Journal Entry for Goodwill on Acquisition
Overview
Sometimes, the company may decide to purchase another business for various reasons, such as acquiring the supplier, eliminating the competitor, or simply trying to expand the scope of its business, etc. Likewise, when the company acquires another company to become its subsidiary, it can make the journal entry for goodwill on acquisition in order to present such goodwill as an intangible asset on the consolidated financial statements.
In accounting, goodwill on acquisition is the difference between the amount the company pays to acquire the subsidiary company and the fair value of net assets that it receives from the acquired company.
In business, goodwill is generally known as a company’s good reputation. In this case, it can represent many positive attributes that the company has, including good location, good management, good customer relations, good employees relationship with excellent skills, good product name and quality, and probably many other good things.
That is why the company usually needs to pay more than the fair value of the net assets in acquiring another company as it will also acquire those positive attributes attached with the acquired company in the purchase as well. This is also why the goodwill that is shown on the balance sheet of the group consolidated financial statements is usually positive goodwill. Of course, there is also a case of negative goodwill but it tends to be very rare.
Journal entry for goodwill on acquisition
The company can make the journal entry for the goodwill on acquisition by debiting the assets at the fair value and the goodwill account and crediting the liabilities at the fair value and the cash account.
| Account | Debit | Credit |
|---|---|---|
| Assets | 000 | |
| Goodwill | 000 | |
| Liabilities | 000 | |
| Cash | 000 |
In this journal entry, the amount of goodwill is the excess amount that the company pays for the acquired net assets (assets – liabilities) of the purchased company which are measured in fair value.
Assets and liabilities in this journal entry are the assets and the liabilities of the subsidiary company, in which they are measured at fair value. As a company purchases another company, it does not only acquire assets but also liabilities. That’s why this journal entry includes both assets and liabilities of another company.
It may be useful to mention that goodwill should only be recognized and recorded when one company purchases another company to become its subsidiary. In accounting, internally generated goodwill is not allowed.
It doesn’t matter how good the reputation the company has, packaging its own goodwill and put it on the balance sheet will go against the accounting rule. One reason may be due to the subjectivity of the dollar value that the company may put on its good reputation. In short, how anyone can reliably measure the reputation in dollar value would be a big question.
Goodwill on acquisition example
For example, on December 31, the company ABC pays $7,000,000 to purchase 100% shares in the XYZ company, which was originally its supplier to become its subsidiary. The net assets of the XYZ are valued fairly at $4,000,000 which comes from the total assets of $15,000,000 and total liabilities of $11,000,000 measured at fair value as listed in the table below:
| Assets | Amount measured at fair value in $ |
| Cash | 1,000,000 |
| Inventory | 6,000,000 |
| Accounts receivable | 2,500,000 |
| Equipment | 3,500,000 |
| Other assets | 2,000,000 |
| Total assets | 15,000,000 |
| Liabilities | |
| Accounts payable | 3,000,000 |
| Note payable | 7,000,000 |
| Other liabilities | 1,000,000 |
| Total liabilities | 11,000,000 |
| Net assets | 4,000,000 |
What is the journal entry for goodwill on acquisition on December 31?
Solution:
With the information in the example, the company ABC can determine the goodwill on acquisition to be $3,000,000 as it pays $7,000,000 for the $4,000,000 net assets.
In this case, the company ABC can make the journal entry for goodwill on acquisition when it purchases the XYZ company on December 31, as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | 1,000,000 | |
| Inventory | 6,000,000 | |
| Accounts receivable | 2,500,000 | |
| Equipment | 3,500,000 | |
| Other assets | 2,000,000 | |
| Goodwill | 3,000,000 | |
| Accounts payable | 3,000,000 | |
| Note payable | 7,000,000 | |
| Other liabilities | 1,000,000 | |
| Cash | 7,000,000 |
In this journal entry, the debit cash of $1,000,000 is the existing cash that the acquired company, which is the XYZ company, has as of the purchasing date while the credit of cash of $7,000,000 is the purchasing price that the company ABC pays for acquiring XYZ. Although this debit and credit of cash will be offset on the balance sheet of the consolidated financial statements, it should not be offset in this journal entry as keeping it this way will make it easier for review and audit of accounting transactions.
No goodwill in the individual company
In accounting, there is no goodwill recorded in the company as the individual. In other words, goodwill will only show up in the group company’s consolidated financial statements that include all the subsidiaries of the company.
In this case, when the company purchases another company to be its subsidiary, it will recognize and record the amount it pays for in account of the investment in subsidiary as an individual company.
For instance, in the example above, if the company ABC’s accountant prepares the financial statement of ABC as an individual company, there won’t be any goodwill shown up on the balance sheet. And the journal entry for the individual company of ABC will not have the debit of goodwill, but the debit of investment in subsidiary account for the amount it pays instead.
In this case, the journal entry for purchase of XYZ in the ABC’s record as an individual company will look like below:
| Account | Debit | Credit |
|---|---|---|
| Investment in subsidiary | 7,000,000 | |
| Cash | 7,000,000 |
This $7,000,000 of investment in subsidiary account will be eliminated in the consolidated financial statements of the group company. Hence, while there is no goodwill on acquisition in the individual company, there is no investment in subsidiary in the group’s consolidated financial statements.
It is useful to note that if the company does not pay the full amount immediately at the purchasing date when acquiring another company, but there is a portion of cash payable in the purchase agreement, the journal entry will include the payables account on the credit side together with the cash account. However, the amount needed to be discounted to the purchasing date using an appropriate discount rate.
For example, if there is an agreement to the remaining amount of $1,000,000 to be paid at the end of the next two years and the appropriate discount rate is 6% per annum, the payable amount should be recorded as $889,996.44 (1,000,000 x (1/(1+6%)^2)) instead of $1,000,000.
$1,000,000 x 1/(1+6%)^2 = $889,996.44
