You are the finance director of ABC Company. ABC is preparing its financial statements for the year ended 31st December 2015. The following item has been brought to your attention:
ABC acquired the entire share capital of XYZ Ltd during the year. The acquisition was achieved through a share exchange. The terms of the exchange were based on the relative values of the two companies obtained by capitalizing the companies’ estimated cash flows. When the fair value of XYZ’s Ltd identifiable net assets was deducted from the value of the company as a whole, its goodwill was calculated at GH¢2.5 million. A similar exercise valued the goodwill of ABC at GH¢4 million. The directors wish to incorporate both goodwill values in the companies’ consolidated financial statements
Required:
Describe how ABC should treat the item in its financial statements for the year ended 31st December 2015 commenting on the directors views, where appropriate. (5 marks)
View Solution
Whilst it is acceptable to value the goodwill of GHC2.5 million of XYZ (the subsidiary) on the basis described in the question and include it in the consolidated balance sheet, the same treatment cannot be afforded to ABC’s own goodwill. The calculation may indeed give a realistic value of GHC4 million for ABC goodwill, and there may be no difference in nature between the goodwill of the two companies, but it must be realized that the goodwill of ABC is internal goodwill and IFRSs prohibit such goodwill appearing in the financial statements. The main basis of this conclusion is one of reliable measurement. The value of acquired (purchased) goodwill can be evidenced by the method described in the question (there are also other acceptable methods), but this method of valuation is not acceptable as a basis for recognizing internal goodwill.