Goodwill amortization refers to the gradual and systematic reduction in the amount of the goodwill asset by recording a periodic amortization charge. The accounting standards allow for this amortization to be conducted on a straight-line basis over a ten-year period. Or, if one can prove that a different useful life is more appropriate, the amortization can be over a smaller number of years.
The one catch to using amortization is that a business must also conduct impairment testing, but only if there’s a triggering event indicating that the fair value of the entity has dropped below its carrying amount. And, you can choose to test for impairment only at the entity level, not for individual reporting units. Since the ongoing amortization of goodwill is going to keep dropping the carrying amount of the entity over time, this means the likelihood of an impairment test is going to decline as time goes by. And since impairment testing is only at the entity level, there’s even less work involved in whatever amount of residual impairment testing there might be.
If a business elects to amortize goodwill, it has to keep doing so for all existing goodwill, and also for any new goodwill related to future transactions. That means an organization cannot selectively apply amortization to the goodwill arising from just specific acquisitions.
If this option is chosen, there will be a large amortization charge that offsets profits for a long time. This means that the users of a company’s financial statements should be educated about the impact of amortization on reported results.
There are reporting requirements associated with goodwill amortization. On the balance sheet, the amount of goodwill net of any accumulated amortization and impairment charges must be presented. This is the same logic we use in presenting fixed assets. And in the income statement, goodwill amortization is presented within continuing operations, unless it’s associated with a discontinued operation – and in that case, it is presented with the results of the discontinued operation.
Until 2001, goodwill was an amortization expense for a period of up to 40 years. Many companies used the 40-year maximum to neutralize the periodic earnings effect and report supplementary cash earnings that they then added to net income. The FASB changed this in June 2001 with the issuance of Statement 142, which prohibits this.
The goodwill amortization alternative only applies to privately held entities.