5.1 Measuring Goodwill

The ASC master glossary, as amended by ASU 2023-05, defines goodwill as “[a]n asset representing the future economic benefits arising from other assets acquired in a business combination, acquired in an acquisition by a not-for-profit entity, or recognized by a joint venture upon formation that are not individually identified and separately recognized.” Because goodwill is not a separately identifiable asset, it cannot be measured directly. It is therefore measured as a residual and calculated as the excess of the sum of (1) the consideration transferred, (2) the fair value of any noncontrolling interest in the acquiree, and (3) the fair value of the acquirer’s previously held equity interest in the acquiree over the net of the acquisition-date values of the identifiable assets acquired and the liabilities assumed.

Occasionally, the sum of (1) through (3) above is less than the net of the acquisition-date values of the identifiable assets acquired and the liabilities assumed. In such a case, the acquirer recognizes a gain, referred to as a bargain purchase gain, in earnings on the acquisition date. Conceptually, goodwill represents both the fair values of the going-concern element of the acquired business and the expected synergies of combining the acquirer’s and acquiree’s businesses. However, because goodwill is measured as a residual, it includes other components as well.

One such component is the difference between the fair values and the amounts at which items that are exceptions to the recognition and measurement principles are recognized. ASC 805 requires entities to measure most assets, liabilities, equity interests, and items of consideration exchanged in a business combination at their fair values as of the acquisition date. However, some items exchanged in a business combination are exceptions to the recognition or measurement principle (or both) and are therefore either recognized or measured in accordance with other guidance or not recognized or measured at all.

For example, income taxes are measured in accordance with ASC 740 rather than at fair value, and preacquisition contingencies are often unrecognized in a business combination. Nonrecognition of items or recognition of items at amounts other than fair value either increases or decreases goodwill. Accordingly, while the FASB strived to reduce the number of exceptions to the fair value and recognition principles in ASC 805, exceptions still exist.

Another component of goodwill is overpayments. In paragraph B382 of the Basis for Conclusions of Statement 141(R), the FASB “acknowledged that overpayments are possible and, in concept, an overpayment should lead to the acquirer’s recognition of an expense (or loss) in the period of the acquisition.” However, the Board noted that “in practice any overpayment is unlikely to be detectable or known at the acquisition date [and] is best addressed through subsequent impairment testing when evidence of a potential overpayment first arises.” Underpayments, however, are not a component of goodwill because ASC 805-30 requires entities to recognize a bargain purchase as a gain in earnings on the acquisition date (see Section 5.2).

ASC 805-30 provides the following guidance on measuring goodwill:

ASC 805-30

30-1 The acquirer shall recognize goodwill as of the acquisition date, measured as the excess of (a) over (b):

The aggregate of the following:The consideration transferred measured in accordance with this Section, which generally requires acquisition-date fair value (see paragraph 805-30-30-7)The fair value of any noncontrolling interest in the acquireeIn a business combination achieved in stages, the acquisition-date fair value of the acquirer’s previously held equity interest in the acquiree.
The net of the acquisition-date amounts of the identifiable assets acquired and the liabilities assumed measured in accordance with this Topic.

In some business combinations, the acquirer obtains a controlling financial interest but less than 100 percent of the equity interests in the acquiree. Such acquisitions, referred to as partial acquisitions, require the acquirer to include the fair value of the noncontrolling interest in the measurement of goodwill. See Section 6.4 for more information about the accounting for partial acquisitions.

In other business combinations, an acquirer obtains a controlling financial interest in an acquiree in which it held a noncontrolling equity interest immediately before the acquisition date. For example, an acquirer may hold a 25 percent noncontrolling equity interest in a business and then acquire an additional equity interest, giving it control of the business. ASC 805 refers to such an acquisition as a business combination achieved in stages, which is also commonly referred to as a step acquisition. In a step acquisition, the acquirer must also include the fair value of its previously held interest in the goodwill calculation. See Section 6.5 for more information about the accounting for step acquisitions.

Once recognized, goodwill is tested for impairment in accordance with ASC 350-20, which also provides an accounting alternative for the subsequent accounting for goodwill for entities that do not meet the definition of a public business entity (PBE) or are not-for-profit entities. Such entities may elect to amortize goodwill acquired in a business combination and to use a simplified, one-step impairment test. See Chapter 8 for more information about accounting alternatives available to private companies and not-for-profit entities.