Magazine article The CPA Journal

The Entity Theory of Recording Goodwill in Business Combinations: Old Stuff

Magazine article The CPA Journal

The Entity Theory of Recording Goodwill in Business Combinations: Old Stuff

Article excerpt

The proposal by FASB and the IASB to adopt the "entity theory" for recognizing the amount of goodwill in a business combination is hardly new to the U.S. accounting literature. This literature has dealt with the preparation of the consolidated statements, but the principle is the same for the journal entry on the acquiring company's books that records the goodwill arising out of the business combination.

To be sure, FASB's September 1991 discussion memorandum, Consolidation Policy and Procedures, treats the entity theory and its consequences for the amount at which goodwill should be recognized when a minority interest exists, but it provides no citations to previous literature. My purpose in this editorial is to bring out the antecedents.

Henry Rand Hatfield, in his highly acclaimed textbook, Accounting: Its Principles and Problems (Appleton, 1927), argued for recognition of 100% of consolidated goodwill even if less than 100% of the shares had been acquired. He wrote: "Inasmuch as in the consolidated balance sheet the full value of each of the assets is shown, although the holding company has only a fractional interest therein, it seems needlessly inconsistent in regard to the single asset goodwill to show only part of its value and to neglect entirely that portion representing the equity of the outstanding stockholders" (page 448).

Maurice Moonitz, a student of Hatfield's, made a similar argument in "The Entity Approach to Consolidated Statements" (The Accounting Review, July 1942) because, according to him, the practice of recognizing only the purchased share of goodwill when there is a minority interest "makes goodwill a function of the number of shares acquired, not a function of any attribute such as superior earning power of either a legal or an economic entity" (page 241). Moonitz expanded on this argument in his monograph The Entity Theory of Consolidated Statements (American Accounting Association, 1944). Both Hatfield and Moonitz were renowned accounting academics at the University of California, Berkeley, from 1910-1940 and 1940-1980, respectively.

No less an authority than William A. Paton, at the University of Michigan, advocated recognizing the goodwill associated with the minority interest. He wrote, "In general, it is reasonable to assume [that] the market value of the minority slice is consistent with the demonstrated value of the majority interest." By not recognizing the minority share of the excess of the purchase price of the shares over the acquired company's book value, including the goodwill, "the consolidated statement is a hodgepodge rather than a clear-cut, consistent presentation from the point of view of the dominant interest-the point of view which should be emphasized in consolidated reporting" (Corporation Accounts and Statements', Macmillan, 1955). …

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