5. Goodwill (business reputation)

All over the world processes of amalgamation of businesses, purchase of enterprises by other ones are widely spread. Therefore there is necessity for accounting conditional cost of business reputation.

The value of any enterprise taken as a whole as an integrated property and economic complex differs from cumulative cost of its assets and liabilities. In other words, there is always difference between the value of the enterprise and cumulative cost of its assets and liabilities. This difference is called goodwill. In economic literature one can come across such concepts as the price of firm, goodwill, business reputation, business ties, partners of the firm, etc.

Goodwill represents advantages which are received by the buyer when purchasing already existing and working company in comparison with the organization of a new firm.

The above mentioned difference can be either positive, or negative.

Positive business reputation means that the cost of the enterprise exceeds cumulative cost of its assets and liabilities, that “something” is inherent in the enterprise that is not defined by the cost of its assets and liabilities. This “something” can be the availability of the permanent customers, a favorable geographical position, the reputation for quality, skills in marketing and selling, a technical know-how, business ties, the experience in management, the personnel skill level, etc. These factors provide higher profit level than that which can be obtained when using analogous assets and liabilities, but without the above mentioned non-material factors.

Negative business reputation testifies to the opposite.

Business reputation does not exist separately from the enterprise. This is unalienable property. It is impossible to dispose of it apart from the enterprise. This feature distinguishes the given kind of assets from all other objects of business accounting including other kinds of non-material assets.

There are two basic approaches to the definition of the goodwill cost. The first one assumes estimating goodwill as a source of additional receipts of the profit (the method of surplus profits) and uses methods of business estimation. For example, the branch consists of three enterprises which have equal assets (1000 monetary units), identical structure and identical technological level (quality). But profitability of assets is different: at enterprise A it makes 25 %, at enterprise B it makes 15 %, at the enterprise C it makes 5 %. Average profitability is equal to 15 %. If to consider that the average price of the enterprise is 1000 monetary units then enterprise A is estimated at 1000*25/15 = 1667 monetary units. Hence, goodwill is 1667 – 1000 = 667 monetary units.

The second approach is based on accounting the results of concrete transactions. The value of the obtained business reputation is received at the rate of the difference between the sum which is actually paid for the enterprise, and the cumulative cost of specific assets and liabilities of the given enterprise, fixed in the accounting balance which was drawn up last. So, if firm A was bought for 1700 monetary units, then goodwill is 1770 – 1000 = 700 monetary units.

Positive business reputation of the organization should be considered as the markup to the price, paid by the buyer in expectation of future economic benefits, and it should be taken into account as a separate inventory object.

Negative business reputation of the organization should be considered as the discount from the price, given to the buyer in connection with the absence of factors of availability of permanent customers, reputation for quality, skills in marketing and selling, business ties, experience in management, the personnel skill level, etc., and it should be taken into account as income of future periods.

Business reputation has no certain term of life. Practice of Russia states that business reputation should be depreciated within 20 years from the date of purchase of the firm. However it is necessary to realize that the accepted period of depreciation is conditional and can affect accuracy of calculating financial results of the enterprise activity.

Some countries have introduced the following maximal period of depreciation: Japan - 5 years, Netherlands - 10, Sweden - 10, Australia - 20, Canada and the USA – 40 years.