How do companies assess the value of goodwill on the balance sheet?
Companies do not amortize goodwill as an expense.
Why? Because goodwill in a sense is indefinite.
Meaning that it does not have a specified life.
When we think about other intangible assets such as patents or customers, there is an average expected life span associated with them.
Patents are often amortized over 20 years because after the patent expires, it becomes worthless.
Customer lists may be amortized over 3-5 years depending on how soon customers will turn over.
So, for GAAP purposes, management will estimate the useful life of the intangible assets and amortize the cost of the asset over time as the value of the asset falls.
But, this is not the case with indefinite-lived intangibles.
Goodwill and brand value are examples of intangibles that are indefinite-lived.
They do not lose a specific amount of value each year.
This does not mean that they are infinite.
Infinite and Indefinite are not the same. No asset is infinite. Because all businesses will fail. It’s just a matter of time. Cynical, I know.
So, instead, the company will test for impairment which is the loss in fair value of that asset.
A brand is indefinite, but it can still lose value if the brand name tarnishes.
Take JCPenny. When the company was filing for bankruptcy, its brand name was probably a lot weaker than it was in the 80s.
People would pay a whole lot less for the brand of a distressed company.
For tax purposes, the IRS requires companies to amortize all intangibles.
This includes both definitive and indefinite assets.
That is assets with a specified life and those without a specified life.
The IRS requires all intangibles to be amortized over a 15 year period.
So, if DropoutEdu has $1500 in goodwill on its balance sheet…
Under GAAP accounting – it will test annually for any impairments (loss of value).
Under tax reporting – it will amortize $100 of goodwill annually.
Bottom-line? Goodwill does not lose value over a predefined period of time, which makes it an indefinite-lived asset.