F 2019 b
For insurer B in this problem, the amount if Goodwill calculated is $1,500. In the examiner report answer on how this is treated in US GAAP income statement, it states Goodwill asset is established, no impact to income statement. From the wiki I thought a goodwill asset equal to 1,500 was created which would impact the income statement as an increase of 1500. Can you explain why it does not impact the income statement?
Comments
Creation of goodwill asset does not hit the earned premium in the income statement. So, no impact on income.
Is goodwill then earned over time, which will flow into earned premium? Or does it never effect the income statement?
According to Odomirok, under GAAP, goodwill is recognized in the Income Statement only when you acquire at a bargain, i.e. purchase price is less than the implied capital of the acquired company. On page 339:
". . . When an entity agrees to buy another entity, under U.S. Generally Accepted Accounting Principles (GAAP) the purchaser is required to state at fair value the assets and liabilities of the purchased entity. This accounting for business combinations is often referred to as Purchase GAAP (P-GAAP). As part of the P-GAAP process, certain intangible assets are included that would not typically be recognized and measured under U.S. GAAP. After the fair value of the assets and liabilities is determined, the implied capital (fair value assets minus fair value liabilities) is compared to the purchase price. If the implied capital is less than the purchase price of the purchased entity, the difference is defined to be goodwill and an asset equivalent to that amount is established. If the implied capital is greater than the purchase price of the purchased entity, the difference is immediately recognized as an operating gain into income. . . ."
Since goodwill in the question was positive, it did not impact income.
Hi, per text, a negative goodwill should "1st offset the book value of the acquired non-current assets", but the goodwill in solution for insurer A went straight to the income. Is the solution outdated? thank you in advance.
Yes, that solution in the examiners' reports appears to be outdated. I'm not sure when the change to the treatment of negative goodwill was made but it does appear that the acquiring company should first apply the $400 to reduce the amounts initially assigned to non-current assets (where long-lived assets are reduced first.)
Only after all non-current assets (excluding goodwill) are reduced to zero, the remaining amount of the $400 is recognized as a gain in the income statement of the purchasing company.
The reason for this is that the accounting standards aim to be conservative. Therefore, they prescribe a method that first reduces the carrying value of the acquired assets before recognizing a gain, to ensure the assets aren't being carried at amounts greater than their economic benefits.
I will adjust the BattleCard 13 in Quiz 2 to reflect this:
Thank you for pointing that out.