International Financial

Report Standards
BUSINESS COMBINATIONS (GOODWILL)
 Introduction

 Companies combine their businesses in order to maximize the value of the enterprise.
 Business combinations should be the result of strategic planning and clear objectives to
achieve the desired success.
 Business combinations types :
1. Horizontal :- Two companies operating in the same sector, for example in the computer
production sector.
2. Vertical :- Two companies complement each other, for example, a company operating in the
Cars sector and the other operating in the Planes sector.
3. Mixed :- For example, a company operating in the production of radio and the other in the
production of televisions sector.
4. Goodwill is a long-term (or noncurrent) asset categorized as an intangible asset. Goodwill arises
when a company acquires another entire business. The amount of goodwill is the cost to
purchase the business minus the fair market value of the tangible assets, the intangible assets
that can be identified, and the liabilities obtained in the purchase.
 IFRS (Goodwill)

 Business combinations the international rules related to initial measurement of goodwill. Goodwill is
recognized only in a business combination and is measured as the different between :
A. The consideration transferred by the acquiring firm plus any amount recognized as non-controlling
interest.
B. The fair value of net assets acquired (Assets acquired – Liabilities assumed).

 When A exceeds B, The difference called a “Goodwill” and recognized as an assets.

 When A is less than B , The difference called a “Negative Goodwill” and recognized as again in net
income by the acquiring firm.
IFRS (Goodwill)

 The amount recognized as goodwill depends on the option selected to

measure any non-controlling interest in the acquired company that might
exist.
 Non-controlling interest measure at :
1. A proportionate share of the fair value of the acquired firm’s net assets
excluding goodwill.
2. Fair value which includes the non-controlling interest share of goodwill.
 Example : initial measurement of goodwill

 George company acquired 90% of the outstanding shares of Chris company by paying $360,000 in
cash. The fair value of Chris’s identifiable assets is $320,000, and the liabilities assumed by George in this
business combination are $40,000.
1. Non-controlling interest measure at proportionate share of the fair value of the acquired firm’s net assets excluding goodwill.

The fair value of Chris’s identifiable net assets is $320,000 – $40,000 $280,000
Non-controlling interest percentage 10%
Equal : Non-controlling interest $28,000
consideration transferred $360,000
Plus : Non-controlling interest $28,000
Equal : $388,000
Less : fair value of Chris’s identifiable net assets ($280,000)
Goodwill $108,000
 OR

Goodwill= Investment cost –(investment%*Net assets ) .

Investment cost = 360,000
Investment % = 90%
Net assets = 280,000
Goodwill = 360,000-(90%*280,000) =
= 108,000
 Example : initial measurement of goodwill

2. Non-controlling interest measure at Fair Value.

Implied fair value of 100% Chris’s Co. $360,000 / 90% $400,000

Non-controlling interest percentage 10%
Equal : Non-controlling interest $40,000
consideration transferred $360,000
Plus : Non-controlling interest $40,000
Equal : $400,000
Less : fair value of Chris’s identifiable net assets )$280,000)
Goodwill $120,000

360,000 investment in Chris

360,000 Cash
 Example 2 : Gain on Bargain Purchase (Negative Goodwill)

 George company acquired 90% of the outstanding shares of Chris company by paying $240,000 in
cash. The fair value of Chris’s identifiable assets is $320,000, and the liabilities assumed by George in
this business combination are $40,000.

Non-controlling interest $28,000

consideration transferred $240,000
Plus : Non-controlling interest $28,000
Equal : $368,000
Less : fair value of Chris’s identifiable net assets ($280,000)
Negative Goodwill ($12,000)

 The Gain from Bargain Purchase would recognized in net income in the year in which the acquisition
take place
 OR

 Goodwill= Investment cost –(investment%*Net assets ).

 Investment cost = 240,000
 Investment = 90%
 Net assets = 280,000
 Goodwill=240,000-(90%*280,000) =(-12,000)
 What is goodwill?

 Before we explain how to test goodwill for impairment, you need to

understand what a goodwill is all about.
 The definition of goodwill from the standard IFRS 3 Business
Combinations tells us that a goodwill is “an asset representing the
future economic benefits arising from other assets acquired in a
business combination that are not individually identified and
separately recognized” (IFRS 3, Appendix A).
 Impairment of goodwill

 As an indefinite-lived intangible assets, goodwill is not amortized. Instead

goodwill must be tested at least annually for impairment.
 Impairment testing of goodwill is performed at the level of the cash-generating
unit (CGU) .
 The CGU is “the smallest identifiable groups of assets that generates cash inflows
that are largely independent of the cash inflows from other assets or groups of
assets”. the impairment test is conducted by comparing the carrying value of
the entire CGU ,including goodwill attributable to that CGU, with its recoverable
amount. The recoverable amount is the hire of the CGU’S (1) value in use and
(2) fair value less costs to sell. Under US GAAP, Impairment of goodwill is tested at
the level of the “Reporting unit”, which can be different (typically larger) than a
cash-generating unit.
 If non-controlling interest was originally measured at the proportionate
share of net assets (alternative 1 ), Then The Carrying value of the entire
CGU must be increased by the amount of goodwill attributable to the
non-controlling interest (as if alternative 2 had been applied).
 The impairment loss on the CGU is the amount by which the CGU’S
carrying out , including goodwill, exceeds its recoverable amount.
 An impairment loss identified at the CGU level is first applied against
goodwill . Ones goodwill has been eliminated, any remaining
impairment is allocated to the others assets of the CGU on a prorated
bases based on their relative carrying amount.
 Example : Impairment of goodwill

Continuing with the example presented earlier ,the goodwill

related to the acquisition of Chris co. will be tested by
comparing Chris Co. carrying amount with it’s recoverable.
At the end of the year George Co. develops the following
estimates for Chris Co. :
Fair value : $280,000
Costs to sell :$30,000
Present Value of future cash flows : $270,000
 Alternative 1

Non-controlling interest measure at proportionate share of the fair value of the acquired firm’s net assets
excluding goodwill.

Chris CO. Net Assets Goodwill Total

Carrying amount 280,000 108,000 388,000
Unrecognized non-controlling interest in goodwill 12,000 12,000
Adjusted carrying amount 280,000 120,000 400,000
Determination of recoverable amount
Fair value less costs to sell (1) 250,000
Present value of future cash flows (2) 270,000
Recoverable amount (higher of (1) &(2) 270,000
Impairment loss (400,000-270,000) 130,000
Allocation of impairment loss

Chris Co. Net Assets Goodwill Total

Carrying amount 280,000 108,000 388,000
Impairment loss (130,000-120,000) 10,000 108,000 118,000
Carrying amount after impairment loss 270,000 0 270,000
 Alternative 2

 Non-controlling interest measure at Fair Value.

Chris CO. Net Assets Goodwill Total

Carrying amount 280,000 120,000 400,000
Determination of recoverable amount
Fair value less costs to sell (1) 250,000
Present value of future cash flows (2) 270,000
Recoverable amount (higher of (1) &(2) 270,000
Impairment loss (400,000-270,000) 130,000
Allocation of impairment loss

Chris Co. Net Assets Goodwill Total

Carrying amount 280,000 120,000 400,000
Impairment loss (130,000-120,000) (10,000) 120,000 130,000
Carrying amount after impairment loss 270,000 0 270,000
 Goodwill Not Allocable to Cash
generating unit
 Bottom-up test : the recoverable amount in testing goodwill for impairment is determined
for CGU to which the goodwill belongs by first applying.
 Top-down test : goodwill is allocated to the smallest group of CGU .
 If goodwill is allocated to the individual CGU and impairment of that CGU under review
then :
 determined by comparing (1)The carrying amount + allocated goodwill (2) The
recoverable amount. ‫كما في المثال السابق‬
 If goodwill cannot be allocated on a reasonable and consistent basis to the CGU under
review then :
 The Bottom-up test & a top-down test should be applied .
 If goodwill can be allocated on a reasonable and consistent basis and impairment of the
group of CGU then :
 determined by comparing (1)The carrying amount of the group+ allocated goodwill (2) The
recoverable amount
 U.S GAAP requires only a bottom-up test.
 Example : Application of the tests of
goodwill

 LaBrea Co. acquired another company that operates a chain

of three restaurant, paying 300,000 for goodwill. By the end of
the year 4 its clear that the restaurant located in Anaheim isn’t
generating the profit and cash flows expected at the date of
purchase. la Brea is required to test for impairment.
 LaBrea cannot allocated the goodwill on a reasonable and
consistent basis to individual restaurant (The Bottom-up test & a
top-down test should be applied) .
Bottom-Up test

CGU Carrying amount Recoverable amount Impairment loss

Anaheim 1,000,000 970,000 (30,000)

Buena park 1,000,000 1,050,000 Zero
Cerritos 1,000,000 1,020,000 Zero

Net Assets
3,000,000 – 30,000 = 2,970,000
Top-Down test

CGU Carrying amount Recoverable amount

Anaheim 970,000 1,000,000
Buena park 1,000,000 1,000,000
Cerritos 1,000,000 1,000,000
Sub total 2,970,000 3,000,000
Goodwill 300,000
Total 3,270,000

Impairment loss = Carrying amount – recoverable amount

3,270,00 – 3,000,000
270,000
 Reversing An Impairment Loss

Reversal of impairment loss

Here, you need to take the same approach as in identifying the impairment loss. You
need to assess at the end of each reporting period whether there is any indication that
an impairment loss recognized in prior periods for an asset (other than goodwill) may no
longer exist or may have decreased.

You need to assess the same set of indications from external and internal sources than
when assessing the existence of impairment, just from the other side.

You can reverse an impairment loss only when there is a change in the estimates used to
determine the asset's recoverable amount. It means that you cannot reverse an
impairment loss due to passage of time or unwinding the discount.