M&A Vocabulary – Experts explain: Goodwill

Goodwill generally represents the difference between the enterprise value and the sum of fair values of assets identifiable according to a given accounting regulation.

Under both IFRS (International Financial Reporting Standards) and HGB (German Commercial Code), it is necessary to differentiate between internally generated and acquired goodwill.

Internally generated goodwill may not be capitalised in the balance sheet as it does not fulfil the recognition criteria and an explicit prohibition on recognition applies. This arises both from HGB (Article 248 para. 2 HGB) and from IFRS (IAS 38.48).

In practice, derivative goodwill plays a much more important role. Article 246 para. 1 sentence 4 HGB defines derivative goodwill as follows: “The difference resulting from the excess of the consideration paid for the acquisition of a company over the company’s individual assets less its liabilities at the time of the acquisition (goodwill acquired for consideration) is deemed to be an asset with a limited useful life”. As can be seen from the definition, derivative goodwill arises from the acquisition of a company for a consideration. Simply put, derivative goodwill reflects the difference between the purchase price and the fair value of the acquired assets less liabilities.

Example of derivative goodwill: Company A acquires Company B on 31/12/2020 in a share deal for a purchase price of 10 million euros. The book value of the assets of Company B as of 31/12/2020 is 12 million euros. The current market value of the assets,  amounts to 14 million euros. The total liabilities of Company B as of 31/12/2020 are 8 million euros. The book value of the liabilities corresponds to their market value. The derivative goodwill arising from the transaction is:

10 million euros (purchase price for Company B)
less 6 million euros as the difference between the market value of the assets of 14 million euros and the market value of the liabilities of 8 million euros = 4 million euros

According to both HGB and IFRS, acquired goodwill is must be capitalised. It must be recognised separately under intangible assets and amortised according to the respective regulations.

Pursuant to HGB, derivative goodwill is amortised over its estimated useful life. If it is not possible to reliably estimate the useful life, it should be amortised over 10 years (Article 253(3) sentence 3 and 4 HGB, GAS (German Accounting Standards) 23 para. 120-123).

According to IFRS, derivative goodwill is not amortised because it is assumed that its useful life is indefinite (IAS 38.107). In accordance with IAS 36, an intangible asset with an indefinite useful life has to be tested for impairment. As defined in IFRS, impairment is the amount by which the carrying amount of an asset exceeds its recoverable amount (IAS 36.6). The so-called impairment test should be performed at least annually, and whenever there is an indication that the intangible asset may be impaired (IAS 38.108). An impairment loss is recognised as an expense in the income statement.