VERIFICATION OF INTANGIBLE ASSETS

Goodwill

Introduction

Goodwill is the difference between the value of a business as a whole and the
aggregate of the fair values of its separable net assets.
Separable net assets are those assets (and liabilities) which can be identified
and sold (or discharged) separately without necessarily disposing of the
business as a whole. They include identifiable intangibles.
Other definitions of goodwill include:
(a) The value attributable to a company’s average strength in areas such
as technical skill and knowledge;
(b) The value of the business community’s attitudes to the entity; and
(c) That part of the value of a business which arises from all its advantageous
circumstances, which generate earnings above an assumed norm (super
profits).

Types of Goodwill

Goodwill can be classified into two, viz:
(a) Non-purchased or Inherent Goodwill
All businesses have an element of non-purchased goodwill, in that as
going concerns they are worth more (positive goodwill) or less (negative
goodwill) than the aggregate of the fair values of their separable net
assets.
(b) Purchased Goodwill
Purchased goodwill is goodwill, which is established as a result of the
purchase of a business. Purchased goodwill will not always be a positive
amount; at some time in the life of a business, its market value may
stand at a discount in relation to the fair value of the separable net
assets employed. This gives rise to ‘negative goodwill’.
Negative goodwill arises from circumstances that are not advantageous
to the entity, such as weak markets or marketing.

Factors Contributing to Goodwill

Positive goodwill arises from advantageous circumstances such as an effective
management team, weakness of competitors, a prime location or established
customers. Other factors which are believed to contribute towards goodwill are
good labour relations, a secret or patented manufacturing process, effective
advertising, high standing in the society through contributions to and
participation in community activities and an excellent reputation for quality
and reliability of products.
Purchased goodwill will also depend on the acquirer’s reasons for the purchase,
such as economy of scale, fiscal advantages from tax losses, diversification of
risk or combined market dominance and other factors which affect the price
such as general economic conditions and cost of financing.

Characteristics of Goodwill

Goodwill is intangible, intrinsic to the business and incapable of realisation
separate from the business; these characteristics of goodwill distinguish it from
most other items in the accounts. Its other characteristics are that:
(a) The value of goodwill has no reliable, predictable relationship to any
costs which may have been incurred;
(b) Individual intangible factors which may contribute to goodwill cannot
be valued;
(c) The value of goodwill may fluctuate widely according to internal and
external circumstances over relatively short periods of time; and
(d) The assessment of the value of goodwill is subjective, in the sense that
not only its value but also the assessment of its actual existence is
subjective.
Thus, any amount attributed to goodwill is arrived at by estimation to the specific
point in time at which it is measured, and is only valid for that point in time,
and in the circumstances then prevailing.

Audit Objective

The audit emphasis for intangible assets should be on determining that:
(a) The carrying value of the assets can be fully recovered;
(b) That there has not been permanent impairment of their value; and
(c) That the remaining period of amortisation is appropriate.
The audit objectives of goodwill and related intangible assets accounts are to
confirm the assertions by management, explicit or otherwise, embodied in the
financial statements as to:

• Existence

That the goodwill reported in the financial statements through measurement
or disclosure exists at the date of the balance sheet. It may be desirable to
confirm the existence of certain material intangible assets by direct
correspondence with third parties.

• Rights and obligations

An asset pertains to the entity at a given date. It must be established that the
entity has the rights and obligations associated with the goodwill reported in
the financial statements.

• Occurrence

A transaction or event took place that pertains to the entity during the period.
For example, the transaction that gave rise to the goodwill occurred within the
financial reporting period.

• Completeness

There are no unrecorded assets, liabilities, transactions or events, or undisclosed
items relating to the matter. For example, all of the entity’s goodwill is reported
in the financial statements through measurement or disclosure.

• Valuation

Goodwill is recorded at an appropriate carrying value. Documentation for an
account balance seldom provides conclusive evidence of value. Auditors require
extensive judgement to substantiate the values of the intangible asset. For
example, that the values of the goodwill reported in the financial statements
through measurement or disclosures were determined in accordance with the
Nigerian Standard on Auditing.

• Measurement

A transaction or event is recorded at the proper amount and revenue or expense
is allocated to the proper period. For example, the amounts associated with the
goodwill reported in the financial statements through measurement or
disclosure were determined in accordance with the Nigerian Standards on
Auditing, and the revenues or expenses associated with the goodwill reported
in the financial statements were allocated to the correct financial reporting
period.

• Presentation and Disclosure

An item is disclosed, classified and described in accordance with the Nigerian
Standards on Auditing. For example, the classification, description and
disclosure of goodwill in the financial statements are in accordance with the
Nigerian Standards on Auditing.

Substantive Tests

In performing a substantive test, the auditor should:
(a) Evaluate the desirability of goodwill and determine the need for
amortisation thereof;
(b) Quantify the amount of the amortisation where a provision is required.
Provide details of the calculation of the provision;
(c) Compare the amount of the provision to the amount established by the
entity and quantify the difference. Summarise the amounts identified;
(d) Obtain a listing of amortisation established at the previous year-end
and ensure all significant movements have been reviewed; and
(e) Discuss findings on the above procedures with management.
Based upon the preceding procedures, the auditor should:
(a) Determine the appropriateness of the client’s amortisation of goodwill;
(b) Review the client’s methods and policies of amortisation;
(c) Confirm that the accounting policies applied for determining goodwill
amortisation are:
(i) Consistent with those applied in the previous year;
(ii) In accordance with relevant accounting principles; and
(iii) Are appropriately disclosed in the entity’s financial statements.
(d) State whether any exceptions were noted in the steps enumerated above,
and if so;
(i) Confirm that they have been recorded on the working papers and
that the nature and level of substantive procedures have been
amended as necessary; and
(ii) Confirm that all exceptions have been carried forward to the
summary of unadjusted differences.
(e) Consider whether the above substantive procedures have provided any
evidence that the entity’s goodwill amortisation are not fairly stated in
its accounts; and
(f) If there is such evidence, document it and discuss with management.

Disclosure Requirements

(a) The accounting policy followed in respect of goodwill should be properly
explained in the notes to the accounts;
(b) The amount of goodwill recognised as a result of any acquisitions during
the year should be shown separately for each acquisition where material;
(c) Where the amortisation treatment is selected, purchased goodwill should
be shown as a separate item under intangible fixed assets in the balance
sheet, until fully written off;
(d) The movement on the goodwill account during the year, showing-
(i) The cost, accumulated amortisation and net book value of
goodwill at the beginning and end of the year, and the amount of
goodwill amortised through the profit and loss account during
the year;
(ii) The period selected for amortising the goodwill to each major
acquisition; and
(iii) The above-stated procedures are of equal application to the audit
of other intangible assets like patents, trademarks, copyrights
and franchise.

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