Depletion of Goodwill : The Real Deal

Depletion of Goodwill

Depletion of Goodwill

As you have already read the first installment about goodwill, it is time to dig a little deeper. Now, you will get a look at the functional areas. Here, you will get to learn-

  • How goodwill is depleted
  • Why goodwill should be depleted
  • What will happen if the depletion work is not done
  • Areas in function exemplified

But, first things first. We will go for why goodwill should be depleted.

 

                       WHY DEPLETION OF GOODWILL SHOULD BE DONE?

                                                 &

                                  WHAT WILL HAPPEN IF NOT DONE?

    Goodwill is a kind of an intangible asset (The type of asset that is untouchable). All the assets, which are of untouchable category, should be recorded in a manner where the expenses will be recorded separately from the assets. It is mandatory. The reason behind this is the expenses are of a nature which can’t be traced back to the asset in discussion. Now, why did expenses come barging amongst the discussions? The reason is, to deplete the intangible assets it is necessary to calculate the value of the asset reliably and meticulously. For instance, Take a look at the example below:

XYZ Co.
BALANCE SHEET (PARTIAL REPRESENTATION)

ASSETS AND LIABILITIES TK.

FIXED ASSETS:

Goodwill 60000
Patent 45000
Trademark 90000
Technical Know-How 26000

LIABILITIES:

Share premium 40000
Retained earnings 126000

          TRIAL BALANCE (PARTIAL REPRESENTATION)

PARTICULRS TK.
Recording expenses 25000
Expenses for court works 20000
Expenses related to administration of intangible assets 7000

 

Here what you can easily see is the assets are all of such a nature, which gives us the unique idea of untouchables.

And, the trial balance gives the expenses which relate to intangible assts.

Now, in the example the expenses are kept in such a nature that they can’t be traced back to individual assets and it is not done willfully. The expenses are kept in such a fashion, because, these expenses are dealt in bulks. So, after the expense occurs, it turns almost a highly tough job to separate them as per their origin and nature. Now, some of you may ask it is not impossible, then why we leave that alone? Because, it is not impossible theoretically but, a large corporation has lots of other tasks to attend to and it is the least they want their labor assigned to. And, after all these explanations whoever among you is/are not satisfied should be happy to know the most beautiful reason rested until now and that is:

                                                          YOU DON’T NEED TO.

Just as simple as that. You don’t need to as per law. IAS states that all the expenses done regarding the intangible assets should be recorded separately as expenses for that period, not as addition to the assets.

Now, as we get to know the real valuation method for goodwill we can go for the reasoning of depletion of goodwill.

It is a mandatory job for the organization/institution to deplete goodwill, because,

  • The asset is losing its value with time like all other tangible assets with usage
  • Though untouched the goodwill (In particular), loses its value gradually over time from the point of purchasing it. It comes out as the excess amount while purchasing a business and as the purchased business does not exist, so, its goodwill should also seize to exist.

An explanation is compulsory here about depleting the goodwill over time. Get to know, the goodwill in discussion can’t be depleted at one time, the explanation is, if the depletion is done all at once then the profit will significantly be reduced and that will cause a violation of the accounting principles (Accounting period principle).

Get it now? If the depletion is not done then it will turn into a violation of the rules. And, it should be done in a manner which is prescribed and, which one is that we will learn now.

 

                HOW GOODWILL IS DEPLETED?

The depletion should reduce goodwill according to the pre-decided rate, the rate a professional accountancy or, financial firm decides. The goodwill can be reduced and the expense can be shown in the income statement as an administrative expense or, the depletion can be deducted from the goodwill as well as from the share premium/retained earnings a/c.

 

                  AREAS IN FUNCTION EXEMPLIFIED

                        After reading this far maybe you are wondering about how these things are applied. Don’t feel disgusted as we are here to help you out. Read along and check out our examples to learn in full:

AT FIRST WE WILL LOOK INTO THE RECORDING PROCEDURE:

    Now consider there are some information provided to you at the foot of the trial balance as some adjustments:

a)      The goodwill will reside with company for 20 years, starting from this accounting period.
b)      Patent will be depleted at a 20% rate per annum.
c)      Trade mark will be depleted against share premium a/c and if there is any amount left deplete              that against retained earnings
d)      Company has invested Tk.50000 more during the accounting period on research

Now the recording procedure involves all the financial statements all the tricks regarding intangible assets’ depletion methods. Get into the illustration:

XYZ Co.

Income Statement (Partial representation)

Prepared for the year ended on …………… (Date/Month), …………… (Year)

Particulars Tk.
Operating expenses:Recording expensesExpenses for court works                              Expenses related to administration of intangible assetsDepletion expenses:GoodwillPatent 2500020000 7000 30009000

And now the balance sheet:

                                                                               XYZ Co.
                                                                         BALANCE SHEET
                                                   As on …………… (Date/Month), …………… (Year)

Particulars Tk. Tk.
Fixed assets:Goodwill Less: Depletion   PatentLess: Depletion   

 

 

Trademarks

Less: Depletion by share premium a/c

 

 

 

Less: Depletion against retained earnings

 

 

 

 

Technical know how

Add: Additional expenses

 

 

 

 

 

 

 

Liabilities:

 

Share premium a/c

Less: Depletion of trademark

 

 

 

 

Retained earnings

Less: Depletion of trademark

 60000(3000)    57000      

36000

 

 

 

 

 

 

 

 

 

 

Nil

 

 

 

 

 

 

76000

 

 

 

 

 

 

 

 

 

Nil

 

 

 

 

 

76000

 

 

 

 

   45000(9000) 
  90000(40000)  
50000 (50000)  
  2600050000  
        40000(40000)

 

   126000(50000) 
 

Now everything should be nice and fine with you and even after all these if the things are not clear to you wait for some time to learn about the journal entries see if they are helpful for you or, not. Wait for the updates to come.

 

 

 

One thought on “Depletion of Goodwill : The Real Deal

  • Mirzelle says:

    Good read on goodwill. Enjoyed your accounting concepts series A.i.r; can you please write something on depreciation?

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