Magazine article CMA - the Management Accounting Magazine

Accounting for Brands: A Call for Clarity

Magazine article CMA - the Management Accounting Magazine

Accounting for Brands: A Call for Clarity

Article excerpt

How to account for brand names in financial statements? As with accounting for goodwill, various countries' opinions on the *subject differ. The differences show up in their rules governing brand treatment - including Canada's - and in how closely they adhere to the rules. The discrepancies might best be addressed by increasing disclosure of brand accounting requirements, and by examining brands' indefinite lives.

A discussion of accounting for brands begins with a look at accounting for goodwill. When the value of a business on a going-concern basis exceeds the value of all its identifiable assets and liabilities, then the business has goodwill. Although its value constantly changes, goodwill exists in most businesses (negative goodwill, while rare, can also exist).

Accounting authorities agree that internally generated goodwill, or inherent goodwill, should be ignored for reporting purposes. For example, the United Kingdom's Exposure Draft #47 notes the following:

"Internally generated goodwill should not be recognized and included in the balance sheet. In a cost-based accounting model, it does not pass the criteria for recognition in the balance sheet because neither its cost nor the transaction which gave rise to it can be identified." (ED #47, part 1, para. 9)(1)

When one company acquires another, goodwill exists if the fair value of the identifiable assets less liabilities exceeds the purchase price. As both the cost and the transaction can be identified, this purchased goodwill meets the above criteria for recognition. However, opinion differs among countries on how to account for this goodwill in financial statements.

Goodwill accounting anomalies

In the United States, Opinion #17 issued in 1970 by the Accounting Principles Board requires companies to amortize purchased goodwill over a maximum of 40 years.(2) (Although an "opinion" is superseded by any Financial Accounting Standards Board (FASB) pronouncement, no such pronouncement has yet been made.)

In the U.K., accounting for goodwill is specified in the Standard Statement of Accounting Practice #22 and Exposure Draft #47.(3) Published in 1984 and revised in 1989, SSAP #22 permits two options. Purchased goodwill is usually written off against reserves at the time of the acquisition. But the company can also capitalize goodwill and write it off over its useful economic life. ED #47 published in 1990 permits only the latter treatment. "Useful economic life" is a maximum of 20 years, or up to 40 years under unusual circumstances.

In Canada, accounting for goodwill is addressed in the Canadian Institute of Chartered Accountants (CICA) Handbook.(4) Paragraphs 1580.54 to 1580.62 instruct a company to capitalize and write off purchased goodwill rationally and systematically over its effective life for up to 40 years.

In all three countries, the customary emphasis on the bottom line motivates companies to choose whichever method minimizes current charges against income. Thus, a company usually amortizes purchased goodwill over the longest possible period. Ideally, the company with the highest net income would take the lowest charge, and the company with the lowest net income would take the highest charge. In practice, the company most motivated to extend its amortization period in order to reduce amortization expense is that with the lowest net income, or the least goodwill. Conversely, a company reporting reasonable or good net income - the one with the greater goodwill - can better withstand a high amortization charge and is therefore more likely to report a high charge.

Before publication of Opinion #17 in the U.S., a struggling company would retain goodwill at cost on its balance sheet until it became obvious that its value had been impaired. At that point, obliged to recognize that its goodwill had evaporated, the company had to write it down to its current value. …

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