In an audit, goodwill refers to the intangible non-current asset that arises in the business combination when the amount paid for acquiring another company is more than the fair value of net identifiable assets acquired.
Similar to other intangible assets with an indefinite life, goodwill is not amortized as it is not deemed to be systematically consumed or worn out. However, the group company needs to review or test goodwill for potential impairment annually.
In the audit of goodwill, the ineffectiveness of the impairment review is usually the main concern for us, auditors. Sometime, the client may not even try to perform the impairment review of their intangible assets at all.
Audit assertions for goodwill
Similar to other intangible assets, audit assertions for goodwill are included in the table below:
|Audit assertions for goodwill|
|Existence||The goodwill shown in the financial statement of the group company at the reporting date is actually genuine.|
|Valuation||The balances of goodwill truly reflect its actual economic value as at the reporting date.|
|Presentation and disclosure||Adequate disclosure related to goodwill has been made in the financial statements.|
Valuation assertion is usually what we have more concern about as it is related to the risk of overstatement due to the improper impairment review of goodwill. Meanwhile, the existence assertion of goodwill here is not much about whether goodwill actually exists, but it is more about whether it is actually a genuine asset.
Audit procedures for goodwill
Goodwill at acquisition
At the acquisition date, goodwill is usually measured by the excess value of the fair value of the consideration paid by the parent and non-controlling interest over the fair value of the net assets of the subsidiary acquired.
Goodwill at acquisition = fair value of consideration paid + value of non-control interest – fair value of subsidiary’s net identifiable assets
In this case, the audit of goodwill at the acquisition is not only to verify whether goodwill actually exists as a genuine asset, but also to evaluate whether it is properly measured at an appropriate value in accordance with acceptable accounting standards.
Example of audit procedures for goodwill at the acquisition include:
- Inspect purchase agreement to ensure consideration paid and purchase date are correct
- Agree the fair value of net identifiable assets to the due diligence report prepared by the independent external party
- Obtain board minutes and review for the discussion about the purchase of the subsidiary company
- Recalculation goodwill and compare with the goodwill recorded by the client
- Ensure that the payment have been made by verifying with the bank statement and other related supporting documents.
Goodwill impairment review
Goodwill that arises from the business combination is subject to annual impairment review. This is to ensure that the goodwill balance is not overstated in the group’s financial statements.
Impairment of goodwill occurs when its carrying value exceeds the recoverable amount. And any impairment loss will be charged directly to the profit and loss statement.
Likewise, in the audit of goodwill, we usually concern more about the risk of material misstatement due to the overstatement of goodwill where the client has not properly performed the impairment review.
Example of audit procedures for goodwill impairment include:
- Confirm whether the impairment test or review has been made on the goodwill
- Verify the validity of relevant supporting documents and data that the management uses to support their assessment, e.g. discount rate, industry data on growth rate and forecast cash flows, etc.
- Evaluate the reasonableness of management’s assessment on goodwill impairment
- Check the arithmetic accuracy of the impairment calculation
- Make sure that impairment loss has been properly accounted for in profit and loss statement
In the test of goodwill impairment, we should always be alert to the signs or indications of the impairment that could occur on goodwill. These may include:
- Significant declines of market value
- Negative impact due to the changes in the law, business environment, or technology
- Deterioration of financial performance
- Significant loss of key personnel, etc.
It is useful to note that the reversal of impairment loss is not allowed on the goodwill that has been previously impaired. This is due to when the situation changes from bad to good leading to the increased value of goodwill, it is considered as an increase of internal goodwill (not the purchased goodwill from the business combination). And internal goodwill is not allowed to be recognized as an asset.