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Amortisation of goodwill explained

Amortisation of goodwill explained

When a company acquires another company, the difference between the purchase price and the net book value (NBV) of the acquired company is called purchased goodwill. Goodwill is included as an intangible fixed asset on the balance sheet and can be considered to reflect the value of the intangible assets acquired. These intangible assets might include brands, trade marks, patents, intellectual property and the value of customer relationships, all of which are not easy and subjective to value other than at times of an acquisition.

According to Bloomberg, the total balance sheet value of purchased goodwill for all publicly listed companies worldwide in September 2018 was $8trn. This compares to $14trn of tangible (i.e. physical) fixed assets. In other words, purchased goodwill accounted for 36% of all publicly listed companies fixed assets.

When a company makes an acquisition and pays a premium over the NBV of the company being acquired, the premium known as goodwill is usually amortised (i.e. written off) on a straight-line basis over the expected useful life. This is normally not more than 20 years. For example, if the purchased goodwill on an acquisition were £60m and written off (i.e. amortised) over 20 years, the NBV of goodwill on the balance sheet would be reduced by £3m for each of the next 20 years and an amortisation of goodwill cost of £3m would be charged to the profit and loss for each of the next 20 years. As with depreciation, amortisation of goodwill is a subjective, non cash cost. Indeed, it could be argued that when managed effectively, the value of the purchased intangible assets could increase substantially rather diminish. Thus, it is important to remember what the accounts represent and what they do not represent.

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