance sheet called goodwill. But if the company is bought at a discount, when the balance sheets of the parent and subsidiary are consolidated, there will be a shortfall in the equity. This shortfall is called negative goodwill, and according to IFRS 3 it must be written off immediately in the profit and loss account. Until recently, this would have appeared as an extraordinary profit, but now it should be included above the line in the P & L and explained in a note to the accounts. Also, it has to be shown in the changes in equity statement, which for some reason the DTC does not require. Depending on the nature of the surplus of assets determines where the write off will appear. If the assets are sufficiently similar to the goods sold by the acquiring company, your auditor may allow the extra profit to go to cost of goods sold and thereby improve your gross profit performance. Let’s say that EFG Ltd wants to buy LMN NV for $2m on 1st January X7. At 31st December X6, assuming only $1 of share capital in each company, their balance sheets were:
After the acquisition, the consolidated balance sheet will be as follows:
But if the acquisition was for only $0.5m then the consolidated balance sheet will look like:
Relevance for Diamond Companies If the development of a brand is carried out in a separate company which is independent of the sightholder group and using external funding, then when it is clear that the brand is robust enough to survive an impairment test, the company can be purchased, either at a discount or a premium. If at a premium, then an intangible asset called goodwill is created. If at a discount, then an opportunity to create some profit is created. But if the brand does not take-off then the loss is kept off the balance sheet.
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