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A critical analysis of goodwill arising from consolidation and the varying effects on financial statements
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A critical analysis of goodwill arising from consolidation and the varying effects on financial statements
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A CRITICAL ANALYSIS OF GOODW ILL ARISING FR O M
CONSOLIDATION A N D THE VARYING EFFECTS
O N FINANCIAL STATEM ENTS
by
Talmadge C alvin T illm a n .J r.
D is s e r ta tio n p re se n te d to th e
FACULTY OF THE GRA D UA TE SCHOOL OF BUSINESS ADMINISTRATION
UNIVERSITY OF SOUTHERN CALIFORNIA
in p a r t i a l f u lf illm e n t o f th e
req u irem en ts f o r th e d eg ree
D OCTOR OF BUSINESS ADMINISTRATION
(A ccounting)
January, 1968
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T his d i s s e r t a t i o n , w r itte n by
TÂ 1M A D G E CALVIN TILLMAN JR.
under th e guidance o f th e F a c u lty Com mittee,
and approved by a l l i t s members, has been
p re se n te d to and ac ce p ted by th e F a c u lty o f
th e G raduate School o f B usiness A d m in istra tio n
in p a r t i a l f u lf i llm e n t o f th e req u irem e n ts f o r
th e d eg ree o f
D O CTO R OF BUSINESS ADMINISTRATION
'< 7
Date
Approved^
Chairmai
Cl
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DEDICATION
This d i s s e r t a t i o n i s d e d ic a te d to my f r ie n d s ,
Edward S eals and U lysses G riggs, and to Timothy and P h ilip ,
my so n s, as w e ll as my p a r e n ts .
1 1
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ACKNOWLEDGMENTS
I am s in c e r e ly g r a te f u l to D rs. W illiam F. Crum,
L e s lie R. Loschen, and R obert Y ost f o r t h e i r v a lu a b le g u id
ance, s u g g e s tio n s , and encouragem ent d u rin g th e p re p a ra tio n
o f th is stu d y . T his com m ittee made t h i s stu d y a tr u e l e a r n
in g e x p e rie n c e .
Thanks a re a ls o extended to two o f my f r ie n d s .
Dr. L eadie C lark and Dr. A lb e rt W right, J r . f o r t h e i r
encouragem ent and p a tie n c e .
I l l
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TABLE OF CONTENTS
Page
ACKNOWLEDGMENTS............................................................................. i i i
LIST OF TABLES................................................................................. v i i
C hapter
I . INTRODUCTION......................................................................... 1
S tatem ent o f th e Problem
The Purpose o f th e Study
Im portance o f th e Study
H ypotheses To Be T ested
Development o f C oncepts B asic to th e Study
and to th e H ypotheses o f Goodw ill
C o n so lid atio n s
D e fin itio n s o f O ther Terms
The R esearch M ethodology
F u rth e r A spects o f th e Study
I I . ACCOUNTING TH EORY IN RELATIONSHIP TO
GOODWILL............................................................................. 20
C h a ra c te ris tic s o f G oodw ill
P o s itio n o f th e Am erican I n s t i t u t e
o f C e rtifie d P u b lic A ccountants
I n te r n a l Revenue P o s itio n
O pinion o f th e S e c u r itie s and Exchange
Commission
The A ccounting E n tity
O ther Concepts and T h eo ries R e la tin g
to Goodwill
D eterm ination o f E arning P eriod
E stim ate o f th e A verage Annual Net Income
S e le c tio n o f an A p p ro p ria te R ate o f R eturn
D eterm ination o f th e Excess Annual E arnings
IV
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Chapter Page
C a p ita liz e d Excess E arnings a t Normal R ate
C a p ita liz in g Excess E arnings a t Higher
R ate o f R eturn
Purchase o f Excess E arn in g s
Summary
I I I . THEORETICAL ALTERNATIVES IN THE TREA TM EN T
OF GOODWILL.................................................................... 50
H ypotheses To Be C onsidered
Reasons f o r Excess o f C ost Over Book V alue
Reasons f o r Excess o f Book V alue Over Cost
P o s itiv e Goodw ill Viewed as an A sset
Erroneous Im p lic a tio n s o f Immediate
W rite-O ff o f P o s itiv e G oodw ill
B alance Sheet D isc lo su re o f P o s itiv e
G oodw ill
B alance Sheet D isc lo su re o f N egative
Goodwill
G oodw ill Should Not Be A m ortized
G oodw ill Should Be A m ortized
Change in P o s itio n C oncerning Goodwill
A m o rtizatio n
A m o rtizatio n To R etain ed E arnings
A m o rtizatio n To Income
Reasons For Not A m ortizing Goodwill
Reasons For A m ortizing G oodw ill
Summary
IV. ILLUSTRATIVE EFFECTS O N USERS O F VARIOUS
ACCOUNTING TREATM ENTS OF GOODW ILL IN
CONSOLIDATED FINANCIAL REPORTS ....................... 90
U sers o f th e R eports and th e Uses
They Make o f R eports
S ele cte d R atio s and Form ulas
I l l u s t r a t i v e Data
A n aly sis o f E ffe c ts
L im ita tio n s o f C o n so lid ated S tatem ents
Summary
V
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Chapter Page
V. GENERAL TREATM ENT OF GOODW ILL BY REGULATORY
AGENCIES.................................................................................. 116
Method o f Computing Rate
E s ta b lis h in g th e R ate o f R eturn
Uniform P ric in g
Going V alue
In ta n g ib le Element in A ccourt 100.5
C iv il A ero n au tics Board
Governm ental R e g u latio n as a Roadblock
in A ccounting
Summary
VI. RECENT PRACTICES IN REPORTING A N D ACCOUNTING
FOR GOODWILL.................................................................... 149
S e le c tio n o f th e Companies
C o lle c tio n o f Data
E x cerp ts from P u b lish ed Annual R eports
A D ecrease in G oodw ill and N o E x p lan a tio n
U t i l i t i e s and R a ilro ad s
G oodw ill Dependent Upon Method o f C o stin g
Investm ents
Summary
V II. SU M M A R Y , CONCLUSIONS, A N D RECO M M EN D A TION S . . 199
Summary
C onclusions
Recommendations
BIBLIOGRAPHY............................................................... 217
APPENDIX A. L is ts o f Companies Included in th e
S t u d y ......................................................................... 230
APPENDIX B. L e tte r s R eceived ................................................. 237
V I
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L I S T O F T A B L E S
T able Page
1. A n aly sis o f th e E ffe c ts of V arious A ccounting
T reatm ents on C e rta in R atio s Im portant to
U sers o f C o n so lid ated F in a n c ia l R eports . . . 105
2. V arious C la s s if ic a tio n s A ppearing on th e
B alance Sheet Under Which Excess C ost Over
Book V alue A p p e a r s ............................................................ 157
3. Excess C ost Over Book V alue A ppearing in th e
Notes to th e S tatem ents b u t Under a D iffe re n t
C aption on th e B alance S h e e t ........................................ 158
4. The V arious Methods by I'Jhich In ta n g ib le s a re
P resen ted on th e B alance Sheet ........................... 168
5. Comparison o f T o ta l A sse ts, Net S ale s and
Net Income o f Those Companies A m ortizing
th e Excess o f C ost Over I n v e s t m e n t .................. 176
6. Comparison o f T o ta l A sse ts, Net S ale s and
Net Income o f Those Companies Not A m ortizing
th e Excess o f Cost Over I n v e s t m e n t .................. 177
7. Number o f Companies Showing th e Amount o f
In ta n g ib le s Changing But No E x p lan a tio n as
to th e C h a n g e .................................................................... 182
8. Summary o f th e C la s s if ic a tio n o f V arious
T reatm ents o f P o s itiv e o r N eg ativ e
G oodw ill . . . . ....................................................... 185
9. In fo rm atio n Used to I l l u s t r a t e th e Four
Methods o f C o stin g Investm ents ........................... 190
V l l
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Table Page
10. F i r s t -In , F i r s t - O u t ............................................................ 191
11. L a s t-In , F i r s t - O u t ............................................................ 192
12. Average C o s t .......................................................................... 193
13. S p e c ific I d e n tif ic a ti o n ................................................... 194
14. Com parative Summary o f th e Four Methods
o f C o s t i n g ......................................................................... 195
v i ix
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CHAPTER I
INTRODUCTION
In th e p re s e n t economy th e a c t i v i t i e s o f two o r
more c o rp o ra te e n te r p r is e s a re o fte n c o n tro lle d by a common
ow nership g roup. This c o n tro l i s u s u a lly achieved th ro u g h
th e a c q u is itio n o f th e m a jo rity o f th e o u tsta n d in g v o tin g
sto c k o f a c o rp o ra tio n by a s h a re h o ld e r o r a group o f s h a re
h o ld e rs . The acco u n tin g p ro fe s s io n deems i t a p p ro p ria te to
combine th e o p e ra tin g r e s u l t s and th e f in a n c ia l c o n d itio n
o f such c o rp o ra te e n te r p ris e s in a s e t o f "c o n so lid a te d "
r e p o r ts .
U su ally on th e d a te o f p u rch ase o f a c o n tr o llin g
i n t e r e s t , th e a c q u is itio n p r ic e i s n o t th e same as th e p ro
p o r tio n a te d o l l a r e q u ity in th e n e t ta n g ib le a s s e ts o f th e
e n te r p r is e s to be c o n tro lle d . In m ost cases th e a c q u is i
tio n p r ic e exceeds th e p ro p o rtio n a te d o lla r e q u ity in n e t
ta n g ib le a s s e ts p ro p e rly v a lu e d . T his a d d itio n a l v a lu e is
u s u a lly r e f e r r e d to as an in ta n g ib le a s s e t, g o o d w ill.
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Statement of the Problem
G en e rally a c c e p te d ac co u n tin g p r in c ip le s p ro v id e
t h a t th e c o s t o f m ost a s s e ts sh o u ld be d is t r i b u t e d o ver th e
p e rio d d u rin g which th e u t i l i z a t i o n o f th e s e a s s e ts has
produced rev en u e. A ccounting th e o ry u t i l i z e s a m atching
concept to m eet t h i s problem . C osts o f a p e rio d should be
m atched w ith th e rev en u es t h i s c o s t has h e lp e d to c r e a te .
The problem , th e r e f o r e , i s to d eterm in e i f th e
c o n s o lid a tio n o f th e s e c o rp o ra te e n te r p r is e s r e s u l t s in
g o o d w ill and, i f g o o d w ill does a r i s e , i f i t i s a tem porary
o r a perm anent p o r tio n o f t o t a l a s s e ts .
The Purpose o f th e Study
In o rd e r to make t h i s in v e s tig a tio n , t h i s stu d y
w i l l a tte m p t to answ er th e fo llo w in g q u e s tio n s :
1. Is a l l o f th e ex cess p r ic e p a id f o r th e in v e s t
ment in a s u b s id ia r y n e c e s s a r ily g o o d w ill?
2. Is g o o d w ill perm anent, o r sh o u ld i t be w r itte n
o f f?
3. I f th e g o o d w ill i s w r itte n o f f , should i t be
a ch arg e to c u r r e n t o p e ra tio n s o r r e ta in e d
e a rn in g s ?
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Importance of the Study
I t i s o f th e u tm o st im portance t h a t th e many a l t e r
n a tiv e methods o f a p p ly in g acco u n tin g p r in c ip le s be n a r
rowed so th a t d e c is io n s can be re n d e re d . U sers o f f in a n c ia l
s ta te m e n ts may make d i f f e r e n t d e c is io n s on th e same d a ta
b ecau se o f th e p r e s e n ta tio n o f th e s e d a ta by a l t e r n a t i v e
m ethods. I f t h is in c o n s is te n c y can be removed, b e t t e r and
more r e l i a b l e d e c is io n s can be re n d e re d .
A ccountants have been inform ed t h a t th e p u b lic
f in d s t h e i r s ta te m e n ts in a d eq u ate and i n s u f f i c i e n t —th a t
sto c k h o ld e rs a re concerned w ith a need f o r more q u a lity and
le s s q u a n tity . I f i t i s n o t p o s s ib le f o r th e a c co u n ta n t
to compare th e f in a n c i a l c o n d itio n and o p e ra tin g r e s u l t s o f
com panies w ith in an in d u s try o r one in d u s try w ith a n o th e r
b ecau se o f th e v a rio u s a l te r n a tiv e s a v a ila b le in ac co u n tin g
m ethods, i t i s h is fu n c tio n to make c l e a r th e re a so n s f o r
h is i n a b i l i t y to make such com parisons.
Spacek e x p re s se s t h i s p o s itio n w e ll when he w rite s :
I f th e re a r e d i f f e r e n t acco u n tin g p r in c ip le s th a t
may be a p p lie d to one tr a n s a c tio n , and each i s accep ted
in some d eg ree by a c co u n ta n ts and by in d u s try , does n o t
th e re p o rtin g company have a c h o ice o f p r in c ip l e s , even
though each would produce a w id ely d i f f e r e n t f in a n c ia l
p o s itio n and o p e ra tin g r e s u l t ? Y et, as p r o f e s s io n a l
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acco u n tan ts who know t h a t t h i s does happen, do we n o t
c e r t i f y each in s ta n c e as b ein g " in co n fo rm ity w ith
g e n e ra lly acce p ted ac co u n tin g p r in c ip le s " ?
Since we know t h a t th e p u b lic u se s th e s e c e r t i f i e d
re p o rts to d eterm in e com parative f i n a n c i a l q u a lity ,
ea rn in g power, and management perform ance, and s in c e
we know th a t such ccsnparisons a r e n o t n e c e s s a r ily
sound, a re we n o t c o n trib u tin g to th e m isu n d erstan d in g
by is s u in g un ifo rm c e r t i f i c a t e s ?
A second l i n e o f a tta c k i s i l l u s t r a t e d by Oswald W .
K p auth :
The a c c o u n ta n t can g e n e ra lly conform th e re p o rts
o f any one company to a s in g le system , so th a t th ey a re
com parable frcm y e a r to y e a r u n le s s c o n d itio n s change
r a d ic a lly . But he can n o t make th e r e p o r ts o f two o r
th r e e companies com parable to each o th e r . Nor can he
add up a number o f r e p o r ts to fin d a g e n e ra l t o t a l . %
The need f o r ad eq u ate acco u n tin g in c re a s e s as more
p eo p le become in te r e s te d in a b u sin e ss i n s t i t u t i o n . The
need becomes even g r e a t e r when th e re a re d iv is io n s o f th e s e
p eo p le in to groups w ith c o n f lic tin g i n t e r e s t s .
M anagers, c r e d i to r s , em ployees, in v e s to r s , ta x in g
a g e n c ie s, governm ental r e g u la to ry a g e n c ie s, and o th e rs
depend upon q u a n tita tiv e m onetary d a ta ab o u t b u sin e ss
a f f a i r s as th e b a s is f o r making f in a n c ia l d e c is io n s about
^Leonard Spacek, "C hallenge to P u b lic A cco u n tin g ,"
H arvard B usiness Review. XXXVI (May-June, 1958), 116.
^Oswald W . K iauth, "An E xecutive Looks a t Account -
ancy, " The Jo u rn a l o f A ccountancy. XCV (Jan u ary , 1957), 29.
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an economic e n t i t y . These d a ta a r e u s u a lly communicated
to th e u s e rs th ro u g h th e f i n a n c i a l sta te m e n ts o f a c c o u n t
in g . As S tans p u t i t .
A ccounting i s th e lan g u ag e in w hich th e c o rp o ra tio n
ta lk s w ith th e bro ad p u b lic . I t has grown in im por
ta n c e and in tr ic a c y w ith th e in c re a s in g com plexity o f
th e b u sin e ss community and i s an i n t e g r a l p a r t o f a
pow erful economic system , and th e s o c ia l s tr u c tu r e t h a t
has grown in re sp o n se to i t . 3
Thus, th e i n t e r e s t s o f in d iv id u a ls and o f c la s s e s
a re to be se rv e d o n ly when th e y do n o t c o n f l i c t w ith th e
i n t e r e s t s o f th e g e n e ra l s o c ie ty . As a prem ise, t h i s is
u n d en iab le . I t was fo rm a lly acknow ledged in 1939 in
A ccounting R esearch B u lle tin , No. 1, iss u e d by th e Com
m itte e on A ccounting P rocedure o f th e American I n s t i t u t e o f
A ccountants th a t :
The com m ittee re g a rd s c o rp o ra tio n acco u n tin g as
one phase o f th e w orking o f th e c o rp o ra te o rg a n iz a tio n
o f b u s in e s s , w hich in tu r n i t view s as a m achinery
c re a te d by th e p eo p le in th e b e l i e f th a t, b ro a d ly
sp eak in g , i t w i l l s e rv e a u s e f u l s o c ia l p u rp o se. The
t e s t o f th e c o rp o ra te system and o f th e s p e c ia l phase
o f i t re p re s e n te d by c o rp o ra te acco u n tin g u ltim a te ly
l i e s in th e r e s u l t s w hich a r e produced. These r e s u l t s
m ust be judged from th e s ta n d p o in t o f s o c ie ty as a
o
M . H. S tan s, "How New S tan d ard s o f F in a n c ia l
R eporting Grow From S o c ia l R e s p o n s ib ility ," Jo u rn a l o f
A ccountancy, XXCVI (A ugust, 1948), 99.
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w hole—n o t from t h a t o f any one group o f in te r e s te d
p a r t i e s . ^
B ecause o f t h i s r e s p o n s i b ilit y , ac co u n tin g r e p r e
s e n ta tio n s m ust be made in a way which i s c o n s is te n t w ith
th e p u b lic i n t e r e s t . T his r e s p o n s i b i l i t y r e q u ir e s th a t th e
m easurem ents o f c o n trib u tio n s and rew ards o f th e many
s e c to r s o f th e economy be c l e a r ly d eterm in ed and re p o rte d .
I f a c c o u n ta n ts a r e going to assume such a r e s p o n s i b ilit y ,
th ey w i l l have to im prove c e r t a in " g e n e ra lly accep ted
a c co u n tin g p ro c ed u res" in o rd e r to e lim in a te e x is tin g
a m b ig u itie s and narrow th e ran g es o f p r a c t ic e .
H is to ria n s have conceded t h a t th e f r e e - e n te r p r is e
system fa c e s a suprem e t r i a l in th e y e a rs to come. The
r e s u l t s o f t h i s t r i a l w i l l depend on th e q u a lity o f th e
sy stem ’ s f a b r ic . T h e re fo re , ac co u n tin g p r a c t ic e s , as a
p a r t o f o u r economic system , sh ould h e lp to develop
s tr e n g th by p e rm ittin g no compromise w ith c l e a r independent
tr u th f u ln e s s in s e rv in g th e p u b lic i n t e r e s t .
Are ac c o u n ta n ts p a ssin g t h e i r fu n c tio n to o th e rs ?
The a c c o u n ta n t's a t t i t u d e ap p ears to be s im ila r to th a t
Committee on A ccounting P ro ced u re, "G eneral I n tr o
d u c tio n and Rules F orm erly A dopted," A ccounting R esearch
B u lle tin , No. 1, Septem ber, 1939, p . 1.
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o f th e sto c k exchanges in th e 1920*s. The s to c k exchange
to o k a n e g a tiv e v ie w p o in t con cern in g th e method and conduct
o f t h e i r b u s in e s s . I f th ey had le d th e refo rm a t th a t
tim e, th e r e i s a p o s s i b i l i t y th e S e c u r itie s and Exchange
Commission m ight n o t e x i s t to d ay . This sh o u ld be an i n
d ic a tio n to a c c o u n ta n ts to le a d t h e i r own refo rm movements.
I f n o t, i t i s c o n c e iv a b le th a t ac co u n tin g m ethods m ight be
re g u la te d by governm ental c o n tr o ls .^
H ypotheses To Be T ested
In answ ering th e s e q u e s tio n s , i t w i l l be n e c e ssa ry
to t e s t th e fo llo w in g h y p o th e ses:
1. G oodw ill from c o n s o lid a tio n i s m erely a gap-
f i l l e r , an amount j u s t s u f f i c i e n t to b rin g
ab o u t a r e c o n c ilia tio n o f th e r e c ip r o c a l
a c c o u n ts .
In te s t i n g t h i s h y p o th e sis, i t w i l l be reco g n ized
t h a t th e amount o f t h i s gap can v a ry b ecau se i t depends on
th e method used by th e c o n tr o llin g e n t e r p r is e in th e c o s t
in g o f in v estm en ts such as f i r s t in - f i r s t o u t, l a s t in -
f i r s t o u t, av erag e and s p e c if ic i d e n t i f i c a t i o n .
^Knauth, op. c i t . . p . 41.
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8
2. When th e re v e rs e o f p o s itiv e g o o d w ill n e g a tiv e
g o o d w ill i s absorbed in c o n s o lid a te d s u rp lu s ,
t h i s a b s o rp tio n i s th e e q u iv a le n t to re c o g
n iz in g a p r o f i t on a p u rch ase.
In t e s t i n g t h i s h y p o th e s is , i t w i l l be reco g n ized
t h a t th e acco u n tin g f o r th e r e s u l t s o f an economic ev en t
sh o u ld be based on sound and ad eq u ate th e o ry .
3. The d is p o s itio n o f g o o d w ill te n d s to fo llo w
one o f s e v e r a l custom ary p r a c tic e s r a th e r th a n
lo g ic a l re a s o n in g .
In t e s t i n g t h i s h y p o th e s is , i t w i l l be rec o g n ized
th a t a premium p a id f o r "above norm al e a rn in g s " sh ould be
charged a g a in s t such e a rn in g s o v er a re a s o n a b le p e rio d o f
tim e. I f n o t, th e c o s t o f g o o d w ill i s n o t m atched w ith th e
revenues r e s u lt in g from g o o d w ill.
PeveloTxnent o f Concents B asic to th e Study
and to th e Hypov-ieses o f G oodw ill
The con cep t o f g o o d w ill was in e x is te n c e long
b e fo re th e advent o f th e modem b u sin e ss p r a c t ic e . In 1620
th e re was a c a se in w hich a p u rc h a se r o f th e w ares o f an
o ld shop p a id th e vendor c o n s id e ra tio n n o t to keep th e s a id
shop in th e same v i c i n i t y . ^ Hie su p p o rt o f th e custom ers
^Broad v . J o ll v f e . 79 The E n g lish R eports 509
(1907).
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
and t h e i r f r ie n d ly a t t i t u d e w ere adjudged to be an elem ent
o f p u rch ase and s a le in c o n ju n c tio n w ith th e w ares. How
ev er, in a c a s e in 1810 i t was n o t th e f r ie n d lin e s s o f th e
p u b lic th a t was th e c o n tr o llin g c o n s id e r a tio n .^ The b e n e
f i t o f a c e r t a in co n v en ien t lo c a tio n and th e h a b it o f th e
custom ers to r e s o r t to i t w ere s a id to be th e e s s e n t i a l
elem ents o f g o o d w ill.
One y e a r l a t e r , in 1811, th e d e f in it io n o f g o o d w ill
as a mere b e n e f i t o f lo c a tio n was c r i t i c i z e d as b ein g to o
Q
narrow . C o n sid e ra tio n was ex ten d ed to in c lu d e ev ery
advantage t h a t m ight have been o b ta in e d by a company in
c a rry in g on i t s b u s in e s s , w h eth er connected w ith th e
prem ises o r th e name o f th e company. By th is tim e an y th in g
which could be a tta c h e d to a p ro sp e ro u s b u sin e ss co u ld be
viewed as an in g re d ie n t o f g o o d w ill. Goodw ill was th u s
composed o f many elem en ts. I t s co m p o sitio n d if f e r e d from
one tra d e to a n o th e r and in a d i f f e r e n t b u sin e ss in th e
same tr a d e .
^C ru ttw e ll V . L yle. 34 The E n g lish R eports 129
(1903).
O
The Commissioners o f In la n d Revenue v . 1 ^1 1 er.
The Law R eports 217 (1901).
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
10
Yang p re s e n ts two re a so n s f o r th e change in th e
le g a l o p in io n s o f g o o d w ill from a f r ie n d ly d is p o s itio n to
an y th in g t h a t can acco u n t f o r th e b e n e f it o f an e s ta b lis h e d
b u s in e s s .
F i r s t , th e circ u m sta n ces in each c a s e b e fo re th e
c o u rt m ig h t have been so d i f f e r e n t t h a t each tr ib u n a l
sim ply a t t r i b u t e d th e b e n e f i t o f an e s ta b lis h e d b u s i
n ess to th e p red o m in atin g f a c t in each p a r t i c u l a r
c a se , u n t i l f i n a l l y th e im p o rtan ce o f th e custom as a
b a s is o f a l l th e f a c t s was g iv en d i s t i n c t re c o g n itio n .
Again, i t i s h ig h ly p ro b a b le th a t when th e term good
w i l l was adopted i t was d u rin g a p e rio d when th e
i n d u s t r i a l developm ent was such th a t th e p e rs o n a l
r e la t i o n s betw een th e b u sin e ss concern and i t s c u s -
tcm ers w ere so c lo s e th a t th e k in d ly a t t i t u d e o f th e
l a t t e r tow ard th e form er was o f dom inant im portance in
b rin g in g th e e u sta n and h e lp in g to com plete a l l b u s i
n e ss tr a n s a c tio n s . As th e i n d u s t r i a l system developed,
how ever, th e p e r s o n a lity o f th e in d iv id u a ls became o n ly
one o f th e many c irc u m sta n ces th a t ten d ed to shape th e
flow o f b u s in e s s , and c o n seq u en tly th e m ore com pre
h e n siv e m eaning o f g o o d w ill was re n d e re d n e c e ss a ry ,
nam ely, e v e ry th in g t h a t m ight be s a id to c o n trib u te to
th e advantage w hich an e s ta b lis h e d b u s in e s s p o sse sse s
over a b u s in e s s to be s t a r t e d anew.^
So f a r g o o d w ill has been c o n sid e re d o n ly from th e
s e l l in g end o f th e e n te irp ris e . N othing h as been s a id about
th e p ro c e ss o f p ro d u c tio n . The e a rly c o u rts h e ld th a t
g o o d w ill clung p rim a rily to th e com m ercial houses in which
th e s e l l i n g o f goods and s e rv ic e s dom inated becau se in
Q
J . M . Yang, G oodw ill and O ther In ta n g ib le s (New
York: Hie Ronald P ress Company, 1927), p . 29.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
11
th e e a rly s ta g e o f in d u s try th e human elem ent in produc
t i o n was o f c o n s id e ra b ly le s s im p o rtan ce th an th e id e a o f
se c u rin g cu sto m ers. As in d u s try grew and expanded in to
la r g e - s c a le p ro d u c tio n , businessm en w ere co n fro n ted w ith
th e problem o f h ir in g a la rg e work f o r c e . Today, th is
problem o f s e c u rin g and m a in ta in in g th e u n ity and th e
e f f ic ie n c y o f th e w orkers i s as im p o rta n t as th e o ld p ro b
lem o f g e ttin g th e tr a d e .
T his u n ity o f f r ie n d lin e s s and lo y a lty on th e p a r t
o f th e w orkers i s c o n sid e re d i n d u s t r i a l g o o d w ill as s e t
a p a rt from consum ers * g o o d w ill. The Supreme Court o f th e
U nited S ta te s in 1917 reco g n ized g o o d w ill as p ro p e rty o f
v a lu e .
J . M . Yang i s more f o r c e f u l when he s t a te s :
F in a lly , th e r e a re numerous in s ta n c e s , in th e h i s
to ry o f c o rp o ra te fin a n c e , o f i n d u s t r i a l com bination
and in te g r a tio n w hich have been made p o s s ib le only
through th e f i n a n c ia l backing o f th e i n f l u e n t i a l
bankers and s y n d ic a te s . W hether th e prim e m otive f o r
th e co m b in atio n b e f o r a g r e a te r economy o r f o r a more
com plete c o n tr o l o f supply o f th e p ro d u c ts, th e an
t i c i p a t i o n o f a phenomenal in c re a s e o f inccme o fte n
fu rn is h e s th e ground f o r th e c a p i t a l i z a t i o n o f th e
p ro sp e c t as a c a te g o ry o f c o rp o ra te a s s e t, which i s
in
Hitchman Coal and Coke Co. v . M itc h e ll. 245 U.S.
229 (1918).
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
12
u s u a lly p la c e d on t h e i r f in a n c ia l sta te m e n ts u n d er
th e t i t l e o f g o o d w ill.
As in d u s tr ie s in c re a s e in s iz e , th e r e la tio n s h i p
betw een th e owners and th e em ployees tends to grow more
fo rm al and more im p e rso n al. In ca se o f a t r a n s f e r w ith
a b se n te e ow nership, th e r e te n tio n o f a fix e d management,
p r a c t i c a l l y unchanged, s u p p o rts th e growth o f a fix e d
w orking f o rc e and may b e v a lu e d as g o o d w ill.
Thus i t may be seen t h a t th e g e n e ra l co n cep t o f
g o o d w ill has changed c o n s id e ra b ly o ver th e p a s t c e n tu ry .
At one tim e b u sin e ss g o o d w ill was co n sid ered to p e r ta in
alm ost e x c lu s iv e ly to cu stcm er r e la tio n s . However, good
w i l l i s now used in a much b ro a d e r sen se; i t encom passes
alm ost any in ta n g ib le f a c t o r o f econonic v a lu e to an e n t e r
p r is e .
A. C. Lord M acnaughten made th e rem ark t h a t good
w i ll i s v ery easy to d e s c rib e and v ery d i f f i c u l t to d e f in e .
The fo llo w in g d e f in itio n s w i l l i l l u s t r a t e th a t g o o d w ill i s
d i f f i c u l t to d e fin e :
I t may be ta k en as th e ty p ic a l form o f im m a te ria l
a s s e ts . . . r e p r e s e n tin g . . . th e v a lu e o f b u s in e s s
c o n n e c tio n s, th e v a lu e o f th e p r o b a b ility t h a t p re s e n t
^^Yang, op. c i t . , p . 32.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
13
custom ers w i l l c o n tin u e to buy in s p i t e o f th e a l l u r e
m ents o f com peting d e a le r s .
The v a lu e o f th e b e n e f its o r ad v an tag es w hich
a tta c h to a p a r t i c u l a r b u s in e s s , in a d d itio n to th e
a c tu a l v a lu e o f th e p ro p e rty used in i t s co n d u ct.
The mcmentum a c q u ire d by a going b u s in e s s .
Ih e p r o b a b ility o f th e c o n tin u a n c e o f t h i s advan
ta g e i s th e b a s ic elem ent in th e v a lu a tio n o f good
w i l l .
G oodw ill n ev e r a tta c h e s to a b u s in e s s w hich is
n o t b e lie v e d to p o sse ss p o s s i b i l i t i e s o f b ein g made
p r o f i t a b l e .
G oodw ill may be d e fin e d as th e p u rc h ase p r ic e o f
th e c o n tr o l o f ex cess e a rn in g pow er: T his m eets th r e e
re q u ire m e n ts. A p u rch ase has been made, th e c o n tro l
elem ent e x i s t s , and th e p o t e n t i a l ex cess e a rn in g power
may be assum ed, as a p u rc h a s e r e x p e c ts to r e c e iv e h is
money’s w orth o f th e ta n g ib le (re c o rd e d book v a lu e )
and in ta n g ib le (g o o d w ill) a s s e t s . ^2
The b a s ic th o u g h t u n d e rly in g a l l th e s e d e f in itio n s
i s w e ll e x p ressed by Leake:
G oodw ill in i t s com m ercial se n se i s th e p re s e n t v a lu e
o f th e r i g h t to r e c e iv e ex p ected f u tu r e s u p e r - p r o f its ;
th e term s u p e r - p r o f its m eaning th e amount by w hich
f u tu r e rev en u e, in c re a s e o r ad v an tag e to be re c e iv e d
i s ex p ected to exceed any and a l l e x p e n d itu re i n c i
d e n ta l to i t s p ro d u c tio n .
^^G. A. D. P re in re ic h , "G oodw ill in A ccountancy,”
J o u rn a l o f A ccountancy. LXXVI (J u ly , 1937), 34-36.
^ ^ I b i d . , p . 32.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
14
For th e purp o se o f t h i s stu d y g o o d w ill i s th e
excess o f c o s t p a id by th e p a re n t over th e book v a lu e o f
th e s u b s id ia r y 's s to c k , w hich cannot be a t t r i b u t e d to o th e r
in ta n g ib le s o r to p la n t a s s e ts which have been p re v io u s ly
u n d erv alu ed .
C o n so lid a tio n s
W idespread u se o f c o n s o lid a te d s ta te m e n ts in th e
Ik iited S ta te s d id n o t ap p ear u n t i l 1901 when th e IM ited
S ta te s S te e l C o rp o ratio n p re s e n te d c o n s o lid a te d s ta te m e n ts .
S ince th i s tim e, c o n s o lid a te d sta te m e n ts have beer; an im
p o r ta n t f e a tu r e o f c o rp o ra te r e p o r ts . C o n so lid ated s t a t e
m ents w ere evolved to m eet th e need f o r a c le a r e r p r e s e n ta
tio n o f ccxaplicated o p e ra tio n s o f th e b u sin e ss em pires th a t
w ere b ein g e s ta b lis h e d . T here w ere b ig ad v an tag es to
c o n s o lid a tin g . S u b s id ia rie s co u ld be form ed, in d ep en d en t
o f th e p a re n t, and new b u s in e s s p r a c tic e s could be adopted
f o r c e r t a in p ro d u c ts w ith o u t changing o ld p r a c tic e s
p re v io u s ly ado p ted f o r w e ll a d v e rtis e d p ro d u c ts .
A. Lowes D ickinson, who p lay ed an im p o rta n t p a r t in
th e h is t o r y o f c o n s o lid a te d acco u n tin g , p re s e n te d th e f o l
low ing e x p la n a tio n o f th e need f o r c o n s o lid a te d sta te m e n ts
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
15
in an ad d re ss b e fo re th e F i r s t I n te r n a tio n a l Congress o f
A ccounting in 1904:
During th e l a s t few y ears th e c o r r e c t sta te m e n t o f
th e e a rn in g s o f a company c o n tr o llin g a number o f
s u b s id ia ry com panies has re q u ire d much c o n s id e ra tio n .
L e g a lly , th e e a rn in g s o f such a c o rp o ra tio n c o n s is t o f
th e r e s u l t s o f i t s own o p e ra tio n , to g e th e r w ith any
d iv id e n d s w hich may be d e c la re d on th e sto c k s w hich i t
owns in th e s u b s id ia r y c a a p a n ie s; and so long as th e s e
sto c k s re p r e s e n t o n ly a m in o rity i n t e r e s t in com panies
w hich a r e n o t in any way c o n tro lle d o r o p e ra te d by th e
d ir e c to r s o f th e h o ld in g company, i t would seem t h a t a
p r o f it- a n d - lo s s account p re p ared in such a way would be
a c o r r e c t and p ro p e r sta te m e n t from an acco u n tin g as
w e ll as from a le g a l p o in t o f view . During re c e n t
y e a rs , how ever, th e p r a c tic e o f c o n s o lid a tin g a number
o f concerns by a c o n tro l o f s to c k r a t h e r th an by an
a b s o lu te p u rch ase o f th e b u sin e ss has grown in to fa v o r
and co n seq u en tly i t i s u s u a l to fin d th e h o ld in g com
pany owning e i t h e r th e whole o r a la r g e m a jo rity o f
th e sto c k s o f a number o f com panies doing a s im ila r
b u s in e s s , a p p o in tin g th e d ir e c to r s o f th e s e su b -
com panies, d ic ta t in g t h e i r p o lic y , and g e n e ra lly a c tin g
in ev ery way as i f i t a b s o lu te ly owned th e whole p ro p
e r ty . lAider such c o n d itio n s i t i s su b m itted th a t no
s ta te m e n t o f e a rn in g s can be c o n sid e re d c o r r e c t w hich
does n o t show in one account th e p r o f i t s o r lo s s e s o f
th e w hole group o f com panies, ir r e s p e c tiv e o f w hether
d iv id e n d s have o r have n o t been d e c la re d th e re b y . I f
t h i s p r in c ip le be n o t in s i s t e d upon i t i s w ith in th e
power o f th e d ir e c to r s o f th e h o ld in g company to re g u
l a t e i t s p r o f i t s acco rd in g n o t to f a c t s , b u t to t h e i r
own w ish es, by d i s t r i b u t i n g o r w ith h o ld in g d iv id en d s
o f th e s u b s id ia ry com panies; o r even to la rg e ly o v e r
s t a t e th e p r o f i t s o f th e whole group by d e c la rin g la r g e
d iv id e n d s in th o s e subcom panies w hich have made p r o f i t s ,
w h ile e n t ir e l y o m ittin g to make p ro v is io n f o r lo s s e s
w hich have been made by o th e r com panies in th e g ro u p .
^ Q u o ted by P e rc e iv a l Brundage, "C o n so lid ated
S tate m e n ts, " in Contem porary A ccounting, e d ite d by Thomas W .
Leland (New York: American I n s t i t u t e o f A ccountants,
1945), p. 1.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
16
However, th e re a re c a se s w here s e p a r a te books w ere
n o t k e p t o r a r t i f i c i a l acco u n ts w ere p re p a re d f o r th e
s u b s id ia r y . Hie view s o f th e c o u rts v a r ie d a c c o rd in g to
th e c irc u m s ta n c e s . The Supreme C ourt h e ld in 1920 :
Where su ch ow nership o f s to c k i s r e s o r te d to , n o t
f o r th e p u rp o se o f p a r tic ip a t in g in th e a f f a i r s o f th e
c o rp o ra tio n in v h ic h i t i s h e ld in a m anner norm al and
u s u a l w ith s to c k h o ld e rs , b u t f o r th e p u rp o se o f making
i t a m ere ag e n t o r in s tru m e n ta lity o r d ep artm en t o f
a n o th e r company, th e c o u rts w i l l lo o k th ro u g h th e forms
to th e r e a l i t i e s o f th e r e l a t i o n betw een th e companies
as i f th e c o rp o ra te agency d id n o t e x i s t and w i l l d e a l
w ith them as th e j u s t i c e o f th e c a se may r e q u ir e .
The S e c u r itie s Act o f 1933 gave th e F e d e ra l Trade
Commission power to r e q u ir e c o n s o lid a te d s ta te m e n ts i f they
w ere to r e g u la te new s e c u r ity is s u e s . The S e c u r itie s
Exchange Act o f 1934 gave th e governm ent power to s u p e rv is e
s e c u r ity is s u e s which w ere a lre a d y in e x is te n c e and which
w ere tra d e d on th e exchange.
O ther th a n th e S e c u r itie s Exchange Commission, th e
m ost p ow erful group w ith in flu e n c e to d ev elo p th e u se o f
c o n s o lid a te d s ta te m e n ts has been th e I n te r n a l Revenue
S e rv ic e . C o n so lid ated r e tu r n s w ere r e q u ire d o f a f f i l i a t e d
c o rp o ra tio n s from 1917 to 1921. C o n so lid ated r e tu r n s
^^ I b id . , C hapter V, p. 2.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
17
w ere p la c ed on an o p tio n a l b a s is by th e Revenue Act o f 1921.
In 1932 and 1933, a sm a ll ta x was imposed f o r f i l i n g co n
s o lid a te d r e tu r n s . This p r iv ile g e was re p e a le d e n t i r e l y
in th e 1934 a c t, e x c e p t f o r r a i lr o a d s . C o n so lid a ted r e
tu rn s w ere r e s to r e d to fa v o r in 1940 b ec au se o f th e e x c e s s -
p r o f i t s ta x c o n s id e r a tio n s .
D e fin itio n s o f O ther Terms
O ther term s to be used w hich a r e c o n sid e re d to be
p e r tin e n t in u n d e rsta n d in g t h i s stu d y a re as fo llo w s :
C o n so lid ated S tatem en ts a re th o se f i n a n c i a l s ta te m e n ts
p re s e n tin g th e f i n a n c i a l c o n d itio n s and r e s u l t s o f o p e r
a tio n s o f two o r more c o rp o ra tio n s as a s in g le economic
u n i t . A P a re n t Company is a c o rp o ra tio n owning a t l e a s t a
m a jo rity o f th e v o tin g sto c k o f a n o th e r c o rp o ra tio n . A Sub
s id ia r y i s th e c o rp o ra tio n th a t i s c o n tr o lle d by th e p a re n t.
Since g o o d w ill i s re c o rd e d o n ly when p a id f o r ,
sound acco u n tin g p ro ced u re d i c ta t e s th a t a p p re c ia tio n o f
g o o d w ill n o t b e re c o rd e d in th e a c c o u n ts . There h as been
g e n e ra l agreem ent w ith th is c o n c e p t. However th e re has n o t
been g e n e ra l agreem ent on th e d e p r e c ia tio n o f g o o d w ill and
i t s tre a tm e n t in th e a c c o u n ts. These to p ic s w i l l b e d i s
cussed in su b seq u en t c h a p te rs .
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
IS
The R esearch M ethodology
For th e purpose o f t h i s stu d y , a sam ple o f co rp o
r a t e an n u al f in a n c ia l r e p o r ts w hich w ere f i l e d w ith th e
S e c u r itie s and Exchange Commission has been s e le c te d . The
n o te s to th e f in a n c ia l s ta te m e n ts w ere th o ro u g h ly i n v e s t i
g a te d because th e n o te s a re th e one p la c e w here th e r e
s e a rc h e r can d eterm in e i f th e in v estm en t o f th e p a re n t
company in th e s u b s id ia ry exceeded book v a lu e o r was le s s
th an book v a lu e .
Where th e n o te s to th e f in a n c ia l s ta te m e n ts w ere
n o t s u f f i c i e n t f o r th e p u rp o ses o f th is stu d y , i t was
n e c e s s a ry to co rresp o n d w ith th e firm s them selves and have
th z n d e s c rib e th e acco u n tin g tre a tm e n t o f g o o d w ill from
c o n s o lid a tio n . At th e same tim e, th e ac co u n tin g p ro fe s s io n
and o th e r d is c ip li n e s have developed an abundant su p p ly o f
l i t e r a t u r e on t h i s to p ic . A d e ta ile d survey o f th is
l i t e r a t u r e was made and l e t t e r s to in d iv id u a ls who have
w r itte n on th e s u b je c t in o rd e r to s o l i c i t t h e i r su g g e stio n s
and comments w ere p rep ared and m a ile d . L e tte r s to th e
S e c u r itie s and Exchange Commission and th e C iv il A ero n au tics
Board were a ls o w r itte n .
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
19
Further Aspects of the Study
C hapter I I p re s e n ts v a rio u s and d iv e rs e view s of
what a re c o n sid ered as th e more a p p lic a b le co n c e p ts o f
g o o d w ill and th e s ig n if ic a n c e o f g o o d w ill to th e s e con
c e p ts . These v a rio u s views w i l l se rv e as a u s e f u l fram e o f
re fe re n c e f o r d is c u s s in g g o o d w ill in th e su b se q u en t chap
t e r s . C hapter I I I in c lu d e s d is c u s s io n s o f th e e f f e c t s of
th e a p p lic a tio n o f th e th e o ry p re se n te d in C hapter I I and
a ls o goes in to d e ta ile d a n a ly s is o f th e ac co u n tin g d i s
p o s itio n s o f g o o d w ill. An a tte m p t i s made to r e l a t e some
b a s ic c r i t e r i a to t h i s d is p o s itio n o f g o o d w ill.
In C hapter IV th e h y p o th eses o f t h i s stu d y a re
te s te d by in v e s tig a tin g th e f in a n c ia l sta te m e n ts o f v ario u s
firm s . Also in t h i s c h a p te r w i l l be developed a hypo
t h e t i c a l model to a s s i s t in p re s e n tin g th e s i g n i f i c a n t d i f
fe re n c e s in amount o f g o o d w ill r e s u ltin g from d i f f e r e n t
ty p es o f a l t e r n a t i v e m ethods used in ac co u n tin g , as w e ll as
in a m o rtiz a tio n . C hapter V p re s e n ts th e g e n e ra l tre a tm e n t
o f g o o d w ill by re g u la to ry a g e n c ie s. C hapter VI p re s e n ts a
d e ta ile d a n a ly s is o f th e fin d in g s from th e f i n a n c i a l s t a t e
m ents o f th e v a rio u s firm s. In C hapter V II th e fin d in g s ,
c o n c lu sio n s, and recom m endations a re p re s e n te d .
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
CHAPTER II
ACCOUNTING THEORY IN RELATIONSHIP TO GOODW ILL
The elem ents u n d e rly in g g o o d w ill e i t h e r produce
g r e a te r t o t a l rev en u es, r e f e r r e d to as custom er g o o d w ill,
o r d ec re ase u n it c o s t, r e f e r r e d to as i n d u s t r i a l g o o d w ill.
In th e acco u n tin g se n se , an a s s e t i s view ed as an u n a llo
c a te d c o s t p o rtra y in g in some dim ensions th e p re s e n t v a lu e
o f a n tic ip a te d f u tu r e s e rv ic e s . G oodw ill from t h i s view i s
an a s s e t i f one assumed a payment has been made f o r i t .
Goodwill belongs on th e b alan ce s h e e t s in c e th e c o s t has
n o t been charged a g a in s t r e la te d income. T his view i s
su p p o rted by th e American I n s t i t u t e o f C e r tif ie d P u b lic
A ccountants when i t s t a t e s :
Ihe i n i t i a l amount assig n ed to a l l ty p es o f in ta n g ib le s
should be c o s t, in accordance w ith th e g e n e ra lly
accep ted acco u n tin g p r in c ip le t h a t a s s e ts sh ould be
s ta te d a t c o s t when th ey a re a c q u ire d . In th e ca se o f
non-cash a c q u is itio n s , as, f o r exam ple, w here in ta n
g ib le s a re a c q u ire d in exchange f o r s e c u r i t i e s , c o s t
may be c o n sid ered as being e i th e r th e f a i r v a lu e o f th e
c o n s id e ra tio n g iv en o r th e f a i r v a lu e o f th e p ro p e rty
20
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21
o r r i g h t a c q u ire d , w hichever i s th e more c le a r ly
e v id e n t.^
The p o in t s tr e s s e d h e re i s th a t g o o d w ill as an a s s e t r e p r e
s e n ts p rim a rily a c o s t r a th e r th a n a v a lu e .
In com puting a t h e o r e ti c a l v a lu e f o r g o o d w ill o f an
e n te r p r is e (in c o n tr a s t to c o s t when a c q u ire d ), th e te c h
n iq u e u s u a lly r e s o r te d to i s some ty p e o f c a p i t a l i z a t i o n o f
e a rn in g s . Some e f f o r t i s made to d eterm in e what a "norm al"
r a t e o f r e tu r n on th e in v estm en t m ight b e . Most m ethods
assume a d e f i n i t e term o f e x is te n c e f o r th e excess e a rn in g
c a p a c ity o f th e firm . F u tu re e a rn in g s a re th en e s tim a te d
on th e b a s is o f a p r o je c tio n o f p a s t e a rn in g s , a d ju s te d to
r e f l e c t a t y p ic a l p r o f i t tre n d . This norm al r a t e o f r e tu r n
i s compared w ith th e e s tim a te d f u tu r e e a rn in g s o f th e firm ,
and th e d if f e r e n c e su p p o sed ly r e p re s e n ts g o o d w ill e a rn in g s .
R eg ard less o f th e method u sed in com puting th e p u rch ase
p r ic e o f g o o d w ill, th e paym ent r e p r e s e n ts some ty p e o f
e s tim a te o f th e p re s e n t v a lu e o f f u tu r e "su p e r p r o f i t s " to
be earn ed by th e company.
American I n s t i t u t e o f A cco u n tan ts, Committee on
A ccounting P ro ced u re, A ccounting R esearch B u lle tin No. 43
(New York: American I n s t i t u t e o f A cco u n tan ts, 1947),
p . 38.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
22
How to h an d le g o o d w ill in acco u n tin g has long been
a th o rn y p ro b le n . G oodw ill som etim es a p p re c ia te s in v a lu e
a f t e r a b o n a -fid e purch ase has been made. Since g o o d w ill
ta k e s re c o rd e d form only upon th e ev en t o f an a c tu a l p u r
ch a se, sound acco u n tin g p ro ce d u re d ic ta te s th a t a p p r e c i
a tio n o f g o o d w ill should n o t b e reco rd ed in th e a c c o u n ts.
This co n cep t has been g e n e ra lly accep ted f o r a long tim e.
However, th e r e i s no g e n e ra l agreem ent on th e d e p re c ia tio n
o f g o o d w ill and i t s tre a tm e n t in th e a c co u n ts. Though
a c c o u n ta n ts a g ree th a t g o o d w ill does n o t d e p re c ia te in
e x a c tly th e same sen se as do ta n g ib le fix e d a s s e ts , th ey
do a g re e t h a t g o o d w ill may d e c lin e in v a lu e . W hether o r
n o t d e p r e c ia tio n o f g o o d w ill sh o u ld be shown on th e books
has been a moot p o in t. G ra n tin g t h a t goodw ill in a g iv en
c a se has n o t d e p re c ia te d , th e q u e s tio n con cern in g w hether
o r n o t i t sh o u ld be w r itte n o f f may s t i l l a r is e .
In o rd e r to an a ly ze th e acco u n tin g p ro ced u re used
in h a n d lin g g o o d w ill, i t w i l l f i r s t be b e s t to r e a l i z e th a t
any in v e s tig a tio n o f a s e c tio n o f ac co u n tin g would be
r e s t r i c t e d in i t s achievem ent u n le s s i t was co n fin ed w ith in
th e fix e d lim its o f fundam ental theorem s and p o s tu la te s on
w hich a c co u n tin g p r a c tic e s a re c o n s tru c te d . T h erefo re ,
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23
i t i s n e c e ss a ry to c o n s id e r th e view s o f v a rio u s a u t h o r i t a
t i v e b o d ie s.
C h a r a c te r is tic s o f Goodwill
A g r e a t d e a l o f c o n fu sio n concerning g o o d w ill is
a r e s u l t o f th e f a i l u r e to u n d e rsta n d th e c h a r a c t e r i s t i c s
o f g o o d w ill. The fo llo w in g c h a r a c te r is tic s a r e param ount:
1. In o rd e r to p o sse ss v a lu e , g o o d w ill m ust be
u s e fu l and s c a rc e . To be o f v a lu e , g o o d w ill m ust produce
som ething beyond th e norm al e x p e c ta tio n o f p r o f i t in a p a r
t i c u l a r b u s in e s s .
2. Goodw ill m ust be o f d e f i n i t e d u ra tio n . B efore
g o o d w ill can be o f v a lu e , one must be su re i t i s going to
be in e x is te n c e a f t e r th e v a lu a tio n is com pleted.
3. In o rd e r to have v a lu e , g o o d w ill m ust be
tr a n s f e r a b le ; i f n o t, th e re w i l l n o t be a demand f o r i t .
4. G oodw ill m ust be m easurable in term s o f money.
However, t h i s does n o t mean t h a t any v a lu e p la ced on good
w i l l i s a c c e p ta b le .
P o s itio n o f th e American I n s t i t u t e o f
C e r tif ie d P u b lic A ccountants
The Committee on A ccounting Procedure o f th e
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
24
American I n s t i t u t e o f C e r tif ie d P u b lic A ccountants (AICPA)
su p p o rts th e id e a t h a t g o o d w ill sh o u ld n o t b e e n te re d in
th e accounts u n le s s p u rch ased . G oodw ill when p u rchased
sh o u ld n o t be ch arg ed o f f to earned s u rp lu s im m ediately
upon a c q u is itio n . I f th e amount in v o lv e d i s n o t so la rg e
as to r e s u l t in d i s t o r t i o n , an in m ed iate c h a rg e -o ff to
2
income i s p erhaps a p p r o p r ia te as a p r a c t i c a l m a tte r.
Ih e com m ittee c l a s s i f i e s in ta n g ib le a s s e ts in to two
broad c a te g o r ie s :
(a) Those h av in g a term in e x is te n c e lim ite d by
law , r e g u la tio n , o r agreem ent, o r by t h e i r
n a tu r e (such as p a te n ts , c o p y rig h ts , le a s e s ,
lic e n s e s , f ra n c h is e s f o r a f ix e d term , and
g o o d w ill as to w hich th e r e i s ev id en ce o f
lim ite d d u r a tio n ) ;
(b) Those h a v in g no such lim ite d term o f e x is te n c e
and as to w hich th e re i s , a t th e tim e o f a c q u i
s i t i o n , no in d ic a tio n o f lim ite d l i f e (such as
g o o d w ill g e n e ra lly , going v a lu e , tr a d e names,
s e c r e t p ro c e s s e s , s u b s c rip tio n l i s t s , p e rp e tu a l
f r a n c h is e s , and o rg a n iz a tio n c o s t s ) .^
With r e f e r e n c e s to th e a m o rtiz a tio n o f in ta n g ib le
a s s e ts , th e AICPA s t a t e s :
The c o s t o f ty p e (a) in ta n g ib le s sh o u ld b e amor
tiz e d by s y s te m a tic ch arg es in th e income sta te m e n t
over th e p e rio d b e n e fite d , as in th e c a se o f o th e r
^ I b id . , pp. 3 7 -4 0 . ^ Ib id .
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25
a s s e ts hav in g a lim ite d p e rio d o f u s e fu ln e s s . I f i t
becomes e v id e n t t h a t th e p e rio d b e n e fite d w i l l be
lo n g er o r s h o r te r th a n o r ig in a lly e s tim a te d , re c o g n i
tio n th e re o f may ta k e th e form o f an a p p ro p ria te
d e c re a se o r in c re a s e in th e r a t e o f a m o rtiz a tio n o r,
i f such in c re a s e d charges would r e s u l t in d is t o r ti o n
o f income, a p a r t i a l w rite-dow n may be made by a charge
to earned s u rp lu s .
When i t becomes reaso n ab ly e v id e n t t h a t th e term o f
e x is te n c e o f a ty p e (b) in ta n g ib le has become lim ite d
and t h a t i t has th e r e f o r e become a ty p e (a) in ta n g ib le ,
i t s c o s t sh o u ld be am ortized by s y s te m a tic charges in
th e income sta te m e n t over th e e s tim a te d rem aining
p e rio d o f u s e fu ln e s s . I f , however, th e p e rio d o f amor
t i z a t i o n i s r e l a t i v e l y s h o rt so t h a t m isle a d in g i n f e r
ences m ight be drawn as a r e s u l t o f in c lu s io n o f sub
s t a n t i a l ch arg es in th e income s ta te m e n t a p a r t i a l
w rite-dow n may be made by a ch arg e to earn ed s u rp lu s ,
and th e r e s t o f th e c o s t may be am o rtized over th e
rem aining p e rio d o f u s e fu ln e s s .
When a c o rp o ra tio n d ecid es t h a t a ty p e (b) in ta n
g ib le may n o t c o n tin u e to have v a lu e d u rin g th e e n t ir e
l i f e o f th e e n te r p r is e i t may am o rtize th e c o s t o f such
in ta n g ib le by s y s te m a tic charges a g a in s t income d e s p ite
th e f a c t th a t th e r e a re no p re s e n t in d ic a tio n s o f
lim ite d e x is te n c e o r lo s s o f v a lu e w hich would in d ic a te
th a t i t has become ty p e (a ), and d e s p ite th e f a c t th a t
ex p e n d itu res a re b ein g made to m a in ta in i t s v a lu e .
Such a m o rtiz a tio n i s w ith in th e d is c r e t i o n o f th e com
pany and is n o t to be reg ard ed as o b lig a to r y . The p la n
o f a m o rtiz a tio n sh o u ld be re a s o n a b le : i t should be
based on a l l th e su rro u n d in g c irc u m sta n c e s, in c lu d in g
th e b a s ic n a tu re o f th e in ta n g ib le and th e ex p e n d itu res
c u r r e n tly b ein g made f o r developm ent, e x p e rim e n ta tio n ,
and s a le s prom otion. Where th e in ta n g ib le i s an im por
t a n t incom e-producing f a c to r , and i s c u r r e n tly b eing
m ain tain ed by a d v e rtis in g o r o th e rw ise , th e p e rio d o f
a m o rtiz a tio n sh o u ld be re a so n a b ly lo n g .
The com m ittee took th e fo llo w in g p o s itio n co n cern
in g th e w r i te - o f f o f in ta n g ib le s :
The c o s t o f ty p e (b) in ta n g ib le s sh o u ld be w ritte n
o f f when i t becomes re aso n a b ly e v id e n t t h a t th ey have
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26
become w o rth le s s . Under such circu m stan ces th e amount
a t which th e y a re c a r r ie d on th e books sh ould be
charged o f f in th e inccme sta te m e n t o r, i f th e amount
i s so la r g e t h a t i t s e f f e c t on income may g iv e r i s e to
m islead in g in fe re n c e s , i t sh o u ld be charged to earn ed
s u rp lu s . In d eterm in in g w hether an in v estm en t in
ty p e (b) in ta n g ib le s has become o r i s lik e ly to become
w o rth le s s , c o n s id e ra tio n sh o u ld be g iv en to th e f a c t
th a t in some c a se s in ta n g ib le s a c q u ire d by p u rch ases
may merge w ith , o r be re p la c e d by, in ta n g ib le s a c q u ire d
o r developed w ith re s p e c t to o th e r p ro d u cts o r lin e s
o f b u sin e ss and t h a t in such circu m stan ces may n o t in
f a c t in d ic a te lo s s o f v a lu e .
Lump-sum w r ite - o f f s o f in ta n g ib le s sh ould n o t be
made to earn ed su rp lu s im m ediately a f t e r a c q u is itio n ,
n o r sh ould in ta n g ib le s be charged a g a in s t c a p i t a l
s u rp lu s . I f n o t am ortized s y s te m a tic a lly , in ta n g ib le s
should be c a r r ie d a t c o s t u n t i l an ev en t has ta k en
p la c e w hich in d ic a te s a lo s s o r a lim ita tio n on th e
u s e fu l l i f e o f th e in ta n g ib le s .^
I n te r n a l Revenue P o s itio n
The Revenue Law a ls o makes p ro v is io n s f o r th e
tre a tm e n t o f g o o d w ill. The rev en u e law s ta te s u n d er w hat
c o n d itio n s g o o d w ill may be co n sid e re d in d eterm in in g g a in
o r lo s s and c e r t a i n s e c tio n s o f th e law s a n c tio n such a
pro ced u re.
The I n te r n a l Revenue Law o f 1934 co n sid ered good
w i l l as an a s s e t in d eterm in in g g a in o r lo s s . The law
p ro v id es th a t a g a in o r lo s s from th e s a le o f g o o d w ill
^ I b i d . , pp. 39-40.
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27
r e s u l t s o n ly when th e b u sin e ss to w hich g o o d w ill a tta c h e s
i s s o ld . The g a in o r lo s s w i l l b e d eterm in ed by com paring
th e s a le p r ic e w ith th e c o s t o r o th e r b a s is o f th e a s s e ts
in c lu d in g g o o d w ill. I t i s im m a te ria l t h a t g o o d w ill may
have n ev er been on th e books as an a s s e t. The ta x p a y e r
m ust e s ta b lis h c o s t o r o th e r b a s is o f g o o d w ill by a m ethod
s a t i s f a c t o r y to th e Bureau o f I n te r n a l Revenue. The f o l
low ing r u le s may h e lp th e ta x p a y e r e s ta b lis h th e b a s is f o r
g a in o r l o s s . ^
1. In com puting g a in , th e b a s is o f g o o d w ill p r o
cured b e fo re March 1, 1913, i s e i t h e r i t s v a lu e
as o f th a t d a te o r c o s t, w hichever i s h ig h e r.
2. In com puting a lo s s , th e b a s is o f g o o d w ill
p ro cu red b e fo re March 1, 1913, i s c o s t w hich
is determ ined by th e amount o f payments made
th e r e f o r .
3. The b a s is o f com puting g a in o r lo s s on g o o d w ill
procured March 1, 1913, o r a f t e r is c o s t.
G oodw ill i s reco g n ized as an a s s e t only when
a tta c h e d to a going concern b u s in e s s , and is n o t s u s c e p tib le
J . R. M iles, The T reatm ent o f Goodw ill in F e d e ra l
Income T ax atio n (L in co ln , N ebraska: The U n iv e rsity o f
Nebraska P re ss, 1935), pp. 9-10.
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28
o f b ein g d isp o se d o f in d e p en d en tly . G oodw ill cannot be
ta k e n o u t o f th e b u s in e s s and th e firm l e f t a going co n
c e rn ; th e re fo r e , g o o d w ill may n o t b e tr e a t e d as a s p e c ia l
ite m a p a rt from th e ta n g ib le a s s e t s . S ince g o o d w ill can n o t
be se p a ra te d from th e going b u s in e s s o f w hich i t i s a p a r t ,
a s e l l e r who d is p o s e s o f h is b u s in e s s n e c e s s a r ily p a r ts
w ith th e g o o d w ill a tta c h e d th e r e to . In o rd e r to e s t a b li s h
th e v a lu e o f g o o d w ill, as o f a p a r t i c u l a r day, i t i s n e c e s
s a ry to s e p a ra te g o o d w ill v a lu e from th e v a lu e o f o th e r
in ta n g ib le a s s e t s .
There have been numerous c o u rt c a se s co n cern in g th e
o b so lescen ce o f g o o d w ill. In e a r l i e r c a se s ta x p ay e rs w ere
o f th e o p in io n t h a t a d ed u c tio n f o r o b so le sce n ce o f good
w i l l should b e allo w ed based on p a r ts (4) and (7) o f s e c
tio n 234 (a) o f th e Revenue Act o f 1918. This a c t pro^/ided
t h a t a c o rp o ra tio n in com puting n e t income should be
allow ed as d e d u c tio n s " lo s s e s s u s ta in e d d u rin g th e ta x a b le
y e a r and n o t com pensated f o r by in su ra n c e o r o th e rw ise , "
and "a re a s o n a b le allow ance f o r th e e x h a u stio n , w ear and
t e a r o f p ro p e rty u se d in th e tr a d e o r b u s in e s s , in c lu d in g
a re a so n a b le allo w an ce f o r o b so le s c e n c e ."
The c o u rts ru le d th a t th e Revenue Act o f 1918
lim ite d allow ance f o r o b so le scen ce to such p ro p e rty w hich
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29
is s u b je c t to e x h a u stio n , o r w ear and t e a r by u s e , and h e ld
t h a t g o o d w ill was n o t such p ro p e rty . The c o u rts h eld th a t
th e p h ra se , " in c lu d in g a re a s o n a b le allo w an ce f o r o b s o le s
cence" does n o t p ro v id e f o r new and in d ep en d en t d ed u c tio n ,
b u t i t i s m erely a s p e c if ic a tio n and en larg em en t o f th e
p h ra se "allow ance f o r e x h a u stio n , wear and t e a r . " T here
f o re s in c e g o o d w ill was n o t an a s s ig n a b le a s s e t s e p a ra te
and d i s t i n c t from th e b u s in e s s , i t co u ld n o t be made th e
s u b je c t o f an independent claim f o r a d e d u c tio n from inccme
u n d er s u b s e c tio n (4) o f s e c tio n 234 ( a ) .
The c o u r t’s d e c is io n was handed down in th e case o f
Red wing M alting Co. v s . W illc u ts . A summary o f th e d e c i
s io n i s as fo llo w s:
The I n te r n a l Revenue h e ld th a t th e Red Wing M alting
Co. was n o t e n t i t l e d to make d e d u c tio n s f o r " o b so le s
cence" o f "g o o d w ill" in com puting in co n e and excess
p r o f i t ta x e s .
Revenue Act 1918 S e c tio n 234 (Comp. S t. Ann Supp.
1919) allo w in g d e d u c tio n o f " re a so n a b le allow ance f o r
o b so lesce n ce o f p ro p e rty u sed in tr a d e o r b u s in e s s ."
D epartm ental R e g u latio n 45, a r t . 143 and re g u la tio n 62,
r e l a t e o n ly to ta n g ib le p ro p e rty and m a ltin g company,
fo rc e d by p r o h ib itio n l e g i s l a t i o n to d is c o n tin u e b u s i
n e s s , h e ld u n a u th o riz e d , in com puting inccm e and excess
p r o f i t ta x e s , to make d e d u c tio n f o r o b so le scen ce o f
g o o d w ill; "g o o d w ill" m eaning good c h a r a c te r o r r e p u ta
tio n earned by conduct o f a b u s in e s s , and bein g p ro p
e r ty in se n se o f b e in g o f law, b u t n o t p ro p e rty "used
in tr a d e o r b u s in e s s " w ith in Revenue Act 1918 and
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
30
o b so le sc e n c e b ein g d e fin e d as th e c o n d itio n o r p ro c e ss
o f g ra d u a lly f a l l i n g in to d is u s e .&
The c o u rts have h e ld th a t g o o d w ill a m o rtiz a tio n o r
w r ite down may n o t, u n d er any circu m stan ce, be d ed u cted
from inccm e f o r inccme ta x p u rp o ses.
O pinion o f th e S e c u r itie s and Exchange Ccmmission
A ll c o rp o ra tio n s having s e c u r itie s l i s t e d f o r
tr a d in g on n a tio n a l s e c u r i ti e s exchange a re r e q u ire d to
f i l e w ith th e S e c u r itie s and Exchange Commission (SEC) an
a p p lic a tio n f o r r e g i s t r a t i o n c o n ta in in g a s u b s t a n t i a l amount
o f s i g n i f i c a n t in fo rm a tio n r e l a t i n g to th e ccmpany, i t s
b u s in e s s , s e c u r i t i e s , and management. Ih e se com panies m ust
a ls o f i l e an n u al and o th e r r e p o r ts w ith th e SEC in o rd e r
t h a t th e in fo rm a tio n on f i l e (which i s a v a ila b le to th e
p u b lic ) may be re a so n a b ly c u r r e n t. F in a n c ia l s ta te m e n ts
a re an im p o rta n t p a r t o f th e in fo rm a tio n th e s e l i s t e d ccm-
p an ies m ust f u rn is h to th e SEC.
There was a tim e when th e SEC was o f th e o p in io n
th a t g o o d w ill sh ould be e lim in a te d frcm a l l b a la n c e s h e e ts
f i l e d w ith th e ccm m ission. C o rp o ratio n s d e s iro u s o f hav in g
^Red Wing M alting Co. v . W illc u ts . 8 F e d e ra l Re
p o r te r 2d S e rie s 180 (1926).
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31
t h e i r sta te m e n ts accep ted would am o rtiz e o r w r ite o f f good
w i l l ap p earin g in t h e i r b a la n c e s h e e ts . This p o lic y is
no lo n g er re q u ire d by th e com m ission. The views o f SEC a re
s im ila r to th o se o f th e American I n s t i t u t e as p u b lish e d in
A ccounting R esearch B u lle tin No. 43 in 1953.
The q u e s tio n has a r is e n , "Should a f in a n c ia l s t a t e
ment f i l e d w ith th e SEC w r ite g o o d w ill down o r o f f to
c a p i t a l su rp lu s ? " The p o s itio n o f th e SEC was e s ta b lis h e d
in th e m a tte r o f th e A sso ciated Gas and E le c tr ic Company.
This p o s itio n i s s e t f o r th in A ccounting S e rie s R elease.
No. 50, 1945.
Hie p o s itio n ta k en w ith r e s p e c t to in ta n g ib le s n o t
s u b je c t to a m o rtiz a tio n assumes t h a t as long as th e
w r ite - o f f i s made becau se o f co n se rv a tism b e fo re a c tu a l
r e a l iz a tio n o f th e lo s s , th e w r i t e - o f f may be made to
c a p ita l s u rp lu s . This p r a c t ic e would p erm it a c o r
p o ra tio n to circum vent ch arg es w hich should be made
a g a in s t income o r earned s u rp lu s by re c o g n iz in g them
in advance as a charg e a g a in s t c a p i t a l s u rp lu s , in o u r
o p in io n , i t i s n o t c o n s is te n t w ith th e fundam ental
p r in c ip le t h a t a d i s t i n c t i o n sh o u ld be m ain tain ed
between c a p i t a l and incom e.^
The commission i s o f th e o p in io n t h a t a w r ite - o f f o f good
w ill to c a p ita l su rp lu s is c o n tra ry to sound acco u n tin g
p r in c ip l e s .
^U nited S ta te s S e c u r itie s and Exchange Commission,
A ccounting S e rie s R eleases (R eleases 1 to 77, I n c lu s iv e ) ,
1956, pp. 123-124.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
32
C onsequently, th e income sta te m e n t o r a n o te to th e
sta te m e n t m ust s t a t e th e p o lic y follow ed w ith r e s p e c t to
th e p ro v is io n f o r d e p re c ia tio n and a m o rtiz a tio n o f in ta n
g ib le s in c lu d in g th e m ethods and i f p r a c tic a b le , th e r a te s
used in co n p u tin g th e an n u al am ounts.
Rule 5.02 o f R e g u latio n S-X s e ts f o r t h th e r e q u ir e
m ents in form and c o n te n t o f b a lan ce s h e e ts and income
sta te m e n ts . T his r u l e r e q u ir e s th a t s i g n i f i c a n t amounts
o f in ta n g ib le a s s e ts b e shown s e p a r a te ly in th e f in a n c ia l
sta te m e n ts f i l e d w ith th e Commission. F u rth e r, an a n a ly s is
i s re q u ire d o f th e tr a n s a c tio n o f each in ta n g ib le a s s e t and
re s e rv e a c co u n t. The SEC r e q u ir e s r e p o r tin g com panies to
d is c lo s e th e amount and d is p o s itio n o f th e d e b it d i f f e r e n
t i a l (excess o f c o s t o v er book v a lu e ) in c o n s o lid a te d
b a la n c e s h e e ts . However, th e SEC does n o t r e q u ir e an a n a ly
s i s o f th e d e b it d i f f e r e n t i a l f o r th e p u rp o se o f making an
a p p ro p ria te f i n a n c i a l sta te m e n t d is p o s itio n o f th e item as
does th e AICPA Committee on A ccounting P ro c e d u re s.
The A ccounting E n tity
F ollow ing th e a d o p tio n o f a co n cep t o f g o o d w ill and
a b a s is f o r id e n tif y in g i t , a need th e n a r is e s f o r th e
s e le c tio n o f an in d iv id u a l o r group o f in d iv id u a ls to w hich
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
33
th e income can be a t tr i b u t e d . The problem o f th e s e le c tio n
o f a u n i t w ith w hich income can be id e n t if i e d e v e n tu a lly
becomes an is s u e . The u n i t s e le c te d u s u a lly tu r n s o u t to
be e i t h e r th e p erso n o r p erso n s who have power o f a u th o rity
and d i r e c t th e w ea lth item s o r th e t o t a l w e a lth o f th e
o p e ra tin g u n i t ta k en as a w hole—th e b u s in e s s e n t ity o r
e n te r p r is e . The in fe re n c e i s t h a t income may b e p re se n te d
as t h a t o f th e owner ( p r o p r ie to r ) o r as t h a t o f th e e n t e r
p r i s e ( e n t i t y ) .
The p r o p rie ta r y th e o ry a s s e r ts t h a t th e owner is
th e c e n te r o f acco u n tin g , and a l l th e a c c o u n tin g co n cep ts
and p ro c e s s e s r e l a t e to th e ow ner’s i n t e r e s t . The a s s e ts
a re th e p ro p e rty o f th e owner and th e l i a b i l i t i e s a re h is
d e b ts . T his th e o ry em phasizes th e owner as th e s in g le
im p o rta n t f a c to r in th e e n t e r p r is e and a s s e r ts th e view
p o in t o f t h a t s in g le in d iv id u a l in th e e x p la n a tio n and
re c o rd in g o f b u sin e ss tr a n s a c tio n s .
The com m ittee on co n cep ts and s ta n d a rd s o f th e
American A ccounting A sso c ia tio n e x p la in s th e b u sin e ss
e n t i t y as fo llo w s :
A b u s in e s s e n t i t y i s a form al o r in fo rm a l u n i t o f
e n t e r p r i s e —a c o lle c tio n o f econonic goods and s e rv ic e s
and a group o f p e rs o n s —o rg an ized to acccm p lish c e r t a in
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34
ex p ress o r im p lied p u rp o se s. The a c t i v i t i e s o f such an
e n t ity a r e u s u a lly o r ie n te d tow ard p r o f i t o b je c tiv e s
and, in broad o u tlin e , in v o lv e th e a c q u is itio n s , and
th e d e liv e r y o f th e r e s u l t i n g o u tp u ts to m ark et.
A ccounting p ro ced u res and f in a n c ia l r e p o r ts a r e co n
cerned w ith s p e c if ic b u s in e s s e n t i t i e s and t h e i r
a c t i v i t i e s .
The e n t i t y con cep t assum es th e predom inance o f th e
economic a s p e c ts o f b u s in e s s o rg a n iz a tio n . Tlius i t may
be p r e f e r a b le th a t one s e t o f f in a n c ia l r e p o r ts co v er
th e s ta tu s and o p e ra tin g r e s u l t s o f a number o f a f f i l i
a te d c o rp o ra tio n s . The b u s in e s s e n t ity co n cep t p ro
v id e s a b a s is f o r id e n tif y in g economic re s o u rc e s and
a c t i v i t i e s w ith s p e c if ic e n te r p r is e s , and th u s f o r
d e fin in g th e a re a o f co v erag e a p p ro p ria te to a g iv en
s e t o f re c o rd s o r r e p o r t s . &
A ccording to th e p r o p r ie ta r y th e o ry , th e b u sin e ss b elo n g s
to one o r more perso n s th o u g h t o f as p r o p rie to r s o r ow ners,
and t h e i r v iew p o in t i s r e f l e c t e d in th e acco u n tin g . In th e
e n t ity co n cep t, th e b u sin e ss m ust be co n sid ered as e n t i r e l y
a p a rt from th e ow ners. A lso in th e p r o p rie ta r y co n c ep t,
i n t e r e s t and income ta x e s a r e n e g a tiv e elem ents in th e p ro
cess o f m easuring w e a lth changes accru in g to th e b e n e f i t o f
th e p r o p r ie to r s .
Ihe acco u n tin g p r in c ip le s and p r a c tic e s a r is i n g o u t
o f th e p r o p rie ta r y and e n t i t y concepts p re s e n t opposing
view s. For example, A rth u r L o rig w ro te:
g
American A ccounting A sso c ia tio n , Committee on Con
ce p ts and S tan d ard s, "The E n tity C oncept," The A ccounting
Review, XL (A p ril, 1965), 359.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
35
The p r o p r ie ta r y co n cep t i s th e more r e a l i s t i c and
th e o r e t i c a ll y a c c u ra te and p r a c t i c a l , and more in co n
fo rm ity w ith a c tu a l p r a c t ic e . I t s ad o p tio n as th e
b a s ic co n cep t to be used f o r a l l acco u n tin g e n t i t i e s
would be a boon to im proved c l a r i t y in a c c o u n tin g .^
A rth u r K elley to o k th e fo llo w in g p o s itio n :
I n te r e s t ch a rg e s lik e w is e a r e c o s ts o f borrow ing
funds needed by th e e n te r p r is e and i t i s h ard to se e
any u s e f u l p u rp o se accom plished by c o n s id e rin g i n t e r
e s t ch arg es as d i s t r i b u t i o n o f inccme to th e c r e d i to r s ,
as some eco n o m ists view them, in s te a d o f as c o s t in
d eterm in in g n e t incom e, w hich i s th e u n iv e r s a l b u s in e s s
co n c ep t. I t w ould seem h ig h ly d e s ir a b le f o r a c c o u n t
a n ts to fo llo w b u s in e s s custom and ad h ere to one co n
ce p t o f c o rp o ra te n e t income, nam ely, n e t income to th e
s h a re h o ld e rs .
The id e a o f a b u sin e ss e n t i t y m ust become in v o lv e d
i f a d i s t i n c t i o n i s go in g to be made betw een th o se who p ro
v id e th e w e a lth item s and th e o rg a n iz a tio n which u se s th e s e
item s.
The a c c o u n ta n t m ust c o n c e n tra te e i t h e r upon th o s e
who p ro v id e w e a lth o r upon th e t o t a l w ea lth b ein g employed
to induce changes in w e a lth . T his t o t a l w e a lth may be
th o u g h t o f as th e e n t i t y . The problem , th e n , i s , "Should
9
A rthur N. L o rig , "Some B asic Concepts o f A ccount
ing and T h eir I m p lic a tio n s ," A ccounting Review, XXXIX
(Ju ly , 1964), 573.
^^A rthur C. K elley , "Ccmments on th e 1957 R ev isio n s
o f C o rp o rate A ccounting and R ep o rtin g S ta n d a rd s," A ccount
ing Review. XXXIII (A p ril, 1958), 215.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
36
w ealth changes be d e a lt w ith in term s o f a g a in to th e
s p e c if ic p ro v id e rs o f th e w e a lth o r in term s o f th e t o t a l
w ea lth re g a rd le s s o f who p ro v id e s it? "
M aurice ^ o n i t z p re s e n ts h is p o s itio n in fa v o r o f
th e e n t i t y concept by sa y in g , "The a c co u n ta n t . . . is
alm ost always concerned w ith s p e c if ic u n its and m ust a s sig n
th e * w ealth* and changes to seme s p e c if ic e n t i t y f o r a
s p e c if ie d tim e p e rio d .
P ro fe ss o r îfo o n itz i s o f th e o p in io n t h a t i t is th e
e n t i ty which tran sfo rm s w e a lth in to th e p ro d u c tio n o f goods
and s e r v ic e s . T his view i s s im ila r to th a t o f P aton and
L i t t l e t o n . P aton and L ittle to n * s p o s itio n i s :
The o r ig in o f earn ed s u rp lu s i s e s s e n t i a l l y th e
accum ulated b a la n c e o f th e income ac co im t. Once th e
t r a n s f e r to s u rp lu s has been e f f e c te d , how ever, th e
income b a la n c e becomes an acknowledged elem ent o f
s to c k h o ld e rs * e q u ity .
] h a t t h i s view i s c o n s is te n t was e s ta b lis h e d by
Husband, a proponent o f th e p r o p r ie ta r y c o n c e p t. He s ta te d :
^^M aurice M oonitz, The B asic P o s tu la te s o f Account-
in g : A ccounting R esearch Study No. 1 (New Y ork: 1961),
p . 12.
12
W . A. Paton and A. C. L i tt l e t o n , " S u rp lu s, " An
In tro d u c tio n to C o rp o rate A ccounting S tan d ard s (Chicago:
American A ccounting A ss o c ia tio n , 1940), p. 105.
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37
Viewed as a le g a l e n t i t y income earned by th e c o r
p o ra te endeavor i s th e p ro p e rty o f th e c o rp o ra tio n ,
p e r s e . To th e e x te n t t h a t such income i s r e ta in e d in
th e b u s in e s s i t in e f f e c t becOTies th e c o r p o r a tio n 's
p r o p r ie ta r y e q u ity in i t s e l f . To c o n s id e r i t o th e rw ise ,
as when i t i s tr e a te d as p a r t o f th e book v a lu e o f th e
s to c k h o ld e r 's e q u ity , i s to im ply accep tan ce o f th e
agency o r r e p r e s e n ta tiv e p o in t o f view .
W illiam J . V a tte r was n o t in a b s o lu te accord w ith
th e p r o p r ie ta r y o r e n t ity co n cep t. R ath er h is co n cep ts
w ere as fo llo w s :
There i s n c person to whom th e income concept can
be r e l a t e d , u n le ^ - i t be th e f i c t i t i o u s le g a l c r e a tio n ,
o r an assumed " e n t i t y . ” . . . Thus, th e " e n t it y ” co n
c e p tio n o f income i s b o m o u t o f n e c e s s ity ; th e rev en u e
and expense o f th e co z rp o ratio n 's o p e ra tio n s a r e r e l a t e d
to a p u re ly h y p o th e tic a l p e rso n , so as to p ro v id e a
" r e c i p i e n t ” f o r income. . . . The f in a n c ia l r e p o r ts a r e
th e r e p o r ts o f " e n tity ” o p e ra tio n s and a re concerned
w ith th e th in g s th a t ap p ear to be o f im portance to th e
" e n t i t y . ”
In o rd e r to have s ig n if ic a n c e f o r th e in v e s to r o r
s to c k h o ld e r, e n t i t y income m ust be r e la te d to th e
f a c to r s th a t a re s ig n if ic a n t in th e p re s e n t o r p ro s p e c
ti v e s to c k h o ld e r - in v e s to r 's s i t u a t i o n . T h erefo re, th e
in v e s to r m ust i n t e r p r e t th e e n t i t y income f ig u r e by
a n a ly z in g i t s components and by making such a d ju s w e n ts
and r e c a lc u la tio n s as a re needed to f i t h is c a s e .
The v a rio u s view s ex p ressed make i t e v id e n t t h a t
th e problem o f acco u n tin g f o r income s t i l l rem ains u n so lv ed
1
George R. Husband, "The E n tity Concept in A ccount
in g , " The A ccounting Review, XXIX (O ctober, 1954), 554.
^ ^ i l l i a m J . V a tte r, The Fund Theory o f A ccounting
and I t s Im p lic a tio n s f o r F in a n c ia l R eports (Chicago : The
U n iv e rs ity o f Chicago P ress, 1947), p. 33.
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38
when th e q u e s tio n o f whose income i t i s a r i s e s . The s e le c
tio n i s betw een o b serv in g w e a lth changes in term s o f w ea lth
p ro v id e rs o r w e a lth changes o f th e e n t i t y as a w hole.
O ther Concepts and T h eo ries R e la tin g
to G oodw ill
G oodw ill i s g e n e ra lly c o n sid e re d to a r is e from a l l
o f th e s p e c ia l b e n e f its connected w ith a b u s in e s s , such as
a good name, com petent p e rso n n e l, s u p e rio r f in a n c ia l s ta n d
in g , e x c e lle n t lo c a tio n , h ig h q u a lity p ro d u c ts , and th e
harm onious r e la tio n s h ip s enjoyed by a b u s in e s s firm th ro u g h
o u t th e d i f f e r e n t phases o f i t s o p e ra tio n s . These b e n e f its
evidence them selves in th e form o f ea rn in g s in an amount
g r e a te r th a n th o se expected in a ty p ic a l firm in th e i n
d u s try w ith a s im ila r c a p i t a l in v e stm e n t. In most cases
th e methods used in e s tim a tin g th e amount o f goodw ill i n
v o lv es th e fo llo w in g p ro ced u re:
1. D eterm ine th e ea rn in g s p e rio d to b e used fo r
p r o je c tio n .
2. E stim ate th e average an n u al n e t income a n t i c i
p a te d .
3. S e le c t an a p p ro p ria te r a t e o f r e tu r n .
4. D eterm ine th e excess an n u al e a rn in g s.
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39
5. C a p ita liz e excess an n u al e a rn in g s to d eterm in e
th e e s tim a te d p re s e n t v a lu e o f g o o d w ill.
D eterm in atio n o f E arning P eriod
P a st e a rn in g s u s u a lly o f f e r th e b e s t b a s is upon
which to d ev elo p a s p e c if ic v a lu e f o r g o o d w ill. However
th e p u rc h a se r i s n o t paying f o r th e excess p r o f i t s o f th e
p a s t b u t f o r th e p ro b a b le ex cess p r o f i t s o f th e f u tu r e .
The su ccess o f th e p a s t f u rn is h e s th e b e s t ev id en ce o f p o s
s i b l e accom plishm ents in th e f u tu r e .
Simons and K arrenbrock su g g e sted th e fo llo w in g :
In c o n s id e rin g p a s t e a rn in g s as a b a s is f o r p ro
je c ti o n in to th e f u tu r e , r e fe re n c e should be made to
ea rn in g s m ost r e c e n tly e x p e rie n c e d . A s u f f i c i e n t num
b e r o f p e rio d s sh ould be in c lu d e d in th e a n a ly s is so
th a t a r e p r e s e n ta tiv e m easurem ent o f b u s in e s s p e r
form ance i s a v a ila b le .
In making a sta te m e n t o f p a s t p r o f i t s w hich a r e to
be used as th e b a s is f o r com puting th e g o o d w ill, F inney and
M ille r c o n s id e r th e fo llo w in g :
1. The r e s u l t s o f o p e ra tio n s f o r one p re c e d in g
y e a r a r e n o t a s u f f i c i e n t b a s is f o r e s tim a tin g
f u tu r e r e s u l t s o f o p e ra tio n s , b ec au se a s t a t e
ment f o r one y e a r would n o t d is c lo s e f l u c t u
a tio n s in e a rn in g s .
"H arry Simons and W ilb ert E. K arrenbrock, ’’I n ta n
g i b l e s ," In te rm e d ia te A ccounting (4 th e d .; New R o c h elle,
N .Y .: South-W estern P u b lish in g Company, 1964), p . 517.
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40
2. A ll ex tran eo u s and n o n o p e ra tin g g a in s and
lo s s e s should be ex clu d ed .
3 . I f any known f a c ts p o in t to a p o s s ib le d i f f e r
ence betw een p a s t and f u tu r e inccm e r e s u l t s ,
th e s e f a c ts should be c o n sid e re d .
4 . C o n sid e ra tio n sh o u ld be g iv e n to th e tre n d o f
e a rn in g s and perhaps to th e tre n d o f some o f
th e im p o rtan t item s o f rev en u e and ex p en se. ®
G e n e ra lly , a firm is n o t in te r e s te d in d eterm in in g
what p a s t e a rn in g s were b u t how p a s t ex p e rien ce can h e lp in
e s tim a tin g p ro b a b le fu tu re p r o f i t s . Inccme s ta te m e n ts th a t
appear to b e r e p r e s e n ta tiv e o f th e o p e ra tio n s o f a b u sin e ss
f o r a number o f p rev io u s y ea rs sh o u ld be s e le c te d and ad
ju s te d f o r e x tra o rd in a ry item s.
E stim ate o f th e Average Annual Net Income
An av erag e o f p a s t e a rn in g s w i l l p ro b ab ly be more
r e p r e s e n ta tiv e o f th e su ccess o f th e b u sin e ss th a n th e
e a rn in g s o f a s in g le y e a r. The av erag e should c o n ta in a
s u f f i c i e n t number o f y ea rs to e lim in a te any f lu c tu a tio n in
th e tre n d o f th e p r o f i t s o f th e firm . S p e c ia l c o n s id e ra tio n
should be g iv e n to any tre n d . M eigs, Johnson, and K e lle r
H. A. Finney and H. E. M ille r, " I n ta n g ib le Fixed
A s s e ts ," P rin c ip le s o f A ccounting: In te rm e d ia te (5 th e d . ;
Qiglewood C l i f f s , N .J .: P re n tic e -H a ll, I n c ., 1958),
pp. 404-406.
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41
ex p ress t h e i r p o s itio n in t h i s way:
In e v a lu a tin g an average o f p a s t d a ta , p a r t i c u la r
a t te n t io n m ust be p aid to s i g n i f i c a n t tre n d s . Two
companies may, f o r exam ple, have th e same f iv e - y e a r
average rev en u e s, b u t i f th e rev en u es o f one company
have in c re a se d in each o f th e p a s t f iv e y e a rs , w h ile
th e revenues o f th e o th e r s te a d ily d e c lin e d , th e a v e r
age f ig u r e sh ould be in te r p r e te d d i f f e r e n t l y . I ?
S e le c tio n o f an A p p ro p riate R ate o f R eturn
Q uite o fte n th e norm al r a t e o f r e tu r n can be ob
ta in e d from tr a d e a s s o c ia tio n s , governm ent p u b lic a tio n s ,
and banks. O ften, an ad ju stm en t to th e s e p u b lish e d f ig u re s
has to be made in o rd e r to r e f l e c t c o n d itio n s p e c u lia r to
th e b u s in e s s .
M eigs, Johnson, and K e lle r in t h e i r d is c u s s io n on
choosing an a p p ro p ria te norm al e a rn in g s r a t e s t a t e th e
fo llo w in g :
The r a t e o f r e tu r n to be used in c a p ita liz in g e s t i
m ates o f f u tu r e ea rn in g s and in s e p a ra tin g s u p e rio r
from o rd in a ry ea rn in g s i s determ ined on th e b a s is of
judgm ent and a knowledge o f th e a v a ila b le a l te r n a t i v e s .
The o b je c tiv e i s to approxim ate th e r a t e n e c e ssa ry to
a t t r a c t c a p i t a l to th is p a r t i c u l a r b u sin e ss under th e
e x is tin g r i s k c o n d itio n s . The p r ic e o f c a p i ta l , lik e
o th e r p r ic e s , v a r ie s from tim e to tim e and from
W alter B. Meigs, C harles E. Johnson, and Thomas
F. K e lle r, " In ta n g ib le A s s e ts ," In te rm e d ia te A ccounting
(New York: McGraw-Hill Book Company, 1963), p . 615.
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42
s i t u a ti o n to s it u a ti o n in r e l a t i o n to a w ide v a r ie ty
o f f a c t o r s . Hie prim ary c a u se o f d if fe re n c e s in th e
r a t e o f r e tu r n n e c e ssa ry to a t t r a c t c a p i t a l to d i f f e r
en t k in d s o f in v estm en t a t any g iv e n tim e i s th e
v a r ia tio n in th e amount o f r i s k in v o lv e d .
A norm al r a t e of r e tu r n i s d e fin e d as a r a t e which
is "high enough to in s u re th e m ain ten an ce o f th e c a p i t a l o f
th e in d u s try and re a s o n a b le a d d itio n s as th e demand f o r
th e p ro d u ct in c r e a s e s ."
The s e le c tio n o f a norm al r a t e o f r e tu r n f o r a
b u sin e ss i s ex trem ely d i f f i c u l t . T his s e le c tio n re q u ire s
a keen judgm ent and a knowledge o f th e r a t e o f r e tu r n
n e c e ssa ry to a t t r a c t c a p ita l to an in d u s try w ith th e p a r
t i c u l a r d eg ree o f r i s k in v o lv ed .
D eterm in atio n of th e Excess Annual E arnings
The ex cess annual ea rn in g i s c a lc u la te d by d e d u c t
ing th e t o t a l norm al earn in g s from th e e stim a te d p e rio d ic
t o t a l e a rn in g s . T his excess e a rn in g i s r e f e r r e d to as
s u p e r - p r o f it by Leake and s u p e rio r e a rn in g s by M eigs, John
son, and K e lle r. I t is th e p ro d u ct o f an u n id e n tif ia b le
in ta n g ib le w hich en ab les th e company to e a rn a h ig h e r th a n
^^I b id . , p. 619.
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43
norm al r e tu r n . One o f th e m ost im p o rtan t c o n s id e ra tio n s
in th e e v a lu a tio n o f ex cess an n u al ea rn in g i s th e q u e s tio n
o f d u ra tio n . Some a c c o u n ta n ts arg u e t h a t excess e a rn in g s
have only lim ite d l i f e . However, most a c c o u n ta n ts b e lie v e
t h a t excess e a rn in g s w i l l c o n tin u e fo r an undeterm ined tim e
in to th e f u tu r e .
C a p ita liz e d Ekcess E arnings a t Normal R ate
% e assum ption h e re i s t h a t th e above norm al e a rn
in g s w i ll e x i s t p erm an en tly . Goodw ill i s computed in th e
fo llo w in g m anner.
C a p ita liz e d e s tim a te d av erag e n e t p r o f i t s X X
Less c u r r e n t m arket v a lu e o f n e t a s s e ts X X
G oodw ill X X
S ev eral w r i te r s do n o t b e lie v e th a t above norm al
earn in g s w i l l e x i s t i n d e f i n i t e l y . Leake ex p re sse s s tro n g
o p p o sitio n in th e fo llo w in g s ta te m e n t:
With re g a rd to th e d eg ree o f perm anence in v a lu e o f
g o o d w ill i t i s c l e a r t h a t owing to th e o p e ra tio n of
economic law s, s u p e r - p r o f it can n ev er e x i s t perm anently,
though i t may scm etim es c o n tin u e to a r is e o u t o f an
u n d erta k in g f o r a g r e a t number o f y e a rs . One p r in c ip a l
rea so n f o r th e tem porary c h a ra c te r o f th e s u p e r - p r o f it
is th e e x is te n c e o f c o m p e titio n . Commercial co m p eti
tio n i s u n iv e r s a l and i s c o n s ta n tly a t work s t r i v i n g to
se cu re a sh a re in s u p e r - p r o f it o f a l l k in d s w herever
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44
i t a r i s e s , and whenever an u n d e rta k in g i s earn in g
s u p e r - p r o f it i t w i l l always ten d to a t t r a c t im ita to r s .
This o p e ra te s to red u ce, and w i l l u ltim a te ly le v e l, th e
earn in g s to a r a t e o f p r o f i t n o t exceeding th e norm al
r a t e o f i n t e r e s t on th e c a p ita l in v e s te d having re g a rd
to th e n a tu re o f th e r i s k . A nother re a so n why su p e r
p r o f i t i s alw ays o f a tem porary c h a r a c te r i s th a t th e
demand f o r any commodity o r s e rv ic e may a t any tim e
sla c k e n o r c e a se , owing to a l l k in d s o f changing co n
d itio n s in c lu d in g new in v e n tio n s . On commonly accep ted
econcsnic grounds, th e re fo r e , s u p e r - p r o f it m ust n ev e r be
tr e a te d as b ein g in th e n a tu re o f a p e r p e tu ity ; i t i s
e s s e n ti a ll y in th e n a tu re o f an a n n u ity extending o v er
an unknown b u t lim ite d p e rio d o f y e a rs , and th e re fo r e
th e v a lu e o f g o o d w ill is n o t perm anent.
A s o lu tio n to t h i s problem o f th e in d e f in i te e x i s
te n c e o f g o o d w ill i s p re se n te d by M ilroy and W alden:
A more lo g ic a l approach i s to e s tim a te th e p e rio d
fo r which th e ex cess ea rn in g may be expected to co n
tin u e . For exam ple, i f i t i s re a s o n a b le to expect th a t
th ey w i l l c o n tin u e f o r , say 10 y e a rs , th e n th e v a lu e o f
th e g o o d w ill w i l l be th e p re s e n t v a lu e o f th e r i g h t to
r e c e iv e th e ex cess e a rn in g s f o r t h i s p e rio d . The r a t e
o f r e tu r n sh o u ld n o t be as h ig h as th a t used to c a p i t a l
iz e excess e a rn in g s . The re aso n , o f co u rse, i s t h a t
th e r i s k o f e r r o r has been somewhat reduced by th e
e s tim a te o f th e le n g th o f tim e f o r w hich th e earn in g s
w i l l c o n tin u e . On th e o th e r hand, i t sh ould p ro b ab ly
n o t be as low as th e r a t e a p p lie d to th e o th e r a s s e ts
s in c e i f th e ex cess e a rn in g s do n o t c o n tin u e th e re i s
no p o s s i b i l i t y o f r e a l i z a t i o n o f even a p a r t o f th e
investm ent th ro u g h s a le o f an u n d e rly in g a s s e t.
D. Leake, "The Value o f G oodw ill, " C cm nercial
G oodw ill (New York: S ir Isa a c Pitm an and Sons, L td .,
1929), p . 26.
on
R. R. M ilroy and R. E. Walden, " In ta n g ib le Fixed
A s s e ts ," A ccounting Theory and P r a c tic e : In te rm e d ia te
(Cambridge: Houghton M ifflin Company, 1960), pp. 361-362.
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45
C a p ita liz in g Excess E arnings a t
H igher R ate o f R eturn
Because u n c e r ta in ty and f lu c tu a tio n s in v a lu e
r e s u l t in a h ig h d eg ree of r i s k , in v e s to r s a re r e lu c ta n t to
ac c e p t th e norm al r a t e o f r e tu r n earned on i d e n t i f i a b l e
a s s e ts as an ad eq u ate r e tu r n on t h e i r in v estm en t in good
w i l l . T h erefo re th e s e in v e s to rs would r e q u ir e a h ig h e r
r a t e .
P urchase o f Excess E arnings
Under t h i s method i t i s assumed t h a t th e excess
e a rn in g s w i l l c o n tin u e f o r an in d e f in i te p e rio d o f tim e.
This method i s i l l u s t r a t e d as fo llo w s :
The ex cess e a rn in g s o f th e N elson Company a re
$12,000; th e c u r r e n t m arket v a lu e o f n e t a s s e ts a r e $400,000
and th e company buys te n y ea rs o f excess e a rn in g s as good
w i l l.
C u rren t m arket v a lu e o f n e t a s s e ts $400,000
Goodw ill (10 X $12,000) 120.000
Purchase p r ic e o f th e b u sin e ss $520,000
Ih e amount p a id fo r g o o d w ill g e n e ra lly i s decided
by n e g o tia tio n s . The m ethods p re v io u s ly d isc u sse d in d ic a te
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46
f a c to r s and p ro ced u res which may be tak en in to c o n s id e r
a tio n by th e v en d o r and vendee d u rin g th e b a rg a in in g .
Summary
G oodw ill, as an a s s e t, r e p r e s e n ts a c o s t r a th e r
th a n a v a lu e and sh o u ld n o t be re c o rd e d u n le s s p a id f o r .
The te c h n iq u e u se d in e v a lu a tin g g o o d w ill u s u a lly in v o lv e s
some ty p e o f e a rn in g s . Two o f th e m ost im p o rta n t d e c is io n s
to be made in com puting th e c a p i t a l i z a t i o n o f ea rn in g s a re
th e "norm al r a t e o f r e tu r n " on in v estm en t and th e d e f i n i t e
term o f e x is te n c e o f th e excess e a rn in g c a p a c ity .
The view s o f v a rio u s a u t h o r i t a t i v e b o d ie s have been
p re s e n te d to e s t a b l i s h fix e d lim its to th e fundam ental
theorem s and p o s tu la te s on w hich a c c o u n tin g p r a c tic e s a re
c o n s tru c te d . The American I n s t i t u t e 's Committee on A ccount
in g P rocedure c l a s s i f i e s in ta n g ib le s in to two g ro u p s --th o s e
having a lim ite d term o f e x is te n c e and th o s e having no such
lim ite d term o f e x is te n c e . I f th e l i f e o f such in ta n g ib le s
ap p ears n o t to b e lim ite d , no s y s te m a tic a m o rtiz a tio n
p o lic y i s r e q u ir e d . Those in ta n g ib le s w ith a lim ite d term
o f e x is te n c e sh o u ld be am o rtized by ch arg es to income over
th e e s tim a te d p e rio d o f u s e fu ln e s s . The Committee i s o f
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47
th e o p in io n t h a t u n d er no circu m stan ces may p u rch ased good
w i l l b e w r itte n o f f by ch a rg e s to c a p ita l s u rp lu s .
The I n te r n a l Revenue Law o f 1934 c o n s id e rs g o o d w ill
as an a s s e t in d eterm in in g g a in o r lo s s . However, g o o d w ill
i s re c o g n iz e d as an a s s e t o n ly when a tta c h e d to a going
co n cern and i s n o t s u s c e p tib le o f b ein g d isp o sed o f in d e
p e n d e n tly . The c o u rts have h e ld t h a t o b so le scen ce o f good
w i l l i s n o t d e d u c tib le in com puting income and excess
p r o f i t ta x e s . They have a ls o h e ld th a t g o o d w ill a m o rtiz a
tio n o r w r ite down may n o t, u n d er any c irc u m sta n c e s, be
deducted from income f o r income ta x p u rp o ses.
The S e c u r itie s and Exchange Commission changed i t s
p o s itio n frcm having g o o d w ill e lim in a te d from a l l b a la n c e
s h e e ts f i l e d w ith th e C onm ission to one which i s s im ila r to
t h a t o f th e American I n s t i t u t e o f C e r tif ie d P u b lic A ccount
a n ts . The SEC r e q u ir e s a d is c lo s u r e o f th e amount and
d is p o s itio n o f th e d e b it d i f f e r e n t i a l in c o n s o lid a te d
b a la n c e s h e e ts . However th e SEC does n o t r e q u ir e an a n a ly
s i s o f th e d e b it d i f f e r e n t i a l as does th e AICPA Committee
on A ccounting P ro ced u res.
The v a rio u s com m ittees o f th e American A ccounting
A sso c ia tio n have n o t d is c u s s e d th e problem o f g o o d w ill in
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48
t h e i r p u b lic a tio n s .
At th e same tim e, income can be d e fin e d as a change
accru ed to e i t h e r th e p ro p rie to r s o r to th e p ro v id e rs o f
w e a lth . Kie p r o p rie ta r y concept view s income as th e i n c r e
m ents in w ea lth w hich can be c o n sid e re d to b e th e i n t e r e s t
o f p r o p r ie to r s o n ly . Ihe e n t i t y co n cep t view s income as
th e in crem en ts in w ea lth o f th e e n t i r e e n te r p r is e —th a t o f
th e owners as w e ll as o th e r p ro v id e rs o f e n t i t y w ealth .
The ac co u n ta n t p r e f e r s a concept w hich shows increm ents o f
w ea lth a c c ru in g to th e owners and th e m anagers. Account -
a n ts e x p la in th e changes by m atching p a s t exchange v alu e s
w ith th e in crem en ts in w ea lth which th e s e v a lu e s have
h elp ed to c r e a te .
Businessm en know th a t r e p u ta tio n , custcm er lo y a lty ,
p ro d u ct q u a lity , r e l i a b l e s e rv ic e , and o p e ra tin g e f f ic ie n c y
p erm it some firm s to earn more th an a norm al r a t e o f r e tu r n .
When a firm i s a b le to e a rn excess p r o f i t s , i t is s a id to
p o ssess th e in ta n g ib le a s s e t c a lle d g o o d w ill. Thus, th e
l a t t e r p a r t o f t h i s c h a p te r d e a lt w ith th e measurement o f
g o o d w ill. V arious s te p s w ere p re se n te d to b e used in com
p u tin g th e amount o f g o o d w ill. The m ost d i f f i c u l t d e c i
sio n s in com puting g o o d w ill a re th e s e le c tio n o f a norm al
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49
r a t e o f r e tu r n and th e p e rio d o f tim e t h a t excess e a rn in g s
do o r do n o t c o n tin u e .
The m ethods p re se n te d in re c o rd in g g o o d w ill a r e th e
fo llo w in g :
1. C a p ita liz e d excess e a rn in g s a t a norm al r a t e .
2 . C a p ita liz e d excess e a rn in g s a t a h ig h e r r a t e
o f r e tu r n .
3 . Purchase o f ex cess e a rn in g s .
In a l l th r e e m ethods th e p r ic e p aid fo r g o o d w ill i s
d ecid ed , g e n e ra lly , by n e g o tia tio n s .
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
CHAPTER I I I
THEORETICAL ALTERNATIVES IN THE TREATM ENT
OF GOODW ILL .
H ypotheses To Be C onsidered
The v a rio u s a l te r n a ti v e s p re s e n te d in t h i s c h a p te r
su g g e st th a t th e r e a re as many m ethods to f i l l th e gap o f
re c o n c ilin g th e r e c ip r o c a l acco u n ts as th e r e a re a u th o rs
and p r a c t i t i o n e r s . This c o n tro v e rsy as to w hat t h i s ex cess
o f c o s t o v er book v a lu e i s due to and how i t sh o u ld be
c l a s s i f i e d , in c re a s e s th e dilemma o f anyone who a tte m p ts
to su p p ly a m ethod o f f i l l i n g t h i s gap.
I t i s g e n e r a lly b e lie v e d t h a t th e d is p o s itio n o f
n e g a tiv e g o o d w ill sh o u ld b e made in acco rd an ce w ith th e
circ u m stan ces su rro u n d in g th e in v e stm e n t. The th e o r e t i c a l
a l t e r n a t i v e tre a tm e n ts make th e s e c irc u m sta n c e s v a ry to
such an e x te n t t h a t i t i s d i f f i c u l t to ap p ly sound and ad e
q u ate th e o ry to th e d is p o s itio n o f n e g a tiv e g o o d w ill.
50
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
51
T his c h a p te r a ls o exam ines w hether t h i s g a p - f i l l e r
should be am o rtized . I f so , to w hat account sh o u ld i t be
am o rtized ? The view s p re se n te d in t h i s s e c tio n a re r e p r e
s e n ta tiv e o f t r a d i t i o n a l tre a tm e n t and custom ary p r a c tic e s
and n o t l o g ic a l re a so n in g .
Reasons f o r Excess o f Cost Over Book V alue
The ex cess o f th e c o s t o f an in v estm en t in a su b
s id i a r y o v er th e book v a lu e o f th e investm ent i s u s u a lly
c o n sid ered as g o o d w ill on th e c o n s o lid a te d b a la n c e s h e e t.
I t i s n e c e s s a ry to re c o g n iz e t h a t th e excess o f c o s t over
book v a lu e may n o t, a t a l l tim es, be g o o d w ill i f g o o d w ill
i s d e fin e d as th e v a lu a tio n p la c e d upon e a rn in g power in
excess o f th e norm al. A ccountants g iv e v a rio u s re aso n s f o r
th e ex cess o f c o s t over book v a lu e .
K arrenbrock and Simons p re s e n t th e fo llo w in g ex
p la n a tio n f o r th e excess :
1. The n e t a s s e ts o f th e s u b s id ia ry company a re
in c o r r e c tly s ta te d .
2 . S u b sid ia ry acco u n ts have f a ile d to r e p o r t a s s e t
v a lu e s a t th e tim e o f sto c k a c q u is itio n s .
3 . S u b sid ia ry acco u n ts have f a ile d to r e f l e c t
c e r t a i n in ta n g ib le s .
4 . A payment has been made f o r ac h ie v in g c e n t r a l
iz e d c o n tro l.
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52
5. In c e r t a i n in s ta n c e s th e excess amount p a id
may re p re s e n t a ccmabination o f f a c to r s and i t
may n o t be p o s s ib le to a r r iv e a t a s a t i s f a c t o r y
b a s is f o r a s sig n in g th e ex cess payment to such
f a c t o r s . ^
Ih e view s o f Finney and M ille r on an ex cess o f c o s t
a re as fo llo w s :
The ex c ess may in d ic a te th e e x is te n c e o f u n reco rd ed
in ta n g ib le s o th e r than g o o d w ill, such as p a te n ts and
f r a n c h is e s .
E rro rs o f acco u n tin g p r in c ip l e may have been ccsn-
m itte d by th e s u b s id ia ry , w ith th e r e s u l t t h a t i t s
a s s e ts a r e shown a t book v a lu e s le s s th an p ro p e rly
d eterm in ed c o s t- b a s is v a lu a tio n s .
The s u b s id ia r y a s s e ts may b e w orth more th a n c o s t-
b a s is v a l u e s .2
M ilro y , Walden, and S eaw ell make th e fo llo w in g
comments on th e ex cess o f c o s t o v er book v a lu e :
The s u b s id ia r y book v a lu e s may b e u n d e rs ta te d as
a r e s u l t o f bookkeeping e r r o r s and ac co u n tin g p o lic ie s
which le d to prem ature re c o g n itio n o f expense o r im
p ro p er d e f e r r a l o f rev en u es.
The s u b s id ia r y book v a lu e s . . . may n o t a p p ro x i
m ate m ark et v a lu e s because o f a p p re c ia tio n in a s s e t
v a lu e s . ^
W . E. K arrenbrock and H arry Simons, Advanced
A ccounting (3 rd e d .; New R o ch elle, N .Y .: South-W estern
R ib lish in g Company, 1961), pp. 316-318.
2
H. A. Finney and H erb ert E. M ille r, P rin c ip le s of
A ccounting : Advanced (5 th ed. ; Qiglewood C l if f s , N .J .:
P re n tic e -H a ll, I n c ., 1960), p. 359.
^R. R. M ilroy, R. E. Walden, and L. V. S eaw ell,
Accoim ting Theory and P ra c tic e : Advanced (Cam bridge:
Houghton M if f lin Ccsnpany, 1961), pp. 373-374.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
53
Meigs, Johnson, and K e lle r view th e ex cess in th e
fo llo w in g m anner:
There may be e r r o r s on th e s u b s id ia r y ’s books o r
th e s u b s id ia ry may have fo llo w ed unduly c o n s e rv a tiv e
acco u n tin g p r a c tic e s in th e p a s t.
L e g itim a te ac c o u n tin g v a lu a tio n s may be le s s th a n
f a i r m arket v a lu e a t th e d a te o f a c q u is itio n .
The p r ic e p a id by th e p a re n t may sim p ly r e f l e c t th e
f a c t th a t b ecau se o f s u p e rio r e a rn in g power th e su b
s id ia r y i s w o rth more th a n th e sum o f th e v a lu a tio n s
assig n ed to i t s in d iv id u a l a s s e ts .
In some c a se s w hat ap p e ars to be an ex cess o f c o s t
over th e book v a lu e o f th e s u b s id ia r y may b e n o th in g
more th an an e r r o r in re c o rd in g th e p a r e n t’s c o s t.
In any g iv e n s i t u a t i o n th e t o t a l d if f e r e n c e betw een
th e p a r e n t’s in v estm en t and th e book v a lu e o f th e
s u b s id ia r y ’s n e t a s s e ts may b e a t t r i b u t e d to a com
b in a tio n o f th e v a rio u s f a c t o r s j u s t d i s c u s s e d . ^
Hie Committee on A ccounting P rocedure o f th e Ameri
can I n s t i t u t e o f C e r tif ie d P u b lic A ccountants h as made th e
fo llo w in g reconm endations in A ccounting R esearch B u lle tin
No. 51. con cern in g th e c o s t o f in v e stm e n ts in excess o f
book v a lu e :
Where th e c o s t to th e p a re n t o f th e in v estm en t in
a purchased s u b s id ia ry exceeds th e p a r e n t’s e q u ity in
th e s u b s id ia r y ’s n e t a s s e ts a t th e d a te o f a c q u is itio n ,
as shown by th e books o f th e s u b s id ia ry , th e excess
should be d e a lt w ith in th e c o n s o lid a te d b a la n c e s h e e t
acco rd in g to i t s n a tu re . In d eterm in in g th e d i f f e r
ence, p ro v is io n sh ould be made f o r s p e c if ic c o s ts o r
W . B. M eigs, C h arles E. Johnson, and Thomas F.
K e lle r, Advanced A ccounting (New York: M cGraw-Hill Book
Company, 1966), pp. 250-253.
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54
lo s s e s w hich a re ex p ected to be in c u rre d in th e i n t e
g r a tio n o f th e o p e ra tio n s o f th e s u b s id ia r y w ith th o se
o f th e p a re n t, o r o th e rw ise as a r e s u l t o f th e a c q u is i
tio n , i f th e amount th e re o f can be d eterm in ed . To th e
e x te n t t h a t th e d if f e r e n c e i s c o n s id e re d to be a t
t r i b u t a b l e to ta n g ib le a s s e ts and s p e c if ic in ta n g ib le
a s s e ts , such as p a te n ts , i t sh o u ld be a llo c a te d to
them. Any d if f e r e n c e w hich can n o t be so a p p lie d would
be shown among th e a s s e ts in th e c o n s o lid a te d b a la n c e
sh e e t under one o r more a p p ro p ria te d e s c r ip tiv e c a p
tio n s . When th e d if f e r e n c e i s a llo c a te d to d e p re c ia b le
o r a m o rtiz a b le a s s e ts , d e p r e c ia tio n and a m o rtiz a tio n
p o lic ie s sh o u ld b e such as to ab so rb th e excess over
th e rem aining l i f e o f r e la te d a s s e t s . 5
The a c c o u n ta n t has th e r e s p o n s i b il i t y o f d e te rm in
in g w hether th e ex cess o f c o s t o ver th e book v a lu e may be
in te r p r e te d as g o o d w ill and re co rd ed on th e b a la n c e s h e e t,
w hether only a p o r tio n o f t h i s ex cess s h a l l b e co n sid e re d
g o o d w ill, o r w hether none o f th e ex cess s h a l l be c o n sid e re d
g o o d w ill. I t would b e erro n eo u s to th in k o f g o o d w ill as
th e excess o f c o s t o v er book v a lu e i f th e s u b s id ia ry has an
e r r a t i c ea rn in g re c o rd o r a d e f i c i t . Kie o p e ra tin g h is t o r y
o f such a firm would b e a com plete r e j e c t i o n o f th e e x i s
te n c e o f e a rn in g power, p re s e n t o r p o t e n t i a l , in ex cess o f
th e norm al.
American I n s t i t u t e o f C e r tif ie d R ib lie A ccount
a n ts , Committee on A ccounting P rocedure, A ccounting
R esearch B u lle tin No. 51 (New York: AICPA, A ugust, 1959),
p. 43.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
55
Reasons f o r Excess o f Book V alue Over Cost
A p a re n t company m ight pay le s s th an th e book v a lu e
f o r th e sto c k o f a s u b s id ia r y . When t h i s i s done, th e
ac c o u n ta n t should d eterm in e th e cau se so t h a t th e d i f f e r
ence can be c l a s s i f i e d p ro p e rly on th e c o n s o lid a te d b a la n c e
s h e e t. V arious au th o rs p re s e n t re a so n s f o r th e excess o f
book v a lu e o ver c o s t.
K arrenbrock and Simons o f f e r th e fo llo w in g reaso n s :
1. Net a s s e ts o f s u b s id ia r y in c o r r e c tly s ta te d .
2. F a ilu r e o f s u b s id ia r y acco u n ts to r e f l e c t a s s e t
v a lu e s a t tim e o f s to c k a c q u is itio n .
3. A llowance f o r a s s e t o v e rv a lu a tio n .
4 . In c e r t a in in s ta n c e s a d if fe re n c e betw een th e
amount p a id f o r s to c k and i t s book v a lu e
ex p la in e d by a com bination o f f a c to r s , making
i t im p o ssib le to re a c h a s a t i s f a c t o r y b a s is
f o r a s sig n in g th e d if f e r e n c e to such f a c t o r s . &
An e x p la n a tio n f o r th e re a so n o f book v a lu e s in
ex cess o f c o s t i s summarized by M eigs, Johnson, and K e lle r
as fo llo w s :
1. Net a s s e ts o f s u b s id ia r y o v erv alu ed .
2. B argain p u rch ase.
^K arrenbrock and Simons, op. c i t . , pp. 321-324.
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56
3. E rro rs in re c o rd in g p a r e n t 's c o s t.^
An e x c e lle n t, an n o ta te d l i s t , in d ic a tin g th e circum
s ta n c e s under which th e e q u ity in a s u b s id ia ry w i l l exceed
th e c o s t to a p a re n t company, i s p re s e n te d by Paton:
1. S p e c ific a s s e ts o f th e s u b s id ia r y a re known
to be o v erv alu ed , o r l i a b i l i t i e s u n d erv alu ed .
2. The p a re n t company may have made a b a rg a in
p u rch ase.
3. When sh a re s o f s to c k have been used in s te a d
o f cash o r i t s e q u iv a le n t, th e excess may be
a premium on th e s to c k .
4. A lthough th e re a re a p p a re n tly no erroneous
v a lu a tio n s o f s p e c if ic ite m s, low e a rn in g power
o f th e s u b s id ia ry does n o t j u s t i f y payment o f
book v a lu e f o r i t s s h a re s .
The f i r s t c a se needs no extended comment. The
re q u ire d c o rre c tio n s can be made on th e c o n s o lid a te d
w orking p apers i f n o t on th e s u b s id ia r y 's own re c o rd s .
The v a lu e o f c a r e f u l a p p r a is a ls in t h i s co n n ectio n
should ag ain be n o te d .
The second c a se , though p o s s ib le , i s n o t lik e ly to
be co n sid ered s e r io u s ly by a c c o u n ta n ts. The d i f f i
c u lty o f i t s d e te c tio n and w id esp read a n tip a th y tow ard
reco g n izin g g ain s o r lo s s e s on p u rch ases argue a g a in s t
i t as an im p o rta n t in s ta n c e . I f , how ever, i t does
occur and is re co g n ized , th e in v e stm en t account o f th e
p a re n t company sh ould be in c re a s e d and a s p e c ia l s u r
p lu s account c r e d ite d .
Paton r e f e r s to Staub (T hird I n te r n a tio n a l Congress
on A ccounting) to e x p la in th e t h i r d c a se .
^Meigs, Johnson, and K e lle r, op. c i t . , pp. 253-254.
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57
When th e p u rch ase p r ic e o f s u b s id ia ry sh a re s i s p a id
in sto c k o f th e p a re n t company, a s m a lle r number o f
sh a re s may be g iv en th a n would a p p a re n tly be w arra n te d
by th e v a lu e o f th e s u b s i d ia r y 's a s s e ts . T his i s some
tim es done in o rd e r to s e t up a b o n a -fid e p a id - in
s u rp lu s in th e p a re n t company. There i s no o b je c tio n
to t h i s p ro ced u re i f th e v a lu e o f th e s u b s id ia r y 's
s to c k o f a s s e ts i s re a s o n a b ly e s ta b lis h e d .
The f o u rth c a se i s u s u a lly r e f e r r e d to as " n e g a tiv e
g o o d w ill" alth o u g h th e u n s a tis f a c to r y n a tu re o f th a t
term has le d to su g g e stio n s f o r a b e t t e r one. Mont
gomery su g g e sts "R eserve R e p resen tin g O v e rv alu a tio n o f
A ssets o f S u b s id ia r ie s ." Such a r e s e rv e i s o f th e
n a tu re o f a g e n e ra l re s e rv e o r allow ance a g a in s t a l l
o f th e a s s e ts tak en as a u n i t , n o t a g a in s t a s p e c if ic
a s s e t o r group o f a s s e ts as in th e c a se w ith an a llo w
ance f o r d e p r e c ia tio n o r u n c o l le c tib le s . A noncom m ital
term i s "Excess o f Book V alue A cquired Over C ost o f
S to c k ." I t i s t r u t h f u l b u t h a rd ly e n lig h te n in g to th e
re a d e r o f a statem en t.®
The AICPA Committee on A ccounting P rocedure ta k e s
th e fo llo w in g p o s itio n :
In g e n e ra l, p a r a l l e l p ro ced u res sh ould be fo llo w ed
in th e re v e rs e ty p e o f c a s e . Where th e c o s t to th e
p a re n t i s le s s th an i t s e q u ity in th e n e t a s s e ts o f th e
pu rchased s u b s id ia r y , as shown by th e books o f th e
s u b s id ia ry a t th e d a te o f a c q u is itio n , th e amount a t
which such n e t a s s e ts a r e c a r r ie d in th e c o n s o lid a te d
sta te m e n ts sh ould n o t exceed th e p a r e n t 's c o s t. A ccord
in g ly , to th e e x te n t t h a t th e d if f e r e n c e i s c o n sid e re d
to be a t t r i b u t a b l e to s p e c if ic a s s e ts , i t sh o u ld b e
a llo c a te d to them, w ith c o rre sp o n d in g ad ju stm en ts o f
th e d e p r e c ia tio n o r a m o rtiz a tio n . In u n u su al circu m
sta n c e s th e re may be a rem ain in g d if fe re n c e w hich i t
would be a c c e p ta b le to show as a c r e d i t acco u n t, w hich
g
W . A. Paton, A cc o u n tan ts' Handbook (3rd e d . ; New
York: The Ronald P ress Company, 1948), pp. 1081-1082.
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58
o r d in a r ily would be ta k en in to income in f u tu r e p e rio d s
on a re a s o n a b le and s y s te m a tic b a s is . A p ro ced u re
som etim es fo llo w ed in th e p a s t was to c r e d i t c a p i t a l
sxirplus w ith th e amount o f th e e x c e ss; such a p ro ced u re
i s n o t now c o n sid e re d a c c e p ta b le .
P o s itiv e G oodw ill Viewed as an A sset
The a c c o u n ta n t' s r e s p o n s i b i l i t y in h a n d lin g th e
excess o f book v a lu e o v er c o s t i s to an a ly z e th e e x a c t
n a tu re o f th e ex cess and p re s e n t th e p ro p e r c l a s s i f i c a t i o n
o f th e item on th e c o n s o lid a te d b a la n c e s h e e t. Ih e a c c o u n t-
a n t 's a n a ly s is m ust r e f l e c t th e g e n e ra l p r in c ip le t h a t th e
c o n s o lid a te d b a la n c e s h e e t m ust b e b ased on a c tu a l f a c t s
as c o r r e c t ly as i s f e a s ib le .
Where sh o u ld t h i s d if f e r e n c e betw een c o s t and book
v a lu e ap p ear on th e f in a n c ia l sta te m e n ts ? Is t h i s d i f f e r
ence an a s s e t o r an expense? VJhat c l a s s i f i c a t i o n sh o u ld be
g iv e n to t h i s d if f e r e n c e i f i t i s to b e tr e a te d as an
a s s e t? Yang e x p re sse s th e fo llo w in g o p in io n :
A b u s in e s s can buy th e s e r v ic e o r e f f ic ie n c y o f
i t s p re d e c e ss o r as w e ll as i t can o th e r com m odities or
s e rv ic e s from a n o th e r p e rso n . Ih e e n te r p r is e may be
conducted in e x a c tly th e same manner as b e fo re , b u t th e
in ta n g ib le p r o p e r tie s a c q u ire d a re q u ite d i s t i n c t from
Q
A ccounting R esearch B u lle tin No. 51, p . 43.
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59
th e s k i l l and e f f ic ie n c y o f th e new owner and manage
m ent. They should be a p p ro p ria te ly shown in th e
acco u n ts as investm ent a s s e ts , so t h a t th e e f f ic ie n c y
o f th e new management may be c o r r e c tly m easured by th e
r a t e o f e a rn in g s on th e t o t a l re so u rc e s n o t d ir e c t l y
c o n trib u te d by th e management i t s e l f . The f a c t th a t
th e payment fo r in ta n g ib le s was a payment f o r p r o f i t ,
does n o t a f f e c t th e c o n s is te n c y o f th e s i t u a t i o n , f o r
p r o f i t to one b u sin e ss e n tre p re n e u r may be a c o s t to
a n o th e r. One e n te r p r is e , f o r in s ta n c e , may buy eq u ip
ment o r m a te ria ls f r a n a n o th e r and th e p r ic e p a id may
in c lu d e th e c o s t o f la b o r, m a te r ia ls , overhead ex
p en ses, and in a d d itio n a d i f f e r e n t i a l o r monopoly
p r o f i t ; b u t i t has n ev er been doubted t h a t th e e n tir e
payment re p re s e n ts a le g itim a te acco u n tin g v a lu e to
th e con cern th a t makes th e p u rch ase.
Delmer H ylton is o f th e o p in io n t h a t t h i s d i f f e r
ence i s an a s s e t. He ex p re sse s t h i s o p in io n in th e fo llo w
in g p arag rap h :
The problem o f re c o rd in g goodw ill as an a s s e t l i e s
in th e d i f f i c u l t y o f s e c u rin g an a c c u ra te m easurem ent.
But when a p r ic e is p a id f o r g o o d w ill, a u s a b le
m easurem ent e x is ts . To be s u re , t h i s m easurem ent is
s u b je c t to th e same e r r o r as i s th e v a lu e m easurem ent
in h e re n t in any p u rch ase, b u t th i s does n o t le a d us to
deny th e v a l i d i t y o f such a measurement f o r acco u n tin g
and b u sin e ss u se . Any such m easurem ent o f any p u r
ch ase i s based on f u tu r e e x p e c ta tio n s , and f u tu r e
ev en ts w i l l t e s t and prove o r d isp ro v e th e accu racy of
th e m easurenent now made. How purchased g o o d w ill d i f
f e r s in t h i s re s p e c t from o th e r a s s e ts a c q u ire d i s a
q u e s tio n to which no good answer seems to have been
made.
The a s s e r tio n th a t g o o d w ill i s n o t an a s s e t sim ply
cannot be su p p o rted . I t i s c o n tra ry to known f a c t ;
M . Yang, G oodw ill and O ther In ta n g ib le s (New
York: The Ronald P ress Company, 1926), p. 187.
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60
i f f o r no o th e r re a so n , th e f a c t t h a t funds a re e x
pended f o r g o o d w ill by v a rio u s p u rc h a se rs i s am ple
ev id en ce t h a t e x is tin g g o o d w ill i s a v a lid a s s e t.
Ih e re a re ac co u n tan ts who b e lie v e th a t g o o d w ill
should n o t ap p ear on th e b alan c e s h e e t. Bie b a s is o f such
a b e l i e f i s t h a t th e p re s e n ta tio n o f g o o d w ill on th e b a l
ance s h e e t len d s i t s e l f to v a rio u s a l t e r n a t i v e m ethods.
These a l t e r n a t i v e m ethods th re a te n to d i s t o r t th e a c c o u n t
in g r e p o r ts and th u s th e u s e fu ln e s s o f th e in fo rm a tio n to
th o se who need th e f in a n c ia l sta te m e n ts i s d e s tro y e d .
Leonard Spacek i s an ad v o cate o f n o t p r e s e n tin g
g o o d w ill on th e b a la n c e s h e e t, and he e x p re sse s h is view s
in th e fo llo w in g m anner:
Hie c o s t o f g o o d w ill should alw ays be charg ed
a g a in s t s u rp lu s when i t is p u rch ased . P re fe ra b ly th e
ch arg e sh o u ld b e made a g a in s t earn ed s u rp lu s t o th e
e x te n t a v a ila b le , in o rd e r to keep i n t a c t th e o r ig in a l
c a p i t a l p aid in u n t i l i t s u se i s a u th o riz e d by s h a re
h o ld e rs . In t h i s way, th e book v a lu e o f c o rp o ra te
s to c k w i l l r e p r e s e n t th e amounts c a r r ie d f o r pro d u cin g
a s s e ts o n ly . This should be e s ta b lis h e d as an a c c o u n t
in g p r in c ip le and should always be o b served.
Delmer P. Ifylton, " Im p lic a tio n s o f th e D ire c t
W rite-O ff o f G o o d w ill," New York C e r tif ie d R ib lie A ccount
a n t. XXXVI (December, 1966), 917-918.
12
Leonard Spacek, "Goodwill in th e C o rp o rate
B alance S h e e t," J o u rn a l o f A ccountancy, CXVII (F eb ru ary ,
1964), 39-40.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
61
I t i s e v id e n t th a t Spacek does n o t b e lie v e th a t
g o o d w ill i s an a s s e t. He i s o f th e o p in io n t h a t h is method
o f d e a lin g w ith g o o d w ill w i l l r e s u l t in th e fo llo w in g :
R e sto re th e b a la n c e s h e e t and income sta te m e n t to
a p o s itio n o f u s e fu ln e s s in p re s e n tin g f a c t u a l d a ta
to th e p u b lic —to th o se who m ust u s e th e sta te m e n ts to
e s t a b l i s h a sound b a s is f o r tra d in g in b u s in e s s s e c u r i
t i e s and f o r buying and s e llin g com panies.
The AICPA Ccsnmittee, however, does n o t ag re e w ith
Spacek*s view o f ch arg in g g o o d w ill a g a in s t s u rp lu s when i t
is p u rch ased . B a s ic a lly , th e view o f th e Committee i s as
fo llo w s :
G oodw ill when purchased sh ould n o t be charged o ff
to earn ed s u rp lu s im m ediately upon a c q u is it io n —i f
th e amount in v o lv ed i s n o t so la rg e as to r e s u l t in
d i s t o r t i o n ; an im m ediate c h a rg e -o ff to income i s p e r
haps a p p ro p ria te as a p r a c t i c a l m a tte r.
E rroneous la p lic a tio n s o f Im m ediate W rite-O ff
o f P o s itiv e G oodw ill
Delmer H ylton i s o f th e o p in io n t h a t th e d ir e c t
w r i te - o f f o f g o o d w ill cannot be j u s t i f i e d . H ylton s ta te s
th a t th e d i r e c t w r i te - o f f makes c e r t a in im p lic a tio n s which
^ ^ I b id . , p. 40.
^^American I n s t i t u t e o f A cco u n tan ts, Ccmmittee on
A ccounting P rocedure, A ccounting R esearch B u lle tin No. 43
(New York: American I n s t i t u t e o f A cco u n tan ts, 1947),
pp. 39-40.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
62
a re e rro n e o u s. These im p lic a tio n s a re as fo llo w s :
G oodw ill i s n o t an e x p e n s e .— I f th e ex p e n d itu re
f o r g o o d w ill i s n o t an a s s e t, n e ith e r i s i t tr e a te d
as an expense when i t i s charged d i r e c t l y a g a in s t
r e ta in e d e a rn in g s . B y-passing th e income sta tem e n t
makes t h i s a s s e r tio n c l e a r . F u rth e r, s in c e i t has n o t
been re c o rd e d as an a s s e t, n e i th e r can i t be charged
as an expense in f u tu r e p e rio d s . On th e o th e r hand,
th e ex p ected a d d itio n a l income a c q u ire d by th e p u r
chase w i l l be shown ( i f i t m a te r ia liz e s ) in f u tu re
p e rio d s . Thus, income f o r w hich an e x p e n d itu re was
made w i l l appear on th e inccme sta te m e n t w ith no i n d i
c a tio n t h a t an e x p e n d itu re was made to a c q u ire t h i s
income.
A d iv id e n d ? —An e n try w hich ch arg es re ta in e d e a rn
in g s and c r e d i ts e i t h e r an a s s e t acco u n t o r seme o th e r
ow ners' e q u ity account co u ld in d ic a te th e payment o f a
d iv id e n d . The g o o d w ill w r i te - o f f can n o t q u a lify as
e i t h e r a cash o r sto c k d iv id e n d . In th e f i r s t p la c e ,
th e r e c ip ie n t i s n o t a s to c k h o ld e r in th e paying c o r
p o ra tio n . D ividends can n o t be p a id to th o s e who a re
n o t p a r t o f th e ow nership o f th e p ay o r. In a d d itio n ,
in e i t h e r o f th e k in d s o f d iv id e n d s h e re co n sid ered ,
th e r e c i p ie n t does n o t r e tu r n som ething to th e c o r
p o ra tio n in r e tu r n f o r th e d iv id e n d p a id .
A g i f t ? — I f th e ch a rg e a g a in s t r e ta in e d e a rn in g s is
n o t a d iv id e n d , perhaps i t co u ld be c o n sid e re d as a
g i f t . But t h i s i s u n lik e ly and p ro b ab ly i l l e g a l ; n o t
o n ly i s som ething b ein g a c q u ire d by th e p u rch ase, b u t
a ls o th e r e c i p ie n t f a i l s to q u a lif y as a le g itim a te
o b je c t f o r c h a r ita b le d i s t r i b u t i o n s . In any ca se , th e
p ro p e r e n try f o r a c o rp o ra te c o n trib u tio n i s through
an acco u n t w hich w i l l ap p ear on th e income s ta te m e n t.
Ih u s, th e case f o r w ritin g o f f g o o d w ill as a g i f t seems
to f a i l .
C a p ita l c o n tra c tio n ? - -W ith th e co n cep t o f w r itte n -
o f f g o o d w ill as e i t h e r a d iv id e n d o r a g i f t d isc a rd e d ,
we a r e l e f t w ith l i t t l e c h o ic e b u t to c a l l th e tr a n s a c
tio n an in d ic a tio n o f c a p i t a l c o n tra c tio n . For th e
company whose s h a re s a r e b ein g a c q u ire d , t h i s cannot
b e, f o r i t s c a p i t a l s t r u c t u r e i s u n a lte r e d . The only
b a s is f o r such an e n try o f th e p u rch a sin g company i s
in th e ev en t t h a t n o th in g o f v a lu e i s re c e iv e d f o r
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
63
th e e x p e n d itu re made. Ih e l e g a l i t y o f such a d is s ip a
tio n o f a s s e ts would norm ally be th e o b je c t o f some
p o in te d q u e s tio n s .
C o rre c tio n o f p r io r y e a r 's incom e?--The d ir e c t
w r ite - o f f b e a rs some s im ila r it y to a t l e a s t one o th e r
f a i r l y common tr a n s a c tio n , th e c o r r e c tio n o f p r io r
y e a rs ' e a rn in g s , i f such o ccu rren ces a re reco rd ed
through r e ta in e d e a rn in g s . But th e s i m i l a r it y q u ic k ly
d isa p p e a rs when one an aly zes th e g o o d w ill w r ite - o f f .
G oodw ill, though computed from p a s t e x p e rie n c e , r e l a t e s
to th e f u tu r e . For th e s e llin g c o rp o ra tio n , th e good
w i l l has been co n v erted in to o th e r k in d s o f a s s e ts ,
and th u s no w r i t e - o f f would be a p p ro p ria te on th e s e
re c o rd s . For th e a c q u irin g canpany, a p u rch ase could
h a rd ly a f f e c t ea rn in g s o f p r io r y e a rs , and thus th e
analogy f a i l s to h o ld .^ ^
These im p lic a tio n s p o in t o u t th a t th e d ir e c t w r i te
o ff o f g o o d w ill c a s t g rav e m isg iv in g s on th e s u i t a b i l i t y o f
such a ch arg e to r e ta in e d e a rn in g s.
B alance Sheet D isc lo su re o f
P o s itiv e Goodwill
The re a so n s f o r th e d if fe re n c e betw een c o s t and
book v a lu e have been d is c u s s e d . Now t h a t i t i s known what
causes t h i s d if f e r e n c e one m ust d e c id e what d is p o s itio n is
to be made o f t h i s d if f e r e n c e . The c o n tro v e rsy o v er th e
d ir e c t w r ite - o f f to r e ta in e d ea rn in g s has been e la b o ra te d
on p re v io u sly .
^^H ylton, op. c i t . , pp. 917-918.
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64
Finney and M ille r make th e fo llo w in g canm ents in
r e l a t i o n to th e d is p o s a l o f t h i s d if f e r e n c e :
There seems to be much to be s a id in fa v o r o f d i s
c o n tin u in g th e t r a d i t i o n a l p ro ce d u re o f ap p ly in g th e
t i t l e o f "G oodw ill" to th e t o t a l ex cess o f c o s t over
book v a lu e , and o f ad o p tin g a p ro ced u re o f s c r u tin iz in g
th e s u b s id ia r y b a la n c e s h e e t v a lu a tio n s to d eterm in e
th e e x te n t, i f any, to which rh e ex cess should be
a p p lie d to th e v a lu a tio n s o f v a rio u s a s s e ts . T his does
n o t mean t h a t none o f th e ex cess sh o u ld be shown in th e
c o n s o lid a te d b a la n c e sh e e t as g o o d w ill; i t may be th a t
p a r t o r a l l o f th e excess payment was made in re c o g n i
tio n o f th e s u b s id ia r y 's e a rn in g pow er.
A ccepting th e p ro ced u re o f a d ju s tin g s u b s id ia ry
a s s e t v a lu a tio n s as th e o r e t i c a l l y d e s ir a b le , th e re may
be no s a t i s f a c t o r y in fo rm a tio n ab o u t th e amounts by
which such v a lu a tio n s should be a d ju s te d . I t may th en
be n e c e s s a ry to show th e ex cess as a s e p a ra te item on
th e a s s e t s id e o f th e c o n s o lid a te d b a la n c e s h e e t, w ith
some t i t l e such as "Excess o f Cost o f S u b sid ia ry Stock
Over Book V alue T hereof a t Date o f A c q u is itio n ." I f
p o rtio n s , b u t n o t a l l , o f th e ex cess can be a ssig n e d
to s p e c if ic s u b s id ia ry a s s e ts , th e rem ain d er may be
shown in th e c o n s o lid a te d b a la n c e s h e e t w ith some cap
tio n such as " p o rtio n o f ex cess o f c o s t o f s u b s id ia ry
sto c k o v er book v a lu e th e re o f a t a c q u is itio n n o t
assig n ed to s p e c if ic s u b s id ia ry a s s e ts ." ^ ®
K arrenbrock and Simons a r e more f o r c e f u l in t h e i r
o p in io n :
When c o s t exceeds book v a lu e th e d if f e r e n c e i s
fre q u e n tly tr e a te d as g o o d w ill. T his p ro ced u re may be
follow ed in th e i n t e r e s t s o f expediency r a th e r th a n
from an i d e n t i f i c a t i o n o f th e s p e c if ic f a c to r s t h a t
e x p la in th e p u rch ase o f sto c k a t a p r ic e above book
Finney and M ille r, op. c i t . , pp. 359-360.
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65
v a lu e . When th e c o s t o f a c o n tr o llin g i n t e r e s t exceeds
th e book v a lu e o f s u b s id ia ry s to c k a c q u ire d , th e d i f
fe re n c e i s m ost s a t i s f a c t o r i l y d e s ig n a te d as "Excess
o f c o s t o v er book v a lu e o f S u b sid ia ry I n t e r e s t .
The ap p earan ce o f th e term "g o o d w ill" on th e b a l
ance s h e e t does n o t ap p ear to have th e ac c e p tan c e o f Finney
and M ille r o r K arrenbrock and Simons. M ilroy, Walden, and
Seaw ell a ls o oppose th e u se o f th e term "g o o d w ill" when
th ey make th e fo llo w in g sta te m e n t :
A f i n a l method o f h a n d lin g th e d e b it d i f f e r e n t i a l
i s to c a rr y i t in th e c o n s o lid a te d b a la n c e s h e e t,
w ith o u t a n a ly s is , as an u n id e n tif ie d d e b it b a la n c e .
Because o f a r e lu c ta n c e to u se th e term " g o o d w ill,"
ac c o u n ta n ts g e n e ra lly have adopted th e p h ra se "excess
o f in v e stm e n t c o s t over book v a lu e ." In a number o f
in s ta n c e s i n a c tu a l p r a c tic e , th e d e b it d i f f e r e n t i a l
has been in c lu d e d in th e t o t a l o f c o n s o lid a te d fix e d
a s s e ts . Except in th o se circ u m sta n ces w here a n a ly s is
o f th e d e b it d i f f e r e n t i a l and i t s assignm ent to
ta n g ib le and in ta n g ib le a s s e ts i s im p o ssib le , imma
t e r i a l o r im p r a c tic a l, t h i s method i s u n a c c e p ta b le .^ ^
Roy K e ste r, alth o u g h w ritin g two decades ago, had
id e a s about g o o d w ill s im ila r to th o se ex p ressed by p r e s e n t-
day w r i te r s . K ester* s view s a re as fo llo w s :
P o s itiv e g o o d w ill i s fre q u e n tly added to any o th e r
g o o d w ill item shown on th e b a la n c e s h e e t. In o th e r
ca ses i t i s shown as G oodw ill in C o n so lid a tio n , b eing
l i s t e d s e p a r a te ly from o th e r g o o d w ill. Or i t may be
^^K arrenbrock and Simons, op. c i t . , p . 319.
18
M ilroy, Walden, and S eaw ell, op. c i t . , p . 377.
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66
shown as Excess o f Investm ents in S u b s id ia rie s , o v er
th e Book V alues o f S u b sid ia rie s* S to ck s. In some
cases i t may w ith p r o p rie ty be in c lu d e d as a p a r t o f
th e c o n s o lid a te d ta n g ib le fix e d a s s e t s - - t h e amount
in c lu d e d b ein g in d ic a te d by fo o tn o te s .
Most a c co u n ta n ts c l a s s i f y th e d e b it d i f f e r e n t i a l on
th e c o n s o lid a te d b a lan ce s h e e t in one o f th e fo llo w in g
ways :
1. Excess o f c o s t o v er book v a lu e o f s to c k p u r
ch ased .
This method ap p ears to have th e endorsem ent o f
m ost a u th o rs .
2 . G oodw ill.
I h is method r e p re s e n ts e a rn in g power in ex cess
o f th e norm al.
3 . A d ed u c tio n from th e r e ta in e d e a rn in g s o f th e
p a re n t company.
The au th o rs who l i s t t h i s c a p tio n make th e
comment th a t such a method i s n o t ac ce p ted by
m ost firm s. I h is method i s a ls o prom inent
among th o s e who do n o t c o n s id e r th e d e b it d i f
f e r e n t i a l an a s s e t.
19
Roy K ester, Advanced A ccounting (4 th ed. ; New
York: The Ronald P ress Company, 1946), p. 583.
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67
B alance Sheet D isc lo su re o f
N egative G oodw ill
Now th a t th e d e b it d i f f e r e n t i a l has been d isc u sse d
(excess o f c o s t o v er book v a lu e ) , w hat d is p o s itio n should
b e made o f th e c r e d i t d i f f e r e n t i a l (excess o f book v a lu e
over c o s t) ?
When th e s u b s id ia r y ’s s to c k i s a c q u ire d a t a c o s t
w hich i s le s s th a n i t s book v a lu e , i t i s som etim es c a lle d
’’ n e g a tiv e g o o d w ill.” This term im p lie s t h a t th e c r e d i t
d i f f e r e n t i a l i s to be d ed u cted from th e s u b s id ia r y ’s good
w i l l a c c o u n t.
M ilroy, Walden, and S eaw ell a s s e r t t h e i r p o s itio n
on th e c r e d i t d i f f e r e n t i a l by sa y in g :
The t r a d i t i o n a l tre a tm e n t o f an ex cess o f book
v a lu e o v er c o s t i s to c o n s id e r such ex cess as ’’ n e g a tiv e
g o o d w ill” to be o f f s e t a g a in s t reco rd ed g o o d w ill, i f
any, on th e books o f th e s u b s id ia ry , th e p a r e n t, o r any
o th e r company in th e c o n s o lid a te d group. I f th e c r e d i t
d i f f e r e n t i a l co u ld n o t be d isp o sed o f in t h i s way, i t
was shown in th e c o n s o lid a te d b a la n c e s h e e t as ’’su rp lu s
from c o n s o lid a tio n .”20
These a u th o rs a ls o ex p ress th e view t h a t i f an
a n a ly s is o f a c r e d i t d i f f e r e n t i a l does n o t p erm it i t s id e n
t i f i c a t i o n w ith s p e c if ic s u b s id ia ry a s s e ts , th e n i t should
378.
20
M ilroy, Walden, and S eaw ell, op. c i t . . pp. 377-
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68
b e p re se n te d w ith in th e sto c k h o ld e rs* e q u ity s e c tio n o f th e
c o n s o lid a te d b a la n c e s h e e t as ’’ex c ess o f book v a lu e over
91
c o s t o f s u b s id ia r y s t o c k .”
P ro fe s s o rs Finney and M ille r c o u n te r th e t r a d i
t i o n a l tre a tm e n t by sa y in g :
I t i s now coming to be re c o g n iz e d t h a t th e s e p ro
ced u res [ t r a d i t i o n a l ] a re o f q u e s tio n a b le p r o p r ie ty .
I f g o o d w ill ap p ears in th e b a la n c e s h e e t o f th e
a c q u ire d s u b s id ia r y , i t may b e t h a t th e g o o d w ill i s
f a i r l y v a lu e d b u t o th e r a s s e ts a r e o v erv alu ed . To
apply an ex cess o f book v a lu e o v er th e c o s t o f th e
sto c k o f one s u b s id ia ry a g a in s t g o o d w ill ap p earin g
elsew h ere in th e w orking p a p e rs i s s u b je c t to q u e s tio n
on th e grounds t h a t i t o f f s e t s elem ents t h a t a re
r e la te d in name o n ly , and t h a t i t r e s u l t s in w ritin g
o f f g o o d w ill presum ably p a id f o r in o th e r tr a n s a c tio n s
by th e p a re n t o r o th e r s u b s i d i a r i e s .2%
There i s no one way to d is p o s e o f book v a lu e over
c o s t in c o n s o lid a tio n . This c r e d i t d i f f e r e n t i a l sh o u ld be
c l a s s i f i e d on th e c o n s o lid a te d b a la n c e s h e e t in accordance
w ith th e c irc u m sta n c e s su rro u n d in g th e in v e stm e n t.
G oodw ill Should Not Be A m ortized
A ccountants a re n o t in g e n e ra l agreem ent co n cern in g
th e a m o rtiz a tio n o f g o o d w ill. I t i s agreed t h a t g o o d w ill
^ ^ I b i d . . p . 378.
22
F inney and M ille r, op. c i t . , p. 366.
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69
m ight n o t d e p r e c ia te in e x a c tly th e same manner as p la n t
a s s e ts ; how ever, i t may d e c lin e in v a lu e . In a n a ly z in g th e
p r in c ip le s in v o lv e d , i t w i l l b e b e s t to p re s e n t th e view s
o f th e p ro p o n en ts o f n o t a m o rtiz in g g o o d w ill and a ls o th e
view s o f th o s e who ad v o cate a m o rtiz in g g o o d w ill.
There i s th e p o s s i b i l i t y th a t tr u e g o o d w ill n e v e r
e x is te d , even though th e b u y er o f a b u sin e ss p a id an ex cess
amount in th e b e l i e f th a t h e was re c e iv in g e x tra o rd in a ry
ea rn in g c a p a c ity . I t co u ld b e t h a t th e amount r e p r e s e n tin g
g o o d w ill i s n o th in g more th a n th e d if fe re n c e betw een th e
book v a lu e o f th e n e t a s s e ts and th e e stim a te d v a lu e a t th e
tim e o f p u rch ase . This d if f e r e n c e could a r i s e b ec au se th e
b u y er f a i l e d to a d ju s t th e v a lu e s o f th e ta n g ib le a s s e ts
o f th e b u s in e s s . In such s i t u a t i o n s , th e re i s no r e a l
g o o d w ill and o n ly a few a c c o u n ta n ts would contend t h a t th e
c o s t sh o u ld rem ain on th e b a la n c e s h e e t.
George 0. May, how ever, s t a t e s th e fo llo w in g :
A ccounting does n o t a tte m p t to p ro v id e f o r a d e
c lin e in com m ercial v a lu e o f an e n te r p r is e as a w hole
th a t i s due s o le ly to a f a l l i n g o f f in ea rn in g power
o f th e e n te r p r is e , and i t i s p ro b ab ly n o t d e s ir a b le
th a t i t sh o u ld atte m p t to do so .
In th e s e c irc u m sta n c es i t i s d i f f i c u l t to s e e why
acco u n tin g a u th o rity sh o u ld c a l l f o r o r fa v o r w r itin g
o f f in ta n g ib le a s s e ts when e a rn in g c a p a c ity i s unim
p a ire d as some p ro p o se. Any such ad ju stm en ts a r e
c le a r ly i r r e le v a n t to th e d e te rm in a tio n o f r a t e s , so
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70
t h a t th e consumer i s n o t co n cern ed . Â re q u irem e n t o f
a m o rtiz a tio n can n o t, th e r e f o r e , b e j u s t i f i e d as c a lle d
f o r in th e p u b lic i n t e r e s t .
Roy B. K ester ex p resses th e fo llo w in g view :
There i s u s u a lly no lo g ic a l b a s is f o r w ritin g i t
[g o o d w ill] o f f . When p r o f i t s a r e la rg e , g o o d w ill i s a
v e ry r e a l a s s e t . To w rite i t o f f th e n i s n o t lo g ic a lly
c o n s is te n t. When p r o f it s a re sm a ll and g o o d w ill has
d e c lin e d , i t would h a rd ly b e l o g i c a l to w r ite o f f any
p o rtio n le s s th a n i t s d ec re ase d amount; y e t th e p r o f it s
a t such a tim e a re r a r e ly s u f f i c i e n t to s ta n d so h e ro ic
a tr e a tm e n t.24
A d i f f e r e n t l in e o f a tta c k i s e x p lain e d by W . A.
S tau b :
I t fo llo w s th a t th e re i s no b a s ic reaso n f o r , o r
s c i e n t i f i c method o f, w r itin g - o f f o r am o rtizin g th e
c o s t o f ty p e B in ta n g ib le s , th e v a lu e o f w hich i s con
tin u in g . To r e q u ir e th e com pulsory a m o rtiz a tio n o f
in ta n g ib le s , th e v a lu e o f w hich i s b ein g c u r r e n tly
m a in ta in e d o r even enhanced, seems a d e p a rtu re from th e
"going co n cern " concept o f f i n a n c i a l sta te m e n ts and an
a tte m p t to p ro v id e f o r lo s s e s w hich may be s u s ta in e d
upon te rm in a tio n o r liq u id a tio n o f an e n te r p r is e a t
some tim e in th e f u tu re . 25
Paul Grady p re s e n ts a v e ry p ersu a d in g argum ent w ith
th e fo llo w in g comments :
23
George 0. May, F in a n c ia l A ccounting (New York:
Ih e M acm illan Company, 1943), p . 154.
24
K e ste r, op. c i t . , p. 369.
^^Ouoted by W alter A. S taub, in " In ta n g ib le A s s e ts ,"
Contemporary A ccounting, e d ite d by Thomas W . L eland (New
York: American I n s t i t u t e o f A cco u n tan ts, 1945), Chap
t e r V III, p . 5.
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71
The c h a rg in g o f f o f u n lim ite d term in ta n g ib le s ,
such as g o o d w ill, . . . w hich a re b ein g f u l l y m ain
ta in e d , would r e s u l t in an u n d e rsta te m e n t o f c o s t o f
fix e d a s s e ts and an o v e rsta te m e n t o f ex p en ses. This
would be tr u e even though i t m ight b e d em o n strated in
an unusual c a se t h a t th e o r ig in a l in ta n g ib le s had
ceased to e x i s t and had been re p la c e d by new v a lu e s
a t t r i b u t a b l e to . . . su b seq u en t e x p e n d itu re s w hich
a re charged to c o s t o f o p e ra tio n s . Under such circ u m
s ta n c e s , i t c o u ld n o t f a i r l y be claim ed t h a t th e
o r ig in a l in v estm en t sh o u ld b e charged o f f w ith o u t a t
th e same tim e a d m ittin g th e re a s o n a b le n e ss o f c a p i t a l
iz in g an e q u iv a le n t amount o f th e su b seq u en t e x p e n d i
tu r e s , w hich would c o n s t i t u t e a m ean in g less and s e n s e
le s s acco u n tin g p ro c e d u re .
Spacek i s o f th e o p in io n t h a t a m o rtiz a tio n o f good
w i l l p re s e n ts a m is le a d in g e a rn in g s f ig u r e to th e re a d e r o f
th e sta te m e n t. Spacek e x p re sse s th e id e a :
I r e s p e c tf u lly subm it th a t th e a m o rtiz a tio n o f
goodw ill a g a in s t income i s n o t p ro p e r. Income s t a t e
ments should show e a rn in g s from o p e ra tio n s , u n d is to r te d
by item s th a t a r e in no way r e l a t e d to o p e ra tio n s , such
as charges f o r th e a m o rtiz a tio n o f g o o d w ill. The pub
l i c th en reac h e s an o p in io n , w hich i s c o n s ta n tly ch an g
in g , as to w hat th e ea rn in g s o f th e f u tu r e a re l i k e l y
to be.
G oodw ill Should Be Am ortized
Now to be c o n s id e re d is th e re a so n in g o f th o s e who
oppose th e group who say th a t purchased goodw ill sh o u ld
26
Paul Grady, "A ccounting fo r F ixed A ssets and
T h eir A m o rtizatio n , " The A ccounting Review, X X V (Jan u ary ,
1950), 12.
27
Spacek, op. c i t . , p. 39.
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72
n o t be a m o rtized . I h is group i s o f th e o p in io n th a t good
w i l l sh o u ld be w r itte n o f f even i f v a lu e rem ain s.
A view w hich was fre q u e n tly p re s e n te d in th e p a s t
b u t i s n o t so p o p u la r to d ay i s ex p re sse d by Leake as f o l
lows :
S u p e r-p ro fits can n ev er e x i s t p erm an en tly , becau se
com m ercial c o m p e titio n i s u n iv e r s a l and c o n s ta n tly a t
work, and a ls o , b ecau se th e demand f o r any -commodity
o r s e r v ic e may sla c k e n o r c e a se owing to changing con
d itio n s and new in v e n tio n , and, th e r e f o r e , th e a n n u ity
which th e v en d o r o f g o o d w ill s e l l s sh o u ld n ev e r be
tr e a te d as b ein g in th e n a tu re o f p e r p e t u i t y .^8
Baton makes th e fo llo w in g im p o rta n t sta te m e n t :
I t i s som etim es h e ld th a t s in c e th e e x is te n c e o f
in ta n g ib le s depends upon e a rn in g power th e c o s t o r
v a lu e o f g o o d w ill may be m a in ta in e d on th e books u n d is
tu rb e d so long as th e le v e l o f income does n o t f a l l
below th a t im p lic it in th e o r i g i n a l p u rch a se o r v a l u
a tio n . T his p o s itio n i s o b je c tio n a b le in t h a t i t i s
in c o n s is te n t w ith th e assum ptions o r d in a r ily made in
d e term in in g th e in ta n g ib le v a lu e . I f th e amount o f
g o o d w ill as a c q u ire d i s conceived as th e p re s e n t w orth
o f a te rm in a b le s e r ie s o f s p e c ia l inccxnes i t would seem
to fo llo w th a t th e a s s e t sh o u ld be w r itte n o f f a g a in s t
revenues th ro u g h th e p e rio d in w hich such incomes a re
expected to be r e a l iz e d . The f a c t t h a t th e le v e l o f
ea rn in g s i s m a in ta in e d o r even in c re a s e d f o r a p e rio d
lo n g e r th a n ex p ected does n o t w a rra n t th e co n c lu sio n
th a t th e g o o d w ill re c o g n iz e d sh o u ld n o t be w r itte n o f f .
The s u p e rio r e a rn in g o f l a t e r p e rio d s may be due to
28
p. D. Leake, "G oodw ill: I t s N atu re and How To
V alue I t , " A cco u n tan t, L (January 17, 1914), 85.
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73
f a c ts and c o n d itio n s n o t p re s e n t when th e b u s in e s s was
a c q u ire d .^9
A p o r tio n o f th e th e o ry su p p o rtin g Paton*s q u o ta
tio n i s p re se n te d in th e fo llo w in g comments by L eake:
I t i s u rg ed a g a in s t th e w ritin g o f f o f th e c o s t o f
g o o d w ill--a n d o fte n i t i s a f a c t —th a t th e g o o d w ill o f
a p ro sp ero u s u n d e rta k in g e a rn in g la rg e s u rp lu s p r o f i t s
i s w orth no le s s now th a n i t was when i t was purchased
te n o r tw enty y e a rs ago. The q u e s tio n i s ask ed : "Why,
th e r e f o r e , sh o u ld th e g o o d w ill be w r itte n o f f? " The
answer i s t h a t th e p re s e n t g o o d w ill i s , in th e m ain,
n o t th e g o o d w ill w hich was bought te n o r tw enty y ears
ago. At t h a t tim e —te n o r tw enty y e a rs ago—th e now
e x is tin g g o o d w ill (which i s th e p re s e n t v a lu e o f s u p e r
p r o f i t ex p ecte d to a r i s e in s t i l l f u tu r e y e a rs ) would
have been w orth n e x t to n o th in g .^0
There a re tim es when g o o d w ill i s w r itte n o f f on th e
grounds o f co n serv atism . I h is l in e o f th o u g h t i s sunsnarized
by Yang as fo llo w s :
Whenever in d e f in ite n e s s o f v a lu e o b ta in s , even
though an a c tu a l e x p e n d itu re h as been made, acco u n tin g
fa v o rs w r itin g th e amount o f f as c u rre n t expense or
lo s s , th e e f f e c t o f th e e x p e n d itu re t h e r e a f t e r b eing
accounted f o r through th e ch a n n el o f p e r io d ic a l e a rn
in g s . T his i s tr u e o f a l l v a lu e s which can n o t in th e
ex p e rie n c e o f th e b u sin e ss be a d e q u a te ly te s te d as to
t h e i r s p e c if ic v a l i d i t y o r le g itim a c y and t h e i r a p p li
c a b i l i t y to e a rn in g s o th e r th a n th o s e o f th e e x is tin g
p e rio d . The e x is te n c e o f g o o d w ill as an economic f a c t
OQ
W . A. Paton, Advanced A ccounting (New York : Ih e
M acm illan Company, 1941), p . 435.
30
Leake, op. c i t ., p. 78.
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74
in a n o rm ally e s ta b lis h e d e n te r p r is e does n o t n e c e s
s a r i l y a f f e c t th e soundness o f th e acco u n tin g p r in c ip le ,
f o r a c c o u n tin g as such i s n o t in te n d e d to show th e
p ro b a b le and lo n g -ru n economic s i t u a t i o n b u t th e f a c ts
and happenings o f a d eterm in a b le c h a r a c te r w ith in th e
s p e c if ic b u s in e s s concerned.
Along th e same li n e i s th e co n cep t o f th e s e c r e t
r e s e rv e . When in ta n g ib le a s s e ts a re w r i tte n o f f to rev en u e,
th e s to c k h o ld e rs a re d en ied d iv id en d s up to th e amount o f
th e a m o rtiz a tio n .
H. E. G regory p re s e n ts th is p o s itio n when he w rite s :
C u rren t inccrae i s re in v e s te d i n th e c o rp o ra te
p ro p e rty and f i n a l l y ta k e s th e form o f m isc ellan e o u s
ta n g ib le a s s e ts . The in ta n g ib le , th ro u g h th e p e rio d ic
a m o rtiz a tio n ch arg e, w i l l d isa p p e a r, and in i t s p la c e
w i l l come bona f id e p ro p e rty . The " s a le " w i l l r e q u ir e
some tim e f o r i t s u ltim a te consum m ation.
The g e n e ra l view s o f m ost p r a c t itio n e r s concerning
g o o d w ill a m o rtiz a tio n a re summarized by S an d ers, H a tfie ld ,
and Moore:
The w ritin g o f f o f such in ta n g ib le a s s e rs as good
w i l l evokes s c a rc e ly any p r o te s t, even when i t is
rec o g n iz e d th a t s u b s t a n tia l g o o d w ill e x i s t s . The
g e n e ra l d i s t r u s t o f g o o d w ill and th e knowledge th a t i t
has been w id ely used to c a p ita liz e ex ag g erate d e x p e c ta
tio n s o f f u tu r e ea rn in g s le av e an alm o st u n iv e rs a l
31
Yang, op. c i t . , p. 78.
32
H. E. G regory, A ccounting R eports in B usiness
Management (New York: The Ronald P ress Company, 1928),
p. 182.
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75
f e e lin g t h a t th e b a la n c e s h e e t looks s tro n g e r w ith o u t
i t . When a c tu a l c o n s id e ra tio n has been p a id f o r good
w ill, i t sh o u ld ap p ear on th e company’s b a la n c e s h e e t
long enough to c r e a te a re c o rd o f t h a t f a c t in th e
h is to r y o f th e company as p re se n te d in th e s e r i e s o f
i t s an n u a l r e p o r ts . A fte r t h a t , nobody seems to r e g r e t
i t s d isa p p e a ra n c e when accom plished by m ethods w hich
f u lly d is c lo s e th e c irc u m s ta n c e s .^3
One a u th o r o f a v e ry im p o rtan t a r t i c l e who advo
c a te s th e a m o rtiz a tio n o f g o o d w ill i s an a tto rn e y , R obert H.
N elson. Mr. N elson, in a d d itio n to h is le g a l background,
has been s t a f f a c c o u n ta n t w ith P eat, Marwick, M itc h e ll
and Co. In h is d is c u s s io n o f th e a m o rtiz a tio n o f g o o d w ill.
Nelson r e f e r s to th e Momentum Theory o f G oodw ill. The
Momentum Theory i s th a t a b u y er o f a b u s in e s s p u rch ases a
p ro m o tio n al push in l i e u o f an an n u ity and t h i s ’’p u sh ”
d is s ip a te s l i k e momentum.
In h is d is c u s s io n o f th e Momentum Theory, N elson
w rite s th e fo llo w in g ab o u t g o o d w ill:
G oodw ill i s about as f i c k l e as th e human n a tu r e o f
which i t is an a s p e c t. Some human h a b its a r e s tro n g ,
b u t custom er h a b it i s u s u a lly n o t one o f them. R eputa
tio n s fa d e from memory u n le s s th e r e p u ta tio n i s fed o r
re p le n is h e d by new f e a t s o r rem in d ers. F ic k le o r n o t,
i t is h ard to b u ild up, so th e buyer o f a concern w i l l
T. H. S anders, H. R. H a tfie ld , and U. Moore,
A Statem ent o f A cco-jnting P rin c ip le s (New York: American
I n s t i t u t e o f A ccountants, 1938), p. 14.
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76
o f te n pay a la rg e sum o f money f o r th e g o o d w ill. The
re a so n i s t h a t he w ants t h i s s t a r t i n g "push” in h is
new e n te r p r is e , r a th e r th a n to s t a r t f r e s h in a s im ila r
b u s in e s s and d ev o te such e f f o r t and money o v er a long
p e rio d o f tim e to develop such g o o d w ill, e s p e c ia lly
s in c e h is p r o f i t s a re li k e l y to be m eager u n t i l good
w i l l i s d ev elo p ed . A ccording to w hat I s h a l l c a l l th e
A nnuity Theory, th e buyer i s in v e s tin g in a s e r ie s o f
ex cess e a rn in g s - -an analogy to an in v estm en t in an
a n n u ity . But i s n 't i t o n ly on r a r e o c c a sio n s th a t t h i s
may be th e ca se ? A b e t t e r h y p o th e sis would seem to be
t h a t businessm en a re n o t b uyers o f a n n u itie s b u t b uyers
o f a m ark etin g o r p ro m o tio n al " p u s h ."
T his "push" w hich th e buyer re c e iv e s f o r h is in v e s t
ment in g o o d w ill i s n o t a c o n tin u a l, e v e r la s tin g one,
b u t r a th e r i t i s l i k e momentum o r a ru n n in g s t a r t . He
has to feed in new energy to keep from slow ing to a
s t a n d s t i l l . Thus a r is e s th e Mmnentum Theory w hich, i t
i s hoped, w i l l be d is tin g u is h e d from th e A nnuity
Theory. . . . The assum ption th a t an a s s e t may e x is t
in p e r p e tu ity i s v e ry r is k y , to say th e l e a s t . I t
fo llo w s t h a t th e in v estm en t ought to be charged a g a in s t
income o v er th e e s tim a te d l i f e o f th e momentum, th e
p e rio d d u rin g w hich i t w i l l be c o n trib u tin g i t s "push"
o r b e n e f i t. As a c o r o lla r y th e buyer sh o u ld n o t w r ite
o f f h is in v estm en t by a ch arg e d ir e c t to r e ta in e d e a rn
in g s , u n le s s an u n fo rtu n a te tu rn o f e v e n ts should w ipe
i t o u t. I t a ls o fo llo w s th a t th e in v e stm en t should n o t
be w r itte n o f f by a ch arg e to c a p i t a l s u r p lu s . The
money w hich i s s p e n t on g o o d w ill i s j u s t as good as
th e money sp e n t on p la n t and equipm ent, and th e r e p r e
s e n ta tio n (as to a s s e ts p u rch ased ) w hich i s p u t on th e
b a la n c e s h e e t sh o u ld be made a c c o r d i n g l y . 3*
Nelson concludes h is d is c u s s io n on th e Mcxnentum
Theory w ith p o lic y argum ents ad v o catin g th e w r ite - o f f o f
g o o d w ill:
34
Robert H. N elson, "The Momentum Theory o f Good
w i l l , " A ccounting Review, XXVIII (O ctober, 1953), 491-492.
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77
An argum ent may be made f o r th e a m o rtiz a tio n o f
p urchased "g o o d w ill" on th e ground t h a t such tre a tm e n t
w i l l b e t t e r e f f e c t u a te th e g e n e ra l p o lic y o f th e law
o f d iv id e n d s. T his o b je c tiv e m ight be s ta te d as th e
r e s t r i c t i o n o f d iv id e n d s to p r o je c t c r e d i to r s , s e n io r
s h a re h o ld e rs , and even ju n io r s h a re h o ld e rs . C re d ito rs ,
e s p e c ia lly , need p r o te c tio n , b ecau se a c o rp o ra tio n
enjoys lim ite d l i a b i l i t y .
I f purchased "g o o d w ill" be an in v estm en t in a s s e ts
which a re used up in th e p ro cess o f h e lp in g to produce
inccxae, th e n p a r t o f th e e a rn in g s w hich cane su b se
quent to th e p u rch a se w i l l be a r e tu r n o f in v estm en t.
To l e t th e s e e a rn in g s be p a id o u t as d iv id en d s i s to
pay d iv id e n d s o u t o f c a p it a l . I t i s su b m itted th a t
t h is i s in c o n s is te n t w ith th e p o lic y o f d iv id en d law.
The acco u n tin g p ro fe s s io n seems to have a r e s p o n s i
b i l i t y h e re . The re a so n is t h a t acco u n tin g p r a c tic e
c a r r ie s g re a t w eig h t w ith th e c o u r t s .
Change in P o s itio n Concerning
G oodw ill A m o rtizatio n
From th e v a rio u s o p in io n s p re s e n te d i t i s obvious
acc o u n ta n ts a re in c o n f l i c t co n cern in g th e a m o rtiz a tio n o f
g o o d w ill. However, a c c o u n ta n ts a re n o t o n ly in c o n f lic t
w ith each o th e r b u t some change t h e i r own p o s itio n s . For
exam ple, Finney in h is P rin c ip le s o f A ccounting: I n t e r
m ed iate, 1934 e d itio n , ta k e s one p o s itio n b u t in th e 1946
e d itio n o f th e same work, he is o f a d i f f e r e n t o p in io n .
In th e 1934 e d itio n , F inney s ta te d :
^ ^ I b i d . . pp. 498-499.
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78
W ritin g o f f g o o d w ill i s u n n ec essary and may even
be im proper. I f p r o f i t s have c o n tin u e d o r in c re a s e d ,
th e g o o d w ill v a lu e has n o t d im in ish e d ; to w rite o f f
th e g o o d w ill c r e a te s a s e c r e t r e s e r v e , u n d e r s ta tin g th e
n e t w orth and accum ulated p r o f i t s , a p ro ced u re t h a t may
be p r e ju d i c i a l to th e i n t e r e s t s o f s to c k h o ld e rs w ishing
to m arket t h e i r h o ld in g s . I f p r o f i t s have d im in ish ed
so much as to in d ic a te th a t th e g o o d w ill, once o f r e a l
v a lu e and p a id f o r , no lo n g e r e x i s t s , w ritin g o f f th e
acco u n t red u ces th e s u rp lu s s t i l l f u r t h e r .
In th e 1946 e d itio n o f th e same book, Finney makes
th e fo llo w in g comments :
In th e p a s t i t has u s u a lly been co n sid e re d p ro p e r
to c a rry perm anently as an a s s e t th e c o s t o f a p u r
chased g o o d w ill, even though th e p r o f i t s may have d e
c lin e d to a p o in t where g o o d w ill no lo n g e r e x i s t s .
Modem acc o u n tin g th e o ry , w ith i t s em phasis on th e
re c o rd in g o f c o s ts and c o s t e x p ir a tio n s , seems to be
in c lin in g somewhat in th e d ir e c tio n o f fa v o rin g th e
w ritin g o f f o f th e c o s t o f g o o d w ill w hich has l o s t i t s
potency as a p ro d u cer o f p r o f i t s . Ih e p r a c t i c a l d i f f i
c u lty l i e s in th e p o s s i b i l i t y t h a t , i f th e p r o f i t s a re
n o t s u f f i c i e n t to j u s t i f y c a rry in g th e g o o d w ill acco u n t,
th e s u rp lu s w i l l n o t be la rg e enough to p ro v id e f o r i t s
w r i te - o f f .
37
Finney changed h is p o s itio n from n o t am o rtizin g
g o o d w ill in th e 1934 e d itio n to a m o rtiz in g g o o d w ill in th e
1946 e d itio n .
A nother change in p o s itio n i s p re s e n te d by Mont
gomery. In h is s ix t h e d itio n o f A u d itin g Theory and
36
H. A. F inney, P rin c ip le s o f A ccounting :
m ed iate (New York: P re n tic e -H a ll, I n c ., 1934), p.
07
H. A. F inney, P rin c ip le s o f A ccounting:
m ed iate (New York: P te n tic e -H a ll, I n c ., 1946), p.
I n t e r -
317.
I n t e r -
385.
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79
P ra c tic e , Montgomery s t a t e s : " I t i s n o t th e p r a c tic e and
i t i s g e n e ra lly im p r a c tic a l to a tte m p t to d e p r e c ia te good
w i l l .
However, in th e se v e n th e d itio n , Montgomery s t a t e s :
"A m o rtizatio n o f g o o d w ill sh ould be charged to p r o f i t and
39
lo s s o r, i f m a te r ia l in amount, to earn ed s u r p lu s ."
Again i t ap p ears t h a t m odem ac co u n tin g th e o ry had
made a b reak th ro u g h .
A m o rtizatio n To R etain ed E arnings
I f p o s itiv e g o o d w ill i s t o be am o rtized , how sh o u ld
i t be h an d led ? Should th e am o rtized amount be charged o f f
to r e ta in e d e a rn in g s? Should t h i s amount be shown s e p a
r a t e l y in th e income sta te m e n t o r c l a s s i f i e d in th e o p e r
a tin g s e c tio n o f th e income sta te m e n t? S e v e ra l a c c o u n ta n ts
b e lie v e th a t g o o d w ill sh o u ld be am o rtized d i r e c t l y to a
su rp lu s ac co u n t. Among th e s e a c c o u n ta n ts a re Sherwood,
38
R. H. Montgomery, A u d itin g Theory and P ra c tic e
(6th ed. ; New York: Ih e Ronald P ress Company, 1940),
p . 498.
'3 0
R. K. Montgomery, N. J . L en h art, and A. R.
Je n n in g s, Montgomery * s A u d itin g (7 th e d .; New York : The
Ronald P ress Company, 1949), p. 295.
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80
Culey, and Montgcnnery. Montgomery in h is 1940 e d itio n o f
A uditing Theory and P ra c tic e s t a t e s th e fo llo w in g :
I f any ad ju stm en t in th e book amount o f goodw ill
i s made, th e o f f - s e t t i n g d e b it o r c r e d i t should be
to earn ed s u ^ l u s o r c a p i t a l s u r p lu s , w hiever is
a p p ro p riâ te .
Montgomery in th e 1949 e d itio n o f A u d itin g th eo ry
and P ra c tic e makes th e fo llo w in g comments :
A m o rtizatio n o f g o o d w ill sh o u ld be charged to
p r o f i t and lo s s o r, i f m a te r ia l in amount, to earned
s u rp lu s . A w r i te - o f f o f g o o d w ill w ith u n d isp u ted con
tin u in g v a lu e to c a p i t a l s u rp lu s i s o c c a s io n a lly
j u s t i f i e d . 41
Sherwood and Culey a re o f th e fo llo w in g o p in io n :
A w r ite down o f g o o d w ill sh o u ld be th ro u g h a charge
to s u rp lu s , n o t o p e ra tin g ex p en ses, as such a charge
has n o th in g to do w ith th e c o s t o f p roducing th e p ro d
u c t, w h atev er th a t p ro d u ct may b e.
A m o rtizatio n To Income
Ih e a t t i t u d e o f th o se who b e lie v e th a t am ortized
goodw ill sh o u ld be charged to c u r r e n t p r o f i t and lo s s is
40
Montgomery, op. c i t . , p . 273.
^^Montgomery, L en h art, and Je n n in g s, op. c i t . ,
p. 295.
F. Sherwood and R. T. Culey, A u d itin g Theory
and P rocedure (C in c in n a ti: South-W estern P u b lish in g Com
pany, 1940), pp. 205-206.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
81
p re se n te d by Paton in A ccountants Handbook, th i r d e d itio n ,
and Paton and L i t t l e t o n in An In tro d u c tio n to C o rp o rate
A ccounting S tan d a rd s.
Paton s t a t e s th e fo llo w in g :
I f i t w ere p o s s ib le to s e g re g a te th e s p e c ia l la y e r
o f e a rn in g s as r e a liz e d f o r which g o o d w ill re p re s e n ts
th e amount p a id , th e a m o rtiz a tio n ch a rg e would p ro p e rly
be a s s ig n a b le to such e a rn in g s. S ince th i s i s g e n e r
a l l y o u t o f th e q u e s tio n , th e p e rio d ic a m o rtiz a tio n
sh ould b e in c lu d e d in expenses.
W . A. Staub, who once serv ed as chairm an o f th e
Committee on A ccounting P rocedure, makes th e fo llo w in g
sta te m e n t :
I t i s d e s ir a b le t h a t th e a m o rtiz a tio n ch arg e be
s e t f o r th as a d e d u c tio n frcsn, o r a p p ro p ria tio n o f,
income a f t e r th e n e t income from o p e ra tio n s o f th e
p e rio d i s s h o w n .^
Paton and L i t t l e t o n make th e fo llo w in g comment:
Thus, pu rch ased g o o d w ill r e p re s e n ts an advanced
re c o g n itio n o f a d e b it f o r a p o rtio n o f income t h a t i s
expected to m a te r ia liz e l a t e r . I t fo llo w s th a t th e
amount expended f o r g o o d w ill sh ould be absorbed by
revenue c h a rg e s --d u rin g th e p e rio d im p lic it in th e com
p u ta tio n on w hich th e p r ic e p a id was b a se d —in o rd e r
th a t th e income n o t p a id f o r in advance may be m easured.
T his c o n c lu sio n i s su p p o rted by th e f a c t th a t th e r e i s
ample evidence in a v a ila b le b u sin e ss h i s t o r i e s to show
Paton, op. c i t . , p. 850.
^ S ta u b , op. c i t . , C hapter V III, p. 5.
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82
th a t e x tra o rd in a ry e a rn in g power can n o t be ex p ected
to p e r s i s t i n d e f in i te l y .
The p la n o f a m o rtiz a tio n sh ould be re a s o n a b le and
sh o u ld be based on a l l th e su rro u n d in g c irc u m s ta n c e s . I t
i s d e s ir a b le th a t th e a m o rtiz a tio n ch arg e be in c lu d e d w ith
th e o p e ra tin g ex p en ses.
Reasons For Not A m ortizing G oodw ill
When g o o d w ill has a c tu a lly d e c lin e d in v a lu e , i t i s
n o t n e c e ss a ry to re c o rd th a t d e c lin e in th e o p e ra tin g
a c c o u n ts. The p r o f it- a n d - lo s s re c o rd i s th e b e s t in d ic a
tio n o f th e e x is te n c e o f g o o d w ill. The f u tu r e e a rn in g p o s
s i b i l i t i e s o f th e firm can cau se th e v a lu e o f g o o d w ill to
f lu c tu a te .
The e x te n t to which g o o d w ill h as d e p re c ia te d is
in c a p a b le o f b ein g d eterm in ed a c c u ra te ly .
Goodwill has n o t d e c lin e d in v a lu e so long as th e
e a rn in g power o f th e firm c o n tin u e s. I t i s o v e rc o n se rv a -
t i v e to am o rtize g o o d w ill when i t has n o t d e c lin e d in v a lu e
below th e p ric e p a id f o r i t . To am o rtize g o o d w ill in such
45
W . A. Paton and A. C. L i t t l e t o n , An In tro d u c tio n
to C o rp o rate A ccounting S tandards (Chicago : American
A ccounting A sso c ia tio n , 1940), pp. 92-93.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
83
a c a se c r e a te s a s e c r e t r e s e rv e .
Reasons For A m ortizing G oodw ill
G oodw ill sh ould be am o rtiz ed as a means o f m atching
th e c o s t o f se c u rin g inccme a g a in s t income a c tu a lly r e
c e iv e d .
Most co n fu sio n on th e q u e s tio n o f a m o rtizin g good
w i l l can be tra c e d to th e word " v a lu e ." D e p re c ia tio n
ch arg es a re n o t made as an a tte m p t to show p re s e n t v a lu e .
D e p re c ia tio n acco u n tin g i s a system o f a c co u n tin g which
aims to d i s t r i b u t e th e c o s t o r o th e r b a s ic v a lu e o f
ta n g ib le c a p i t a l a s s e ts , l e s s sa lv a g e ( i f an y ), over
th e e s tim a te d u s e fu l l i f e o f th e u n i t in a s y s te m a tic
and r a t i o n a l m anner.
I t i s a p ro cess o f a llo c a tio n , n o t v a lu a tio n . G oodw ill
a m o rtiz a tio n ch arg es a re o f th e same n a tu re . The f a c t t h a t
th e v a lu e o f p la n t a s s e ts o r th e g o o d w ill has in c re a s e d
d u rin g th e y e a r i s b e s id e th e p o in t. This in c re a s in g o f
v a lu e s does n o t e lim in a te th e n eed f o r d e p re c ia tio n ch arg es
on p la n t a s s e ts and th e a m o rtiz a tio n o f g o o d w ill.
I t h as been argued t h a t i t i s im p o ssib le to d e t e r
m ine a p ro p e r method f o r a m o rtiz in g g o o d w ill becau se th e
46
A ccounting R esearch B u l le t in No. 43, p . 76.
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84
d e c lin e in g o o d w ill i s in c a p a b le o f b ein g d eterm in ec a c cu
r a t e l y . The same i s tr u e f o r a l l p la n t a s s e t s . P r a c t i
c a lly a l l c o s t and income m atching item s a re b ased on
e s tim a te s . I f a d if f e r e n c e e x i s ts , i t i s one o f d eg ree,
and n o t o f k in d .
Stm Tm ary
I t h as been p o in te d out th a t th e excess o f c o s t
over book v a lu e may be th e r e s u l t s o f th e fo llo w in g :
1. U n d e rc a p ita liz a tio n o f a s s e ts on th e books o f
th e s u b s id ia r y . These a s s e ts , e s p e c ia lly p la n t
and equipm ent, have a m arket v a lu e w hich i s in
excess o f th e book v a lu e a t th e d a te o f a c q u i
s i t i o n . E rro rs o f acco u n tin g p r in c ip l e may
have been ccsnm itted by th e s u b s id ia r y ; f o r
exam ple, ex cess d e p re c ia tio n co u ld have been
reco rd ed o r c a p i t a l e x p e n d itu re s co u ld have
been charged o f f as expenses.
2. Ih e e x tra o rd in a ry ea rn in g power o f th e s u b s id i
a ry . In t h i s c a se , th e e a rn in g power i s re c o g
n iz e d as tr u e g o o d w ill.
3. The c o s t in c u rre d d u rin g an in f la t io n a r y p e rio d .
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
85
4 . A premium p a id to a c q u ire c o n tr o l o f th e
s u b s id ia ry .
When th e c o s t i s le s s th a n th e book v a lu e , th e low
c o s t may be th e r e s u l t s o f th e fo llo w in g :
1. A b a rg a in p u rch ase by th e p a re n t company.
2 . O v erv alu atio n o f a s s e ts on th e s u b s id ia r y 's
books. T his o v e rv a lu a tio n i s th e r e s u l t o f a
d e c lin e in th e c u r r e n t v a lu e o f th e in d iv id u a l
a s s e ts , in a d e q u a te d e p re c ia tio n c h a rg e s, o r
im proper a c co u n tin g p r a c tic e s .
3 . Hie low e a rn in g power o f th e s u b s id ia r y . In
t h i s case th e d if fe re n c e i s r e f e r r e d to as
n e g a tiv e g o o d w ill.
I t i s th e a c c o u n ta n t's r e s p o n s i b ilit y to an aly ze
th e d i f f e r e n t i a l betw een c o s t and book v a lu e , w hich w i l l
a s s i s t in th e p ro p er c l a s s i f i c a t i o n o f t h i s d i f f e r e n t i a l on
th e c o n s o lid a te d b alan ce s h e e t.
Hie n e x t d i f f i c u l t y , however, i s d e te rm in in g i f
g oodw ill i s an a s s e t. The m a jo rity o p in io n i s b ased on th e
id e a th a t th e goodw ill a c q u ire d i s q u ite d i s t i n c t from th e
g o o d w ill w hich re p re s e n ts th e s k i l l and e f f ic ie n c y o f th e
new owner and management. T h erefo re, th e new g o o d w ill
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86
ac q u ired sh o u ld be re c o rd e d as an a s s e t so t h a t th e e f f e c
tiv e n e s s o f th e new management may be p ro p e rly m easured,
by th e r a t e o f e a rn in g s on th e t o t a l re s o u rc e s n o t d i r e c t l y
c o n trib u te d by th e management i t s e l f .
Seme w r ite r s do n o t b e lie v e th a t g o o d w ill is an
a s s e t. T h eir view s a r e based on th e b e l i e f t h a t s in c e th e
p r e s e n ta tio n o f g o o d w ill on th e b a la n c e s h e e t len d s i t s e l f
to v a rio u s a l t e r n a t i v e m ethods, th e u s e fu ln e s s o f th e
f in a n c ia l r e p o r ts i s d e stro y e d b ecau se th e in fo rm a tio n
r e l i e d on by th o s e who need th e f in a n c ia l s ta te m e n ts i s
d i s t o r t e d .
At th e same tim e, sh ould g o o d w ill be tr e a te d as a
d ir e c t w r ite - o f f to r e ta in e d e a rn in g s? Most a u t h o r it ie s
b e lie v e th a t i t sh o u ld n o t be a d i r e c t w r i t e - o f f . I t has
been p o in te d o u t t h a t s e v e r a l erroneous im p lic a tio n s a re
p o s s ib le i f g o o d w ill i s c o n sid e re d a d i r e c t w r i te - o f f .
These im p lic a tio n s su g g e st th a t g o o d w ill i s n o t an expense,
a d iv id e n d , a g i f t , c a p i t a l c o n tra c tio n , o r c o r r e c tio n o f
p r io r y e a r s ’ incom e. T h erefo re th e d ir e c t w r i te - o f f o f
g o o d w ill to r e ta in e d ea rn in g s would c a s t g ra v e m isg iv in g s
on th e s u i t a b i l i t y o f such a ch arg e to r e ta in e d e a rn in g s .
The d if fe re n c e s in th e co n cep ts o f g o o d w ill have
r e s u lte d in d if fe re n c e s in th e tre a tm e n t o f g o o d w ill as
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87
e i th e r an a s s e t to be charged to r e ta in e d ea rn in g s o r to
o p e ra tio n s . One re a so n f o r a d if f e r e n c e in concepts i s a
r e s u l t o f th e d if f e r e n c e in d e b it d i f f e r e n t i a l . The t r a d i
t i o n a l tre a tm e n t o f th e d e b it d i f f e r e n t i a l betw een c o s t and
book v a lu e may be sunm arized as fo llo w s :
1. A d e d u c tio n from r e ta in e d e a rn in g s . This
m ethod i s n o t a c c e p te d by m ost firm s nor by
th e AICPA.
2. G oodw ill.
3. A c a p tio n e n t i t l e d Excess o f C ost Over Book
V alue o f Stock P urchased. îto s t a u th o rs en d o rse
t h i s m ethod.
The tre a tm e n t o f th e c r e d i t d i f f e r e n t i a l between
c o s t and book v a lu e may be sum m arized as fo llo w s :
1. "N eg ativ e g o o d w ill" to b e o f f s e t a g a in s t r e
corded g o o d w ill, i f any.
2 . A c r e d i t to c a p i t a l s u r p lu s . This pro ced u re
i s n o t now c o n sid e re d a c c e p ta b le .
3 . P re sen te d in th e s to c k h o ld e rs e q u ity s e c tio n o f
th e c o n s o lid a te d b a la n c e s h e e t as "Ekcess o f
Book V alue Over C ost o f S u b sid ia ry S to ck ."
Once th e p ro p e r tre a tm e n t o f th e d i f f e r e n t i a l on
th e c o n s o lid a te d b a la n c e s h e e t has been d eterm in ed , th e
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
88
n e x t problem i s d eterm in in g w hether th is g o o d w ill sh ould be
am o rtized . Proponents o f n o t a m o rtizin g g o o d w ill su p p o rt
t h e i r view s in t h i s m anner. They would h o ld i t n o t n e c e s
s a ry to re c o rd th e d e c lin e o f g o o d w ill in th e o p e ra tin g
acco u n ts becau se th e p r o f it- a n d - lo s s re c o rd i s th e b e s t
in d ic a tio n o f th e e x is te n c e o f g o o d w ill. I t i s o v e r
c o n s e rv a tiv e to am o rtize g o o d w ill when i t has n o t d e c lin e d
in v a lu e below th e p r ic e p a id f o r i t . Such a s i t u a t i o n
c r e a te s a s e c r e t r e s e rv e . Ih e com putation o f th e a m o rtiz a
tio n o f g o o d w ill cannot be d eterm in ed a c c u r a te ly .
The prop o n en ts o f a m o rtiz in g g o o d w ill p r e s e n t th e
fo llo w in g argum ents : A m ortizing g o o d w ill cem p lies w ith th e
co n cep t o f m atching c o s t w ith rev en u e. I t i s c o n s e rv a tiv e
to am o rtize g o o d w ill and i t i s no more d i f f i c u l t to d e t e r
m ine a s u it a b le method to a m o rtize g o o d w ill th a n i t i s to
d eterm in e a s u it a b le and a c c u ra te method to d e p r e c ia te
p la n t a s s e ts .
Ih e momentum th e o ry was p re se n te d as s u p p o rt f o r
th e argum ent o f a m o rtiz in g g o o d w ill. I h is th e o ry c o n ta in s
th e concept th a t a p ro m o tio n al push, in l i e u o f an an n u ity ,
i s a c q u ire d w here a b u sin e ss i s p u rchased, and t h i s push
d is s ip a te s l ik e momentum.
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89
Scrae a c c o u n ta n ts b e lie v e t h a t th e am o rtized p o rtio n
of g o o d w ill sh o u ld b e a charge to s u rp lu s becau se such a
charge has n o th in g to do w ith th e c o s t o f producing th e
p ro d u c t. O ther a c co u n ta n ts b e lie v e t h a t th e am o rtized p o r
tio n sh ould be in c lu d ed in th e o p e ra tin g expense s e c tio n
and deducted from rev en u es.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
CHAPTER IV
ILLUSTRATIVE EFFECTS O N USERS O F VARIOUS
ACCOUNTING TREATM ENTS OF GOODW ILL IN
CONSOLIDATED FINANCIAL REPORTS
A ccounting, an in d is p e n s a b le to o l o f b u s in e s s , is
th e prim ary means o f accu m u latin g , m easuring and communi
c a tin g b u sin e ss d a ta . I t p ro v id e s f in a n c ia l and o p e ra tin g
in fo rm a tio n about th e a c t i v i t i e s o f an e n te r p r is e , f o r u se
in making d e c is io n s r e l a t i v e to f u tu r e p lan s and to c o n tro l
o f th e o p e ra tin g a c t i v i t i e s .
I f th e re a re d i f f e r e n t acco u n tin g tre a tm e n ts which
can be a p p lie d to one tr a n s a c tio n , and each i s ac c e p te d by
th e acco u n tin g p ro fe s s io n , th e r e s u lt in g f i n a n c ia l r e p o r ts
w ill p re s e n t th e re a d e r o f such sta te m e n ts w ith a w id ely
d i f f e r e n t f in a n c ia l p ic tu r e , th u s d is t o r ti n g any d e c is io n s
w hich can be made.
I t is n e c e ss a ry f o r ac co u n ta n ts to be s u f f i c i e n t l y
r i g i d to g iv e meaning to f i n a n c i a l r e p o rtin g and, a t th e
90
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91
same tim e, f l e x i b l e enough to p erm it changes when th e
c ircu m sta n ces so r e q u ir e . Ih e a c c o u n ta n t should be u n
b ia s e d in a l l r e la tio n s h ip s and r e f l e c t th e tr a n s a c tio n s in
a p ro p e r m anner.
C e rta in u s e rs o f f in a n c ia l s ta te m e n ts w i ll ap p ly
s p e c if ic r a t i o s . The r a t i o s in t h i s stu d y were s e le c te d on
th e b a s is o f th e more p e r tin e n t d e c is io n s made by th e u s e rs
o f such r e p o r ts .
The m ajor u s e rs o f f in a n c ia l sta te m e n ts a re manage
m ent, in v e s to r s , c r e d i to r s , em ployees, ta x in g ag e n cie s, and
governm ental re g u la to ry a g e n c ie s. Each w i l l be d isc u sse d
s e p a r a te ly in t h i s s e c tio n .
U sers o f th e R eports and th e Uses
They Make o f R eports
Management
Management d e s ir e s to o b ta in in fo rm a tio n in f in a n
c i a l sta te m e n ts which would a id th e d ecisio n -m ak in g p ro
c e s s , p a r t i c u l a r l y w ith re g a rd to th e p r o f i t a b i l i t y o f
proposed co u rses o f a c tio n . Management seek s in fo rm a tio n
f o r b e t t e r c o n tr o l, b e t t e r p o lic ie s co n cern in g s e llin g ,
p u rc h a sin g and fin a n c in g , and more e f f i c i e n t u t i l i z a t i o n
o f p la n t and equipm ent. Management i s concerned w ith
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92
e a rn in g a maximum r e tu r n on a l l a v a ila b le fu n d s—b o th th e
in v estm en ts made in th e b u s in e s s by th e sto c k h o ld e rs and
th e e a rn in g s l e f t in th e b u sin e ss f o r expansion o r o th e r
p u rp o se s.
In v e s to rs
In v e sto rs a re in te r e s te d in f in a n c ia l sta te m e n ts
th a t p ro v id e an in d ic a tio n o f th e changes in th e v a lu e o f
th e in v e stm e n t. Ih u s, n e t income becomes th e m a tte r o f
supreme im portance to th e in v e s to r . R eports a re th e c h ie f
b a s is on which th e y r e ly in d e c id in g between a l t e r n a t i v e
in v estm en ts a t any g iv en tim e. S to ck h o ld ers a re a ls o
in te r e s te d in th e n e t v a lu e o f th e a s s e ts , th e p re s e n t and
e s tim a te d f u tu r e e a rn in g s, and th e in d eb ted n ess w hich has
p r io r claim s to income.
C re d ito rs
C re d ito rs a re p rim a r ily in te r e s te d in th e l i q u i d i t y
o f th e firm to w hich i t le n d s - - th e a b i l i t y o f th e firm to
m eet i t s o b lig a tio n s as th e y m atu re. Thus, ac co u n tin g
s ta te m e n ts which em phasize b a la n c e sh e e t v a lu a tio n s would
be o f g r e a te r s ig n if ic a n c e to t h i s group. Some c r e d i t o r s ,
i . e . , th e bondholders who lo a n funds to a b u sin e ss on
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93
a lo n g -term b a s is , a r e concerned w ith th e s a f e ty o f b o th
th e p r in c ip a l and i n t e r e s t on th e in d e b te d n e ss and th e
p ro sp e c ts o f f u tu r e e a rn in g s and grow th o f th e b u s in e s s .
Employees
Employees a re in te r e s te d in o b ta in in g t h e i r sh a re
o f e n te r p r is e p r o f i t s w hich a re th e r e s u l t o f m atching
e n te r p r is e e f f o r t s w ith accom plishm ents. Employees a re
a ls o concerned w ith th e grow th and s t a b i l i t y o f a company.
These em ployees a re concerned w ith d e te rm in in g i f they
would lik e to rem ain w ith a p a r t i c u l a r company u n t i l r e
tire m e n t .
Taxing A gencies
The o b je c tiv e o f ta x in g a g e n c ie s i s to c o l le c t th e
revenue e q u ita b ly and to p ro v id e in c e n tiv e s to s tim u la te
th e economy.
Governm ental R eg u lato ry A gencies
Ih e se a g e n c ie s a re concerned w ith p ro te c tin g th e
p u b lic from e x p lo ita tio n by m onopolies w h ile , a t th e same
tim e, p e rm ittin g in v e s to rs in such m onopolies to earn a
f a i r r e tu r n . Such a g en cies a re a ls o concerned w ith
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9 4
p ro te c tin g th e p u b lic from b ein g charged f o r i n e f f i c i e n t
o p e ra tio n s .
S e le c te d R a tio s and Form ulas
Among th e fo rm u las consnonly u se d , th e fo llo w in g a re
th e ones r e l i e d upon by th e a cc o u n ta n t, e s p e c ia lly in i n
sta n c e s where g o o d w ill in flu e n c e s th e method o f acc o u n t
ancy.
Ratio
R a tio o f n e t income to
n e t s a le s
R ate earned on t o t a l
a s s e ts
R a tio o f n e t s a le s to
t o t a l a s s e ts
R atio o f sto c k h o ld e rs*
e q u ity to t o t a l
l i a b i l i t i e s
Book Value p e r s h a re o f
common sto c k
Per c e n t o f n e t income
to sto ck h o ld ers* e q u ity
Net income p e r s h a re o f
common sto c k (e a rn in g s
p e r sh a re )
Form ula
Net Income A fte r Income Taxes
Net S a les
Net Income A fte r Income Taxes
T o ta l A sse ts
Net S ales
T o ta l A ssets
S to ck h o ld ers * E quity
T o tal L i a b i l i t i e s
Common Stock P lus R etain ed E am -
ings Plus Paid in C a p ita l________
Number o f S hares o f Common Stock
Net Income A fte r Income Taxes
Stockholders* E quity
Net Income A fte r Income Taxes
Minus D ividend R equirem ents on
P re fe rre d S t o c k _______________
Number o f S hares o f Common Stock
O utstanding
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95
Rate earned on common
sto c k h o ld e rs * e q u ity
Stock e q u ity - a s s e t r a t i o
R atio o f sto c k h o ld ers*
e q u ity to fix e d a s s e ts
le s s d e p re c ia tio n
R atio o f n e t s a le s to
fix e d a s s e ts le s s
d e p re c ia tio n
Times Bond I n t e r e s t
Earned
Net Income A fte r Income Taxes
Minus D ividend Requirem ents on
P re fe rre d Stock______________ __
Common S to c k h o ld e rs * E quity
T o tal A ssets
S tockholders * E quity
Fixed A ssets (N et)
Net S ales
Fixed A ssets (N et)
Net Income
Bond I n t e r e s t R equirem ent
R atio o f Net Income to Net Sales
The r a t i o o f n e t income to n e t s a le s m easures th e
r a t e o f r e tu r n on n e t s a le s and i s fre q u e n tly used as a
m easure o f m a n a g e ria l e f f ic ie n c y and p r o f i t a b i l i t y . This
r a t i o re v e a ls th e p ro fita b le n e s s o f th e s a l e s , th a t i s , th e
p ro fita b le n e s s o f th e buying, m an u fa ctu rin g , and s e llin g
o p e ra tio n s o f th e b u s in e s s . The r a t i o in d ic a te s th e number
of c e n ts th a t rem ain a f t e r a l l c u rre n t o p e ra tin g c o s ts and
expenses have been d educted from th e s a le s d o l la r . Gener
a lly , th e h ig h e r th e r a t e o f r e tu r n on s a le s th e more
s a t is f a c to r y th e o p e ra tio n o f th e b u s in e s s .
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96
R ate Earned on T o ta l A ssets
The r a t i o o f n e t income to t o t a l a s s e ts m easures
th e r a t e o f r e tu r n on a s s e ts employed. This r a t i o r e f l e c t s
th e econcmic p r o d u c tiv ity o f th e funds in v e s te d in th e
b u sin e ss and i s an o v e r - a ll m easure o f th e e f f ic ie n c y o f
th e b u s in e s s . I t i s a ls o used in e v a lu a tin g proposed
c a p ita l e x p e n d itu re s .
R atio o f Net S ales to T o tal A ssets
Ih e r a t i o o f n e t s a le s to t o t a l a s s e ts m easures th e
e f f e c tiv e u se o f a s s e ts in making s a le s . A low r a t i o in
com parison w itn p r i o r y ears in d ic a te s t h a t th e a s s e ts a re
too g re a t f o r th e s a le s volume.
R atio o f S to ck h o ld ers* E quity to
T o ta l L i a b i l i t i e s
The r a t i o o f sto ck h o ld ers* e q u ity to t o t a l l i a b i l i
t i e s m easures th e p o r tio n o f c a p i t a l fu rn is h e d by s to c k
h o ld e rs and fu rn is h e d by c r e d ito r s . The more c a p i t a l th e
sto c k h o ld e rs p ro v id e , th e g r e a te r th e p r o te c tio n t h a t i s
re c e iv e d by th e c r e d i to r s .
Book V alue p e r Share o f Common Stock
Book v a lu e p e r sh a re o f sto c k i s used to m easure
th e f in a n c ia l s tr e n g th o f each sh a re of s to c k . This r a t i o
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97
re p re s e n ts th e amount each sh a re would r e c e iv e in ca se o f
liq u id a tio n i f th e a s s e ts w ere s o ld f o r e x a c tly th e book
v a lu e . A lthough an in c re a s e in c a p i t a l s to c k and r e ta in e d
earn in g s d en o tes t h a t th e t o t a l n e t w o rth h as in c re a s e d ,
t h i s in c re a s e does n o t n e c e s s a r ily mean an in c re a s e in th e
v a lu e o f in d iv id u a l s to c k h o ld in g s . I h is in c re a s e in n e t
w orth could have been caused by th e a d d itio n a l iss u a n c e o f
sto c k . T h erefo re, i t i s b e s t to d eterm in e th e book v a lu e
o f each sh a re o f s to c k .
In com puting th e book v a lu e o f comnon s to c k when
more th an one c la s s o f sto c k is o u ts ta n d in g , th e r ig h ts o f
th e v a rio u s c la s s e s o f sto c k must be ta k en in to c o n s id e r
a tio n in com puting th e book v a lu e o f each. Any b a la n c e o f
s to c k h o ld e rs ' e q u ity rem aining a f t e r th e book v a lu e o f
p re fe rre d as computed i s d iv id e d by th e ccmmon s h a re s .
Per Cent o f Net Income to S to c k h o ld e rs'
E q u ity
The purpose o f th i s r a t i o i s to m easure th e r a t e o f
r e tu r n on th e in v e s te d c a p i t a l . T his r a t i o i s ex trem ely
im p o rta n t in m easuring p r o f i t a b i l i t y . A h ig h r a t i o i n d i
c a te s e f f i c i e n t management, e x c e lle n t f i n a n c i a l and p ro d u c
tio n a c t i v i t i e s .
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98
Net Income p e r S hare o f Conmon Stock
(E arnings p e r S h are)
E arnings p e r sh a re o f common s to c k m easure th e
amount o f p r o f i t a c cru in g to each s h a re o f sto c k owned.
The e a rn in g s p e r s h a re a re o f s ig n if ic a n c e to th e s to c k
h o ld e r when compared to h is in v e stm en t in th e sh a re o f
sto c k and th e m ark et v a lu e o f h is s h a re .
R ate Earned on Net S ales
The r a t i o o f n e t income to n e t s a le s m easures th e
r a t e o f r e tu r n on n e t s a le s and i s f re q u e n tly used as a
m easure o f m a n a g e ria l e f f ic ie n c y and p r o f i t a b i l i t y . The
h ig h e r th e r a t e o f r e tu r n on s a le s , th e more s a t i s f a c to r y
i s th e o p e ra tio n o f th e b u s in e s s .
R ate Earned on Common Stockholders* E q u ity
The r a t e earn ed on coimnon sto c k h o ld e rs* e q u ity
m easures th e r a t e o f ea rn in g power on th e p r o p rie ta r y i n
v estm en t. The r i g h t s o f th e v a rio u s c la s s e s o f sto c k m ust
be ta k e n in to c o n s id e ra tio n in com puting th e book v a lu e o f
each.
Stock E q u ity -A sse t R atio
This r a t i o m easures th e p o r tio n o f t o t a l c a p i t a l
provided by th e sto c k h o ld e rs a g a in s t p o s s ib le lo s s e s .
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99
C re d ito rs a re v ery in te r e s te d in th i s cu sh io n (which i s
p ro v id ed by sto ck h o ld ers* e q u ity ) a g a in s t lo s s e s .
R a tio o f S tockholders* E quity to Fixed
A ssets (n e t)
The r a t i o o f sto c k h o ld e rs* e q u ity to fix e d a s s e ts
m easures th e p o s s i b i l i t y o f an over in v estm en t in fix e d
ta n g ib le a s s e ts . This r a t i o a ls o in d ic a te s w h eth er expan
s io n i s ta k in g p la c e th ro u g h borrow ing o r th ro u g h an i n
c re a s e in owners* e q u ity .
R atio o f Net S ales to F ixed A ssets (n e t)
This r a t i o , o f te n r e f e r r e d to as th e fix e d a s s e t
tu rn o v e r r a t i o , m easures th e e f f ic ie n c y o f management in
i t s u t i l i z a t i o n o f c a p i t a l in v e s te d in fix e d a s s e t s . The
h ig h e r th e r a t i o , th e more in te n s iv e ly th e fix e d a s s e ts a re
b ein g u sed .
R a tio o f Net P r o f it to T o ta l T angible A ssets
Net p r o f i t (b e fo re i n t e r e s t c h a rg e s) may a ls o be
r e la te d to t o t a l borrow ed and owned c a p i t a l by d iv id in g n e t
p r o f i t b e fo re i n t e r e s t ch arg es by t o t a l l i a b i l i t i e s and
n e t w o rth . This r a t i o , w hich shows th e n e t r e tu r n on t o t a l
borrowed and owned c a p i t a l employed, r e f l e c t s th e economic
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100
p r o d u c tiv ity o f th e funds in v e s te d in th e b u s in e s s and is
an o v e r - a l l m easure o f e f f ic ie n c y o f th e b u s in e s s .
R a tio o f S tockholders* E quity to
T o ta l E q u itie s
T his r a t i o m easures th e p o rtio n o f t o t a l c a p ita l
p ro v id ed by th e sto c k h o ld e rs a g a in s t p o s s ib le lo s s e s .
C re d ito rs a re p a r t i c u l a r l y in te r e s te d in t h i s cu sh io n
a g a in s t lo s s e s provided by th e sto c k h o ld e rs* e q u ity . Frcm
th e v ie w p o in t o f th e c r e d i to r s , th e h ig h e r th e r a t e o f
e q u ity , th e more p r o te c tio n th e c r e d ito r s have a g a in s t
l o s s e s .
Times Bond I n te r e s t Earned
The number o f tim es bond i n t e r e s t i s earned m easures
th e m arg in o f s a fe ty th a t n e t income p ro v id e s f o r th e r e
q u ire d bond i n t e r e s t paym ents.
I l l u s t r a t i v e Data
For th e purposes o f i l l u s t r a t i n g th e e f f e c ts o f
r a t i o s computed from c o n s o lid a te d sta te m e n ts on th e u s e rs
o f such sta te m e n ts , i t w i l l be assumed t h a t company "P"
p u rch ased , on January 1, 1965, 100 p e r c e n t o f ccmpany "S”
and p o s it iv e goodw ill o f $100,000 r e s u lt e d . The e f f e c ts
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101
o f n e g a tiv e g o o d w ill w i l l a ls o be i l l u s t r a t e d by assum ing
th e p u rch ase r e s u lt e d in n e g a tiv e g o o d w ill o f $100,000.
Condensed f in a n c ia l sta te m e n ts one y e a r a f t e r
a c q u is itio n a re shown in th e fo llo w in g p ag e s.
A n aly sis of E ffe c ts
The R atio o f Net Income to Net S ales
The r a t i o o f n e t income to n e t s a le s i s fre q u e n tly
used as a m easure o f m a n ag eria l e f f ic ie n c y and p r o f i t a
b i l i t y . Ih e h ig h e r th e r a t e of r e tu r n on s a le s , th e more
s a tis f a c to r y i s th e o p e ra tio n o f th e b u s in e s s . I t appears
th a t th e o p e ra tio n s a r e more s a ti s f a c t o r y and a more e f f i
c ie n t management e x i s ts when p o s itiv e g o o d w ill i s n o t
am o rtized . When a company has n e g a tiv e g o o d w ill, i t
appears th e management i s more e f f i c i e n t i f th e n e g a tiv e
g o o d w ill i s re c o rd e d as a d e fe rre d c r e d i t and w r itte n o f f
to income. In b o th c a s e s , however, management * s r e a l e f f i
cien cy is th e same. The method o f re c o rd in g a b u sin e ss
tr a n s a c tio n sh ould n o t determ in e th e e f f ic ie n c y o f p e rso n
n e l and th e p r o f i t a b i l i t y o f o p e ra tio n s . T able 1 g iv es th e
a n a ly s is o f th e e f f e c t s o f v a rio u s a c co u n tin g tre a tm e n ts on
c e r ta in r a t i o s im p o rta n t to u s e rs o f c o n s o lid a te d f in a n c ia l
r e p o r t s .
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
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COMPANY "P" AND SUBSIDIARY COMPANY "S"
CONSOLIDATED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1965
Goodwill
Not Amortized
If Goodwill
is Amortized
Over 20 Years
If Negative Goodwill
is Amortized to
Income Over 20 Years
Net sales $1,000,000 $1,000,000 $1,000,000
Cost of goods sold 650.000 650.000 650.000
Gross profit on sales 350,000 350,000 350,000
Selling general and other expense 270.000 275.000* 270.000
Net income from operations 80,000 75,000 80,000
Negative goodwill amortized to income 5.000
85,000
Income taxes (40%) 32.000 30.000 34.000
Net income after income taxes 48,000 45,000 51,000
Dividends paid 35.000 35.000 35.000
Net increase in retained earnings 13,000 ' 10,000 16,000
^Selling general and other expense of $275,000 includes $5,000 of amortized goodwill.
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COMPANY "P" AND SUBSIDIARY COMPANY "S"
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1965
Goodwill
Not Amortized
If Goodwill
is Amortized
Over 20 Years
If Negative Goodwill
is Amortized to
Income Over 20 Years
Assets
Cash $ 80,000 $ 80,000 $ 80,000
Trade notes and accounts receivable
(net) 320,000 320,000 320,000
Merchandise inventory (cost) 400,000 400,000 400,000
Prepaid expenses 25,000 25,000 25,000
Plant and equipment (net) 760,000 760,000 760,000
Miscellaneous long-term deferrals 15,000 15,000 15,000
Goodwill 100,000 95,000 100,000
$1,700,000 $1,695,000 $1,700,000
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■ D
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8
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1
3
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COMPANY **P*' AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET-
COMPANY **S"
-Continued
Goodwill
Not Amortized
If Goodwill
is Amortized
Over 20 Years
If Negative Goodwill
is Amortized to
Income Over 20 Years
Liabilities and Capital
Trade notes and accounts payable $208,000 $208,000 $108,000
Wages, interest, dividends payable 50,000 50,000 50,000
Income taxes payable 32,000 32,000 32,000
Miscellaneous current liabilities 40,000 40,000 40,000
5% Bonds payable 300,000 300,000 300,000
Deferred revenues 20,000 20,000 20,000
Cost of investment less than
underlying assets 95,000
6% preferred stock, nonparticipating,
$100 par 200,000 200,000 200,000
Common stock, $50 par 500,000 500,000 500,000
Paid-in capital 162,000 162,000 162,000
Retained earnings 188,000 183,000 193,000
$1,700,000 $1,695,000 $1,700,000
TABLE 1
ANALYSIS OF THE EFFECTS OF VARIOUS ACCOUNTING TREJ!
IMPORTANT TO USERS OF CONSOLIDATED FIN/
Positive Goodwill
Included in Assets
and __
Amortized
Not
Amortized
To
Income
To
Retained
Earnings
Included
in Plant
Assets
(a) Ratio of stockholders' equity
to total liabilities
(b) Book value per share of common
stock
(c) Per cent of net income to
stockholders' equity
(d) Ratio of net income to net sales
(e) Rate earned on total assets
(f) Ratio of net sales to total
assets
(g) Net income per share of common
stock (earnings per share)
(h) Rate earned on common
stockholders' equity
(i) Stock equity-asset ratio
(j) Ratio of stockholders' equity
to fixed assets (net)
(k) Ratio of net sales to fixed
assets (net)
(1) Times bond interest earned
1.66:1
$85
4.6%
4.8%
2.8%
.58:1
$3.60
4.2%
61.8%
1.38:1
1.31:1
4.2
1.66:1
$84.70
4.3%
4.5%
2 . 6%
.58:1
$3.30
3.9%
61.2%
1.37:1
1.31:1
4
1.66:1
$84.70
4.3%
4.8%
2. 8%
.58:1
$3.60
4.3%
61.2%
1.37:1
1.31:1
4.2
1.66:1
$85
4.6%
4.8%
2. 8%
.58:1
$3.60
4.2%
61.8%
1.22:1
1.16:1
4.2
Reproduced with permission of the copyright owner. Further reproduction prohibited without
permission.
TABLE 1
105
DUS ACCOUNTING TREATMENTS ON CERTAIN RATIOS
F CONSOLIDATED FINANCIAL REPORTS
odwill Negative Goodwill
Included
in Plant
Assets
Write-off
Immediately
After
Acquisition
Carried as
Deferred Credit
Not Amortized
Amortized to
Income
Shown in the
Stockholders'
Equity
Section
Offset
Against
Positive
Goodwill
1.66:1 1.51:1 1.66:1 1.68:1 1.82:1 1.66:1
$85 $75 $84.70 $85.30 $84.70 $84.70
4.6% 5.1% 4.6% 4.8% 4.2% 4.6%
4.8% 4.8% 4.8% 5.1% 4.8% 4.8%
2.8% 3.0% 2.8% 3.0% 2.8% 2.8%
.58:1 .625:1 .58:1 .58:1 .58:1 .625:1
$3.60 $3.60 $3.66 $3.90 $3.90 $3.90
4.2% 4.8% 4.2% 4.6% 4.2% 4.2%
61.8% 59.4% 61.8% 61.9% 67.6% 65.6%
1.22:1 1.25:1 1.38:1 1.38:1 1.51:1 1.38:1
1.16:1 1.31:1 1.31:1 1.31:1 1.31:1 1.31:1
4.2 4.2 4.2 4.4 4.2 4.2
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permission.
106
R ate Earned on T o ta l A sse ts
R ate earned on t o t a l a s s e ts i s an im p o rta n t to o l in
ju d g in g m an ag erial perform ance, in m easuring th e e f f e c t i v e
n ess o f a s s e ts employed, and in e v a lu a tin g proposed c a p i t a l
e x p e n d itu re s . I t ap p ears t h a t th e management i s le s s
e f f i c i e n t i f p o s itiv e g o o d w ill i s am o rtized to n e t income.
These r e s u l t s a re more s t a r t l i n g i f n e t income b e fo re ta x e s
i s u sed in s te a d o f n e t income a f t e r ta x e s . Management
ap p ears q u ite e f f i c i e n t i f th e d i r e c t w r i te - o f f method is
u se d . In th e ca se o f n e g a tiv e g o o d w ill, management appears
more e f f i c i e n t i f n e g a tiv e g o o d w ill i s am o rtized to income.
Again th e r e s u lt s would ap p e a r to make management more
e f f i c i e n t i f n e t income b e fo re ta x e s w ere u se d . Manage
ment * s r e a l e f f ic ie n c y i s n o t a f f e c te d by th e u se o f e i t h e r
m ethod.
The R a tio o f Net S ales to T o ta l A ssets
The r a t i o o f n e t s a le s to t o t a l a s s e ts m easures th e
e f f e c t iv e u se o f a s s e ts in making s a le s . A ssets t h a t a re
n o t u sed in producing s a le s , p rim a rily in v e stm e n ts, a re
e lim in a te d from t o t a l a s s e t s .
The h ig h e r th e r a t i o th e more e f f e c t iv e ly th e
a s s e ts o f th e company a r e b ein g u sed . The aim o f t h i s
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107
r a t i o i s to make s u re t h a t th e grow th o f th e a s s e ts i s
accompanied by co rresp o n d in g in c re a s e s in s a l e s . A r a t i o
d ec re ase su g g e sts t h a t s a le s a re n o t keeping up w ith th e
changes in a s s e ts , an o v erin v e stm en t in a s s e ts . A r a t i o
in c re a s e may in d ic a te a b e t t e r u t i l i z a t i o n o f a s s e ts . I t
appears t h a t th e in m ed iate w r i te - o f f o f g o o d w ill and th e
d ed u ctio n o f n e g a tiv e g o o d w ill from p o s itiv e g o o d w ill i n d i
c a te s th e b e t t e r u t i l i z a t i o n o f a s s e ts by management.
Again t h i s te c h n iq u e i s m isle a d in g because o f th e a l t e r n a
t i v e m ethods o f re c o rd in g th e same b u sin e ss tr a n s a c tio n .
R atio o f S to c k h o ld e rs ' E quity to
T o ta l L i a b i l i t i e s
R atio o f sto c k h o ld ers* e q u ity to t o t a l l i a b i l i t i e s
in d ic a te s th e e x te n t o f " tra d in g on th e e q u ity ." This
p r a c tic e in v o lv e s th e employment o f borrow ed funds in th e
e x p e c ta tio n t h a t a r a t e o f r e tu r n h ig h e r th a n th e c o s t w i ll
be r e a liz e d . The p r o te c tio n f o r th e income and p r in c ip a l
o f th e f ix e d - r e tu r n in v estm en t i s th e sto c k h o ld e rs* e q u ity .
Hie s to c k h o ld e rs lo s e when th e income on th e c a p i t a l i s
le s s th an c o s t. From th e i l l u s t r a t i o n p re se n te d in t h i s
stu d y , i t ap p e ars th e s to c k h o ld e rs a re n o t a f f e c te d by th e
method employed w ith th e ex c e p tio n o f th e im m ediate
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108
w r ite - o f f m ethod. Under t h i s method th e s to c k h o ld e rs a re
n o t as w e ll o f f as w ith th e o th e r m ethods.
Book V alue p e r Share o f Common Stock
Book v a lu e p er sh a re o f common sto c k i s ccanmonly
used to m easure f in a n c ia l s tr e n g th u n d e rly in g each sh a re o f
sto c k . Ih e r a t i o re p re s e n ts th e amount t h a t each sh a re
would re c e iv e in ca se o f liq u id a tio n i f th e a s s e ts were
s o ld f o r e x a c tly th e book v a lu e . In d eterm in in g th e book
v a lu e o f common sto c k , i t is n e c e s s a ry f i r s t to a s c e r ta in
th e p ro p o rtio n a te p a r t o f th e r e ta in e d e a rn in g s which
re p re s e n t e q u ity o f th e p re fe rre d s to c k h o ld e rs . The i l l u s
t r a t i o n in d ic a te s t h a t common sto c k h o ld e rs a r e in a more
fa v o ra b le p o s itio n i f g o o d w ill i s in c lu d ed in a s s e ts and
n o t am o rtized and a ls o i f n e g a tiv e g o o d w ill i s reco rd ed as
a d e fe rre d c r e d i t and w r itte n o f f to incom e.
Per Cent o f Net Income to S to c k h o ld e rs ' Equity
The p e r ce n t o f n e t income to s to c k h o ld e rs ' e q u ity
m easures th e r a t e o f r e tu r n on th e owners* in v estm en ts and
i s v ery im p o rtan t in m easuring p r o f i t a b i l i t y . A few
a n a ly s ts u s e only th e s to c k h o ld e rs ' e q u ity w hich appears
on th e b a la n c e sh e e t a t th e end o f th e y e a r. O ther a n a ly s ts
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109
ta k e in to c o n s id e ra tio n th e changes in th e sto c k o u ts ta n d
in g , d iv id en d paym ents, and o th e r e q u ity changes. T here
fo re th e s e a n a ly s ts ta k e an average o f th e b eg in n in g and
ending sto ck h o ld ers* e q u ity . A low r a t i o in d ic a te s th a t
th e b u sin e ss i s n o t v e ry s u c c e s s fu l b ecau se o f poor f in a n
c i a l , p ro d u ctio n o r s a le s management, o r g e n e ra l b u sin e ss
c o n d itio n s , o r o v e r-in v e stm e n t in a s s e ts . A h ig h r a t i o o f
n e t income to sto c k h o ld e rs* e q u ity may be a r e s u l t o f e f f i
c ie n t management, o r g e n e ra l b u sin e ss c o n d itio n s , o r tra d in g
on th e c r e d ito r s * fu n d s. The d ir e c t w r i te - o f f method o f
p o s itiv e g o o d w ill and th e a m o rtiz a tio n o f n e g a tiv e g o o d w ill
to income appear to r e f l e c t a more e f f i c i e n t management and
b e t t e r g e n e ra l b u s in e s s c o n d itio n s w h ile th e method of
re c o rd in g n e g a tiv e g o o d w ill in th e sto c k h o ld ers* e q u ity
s e c tio n and in c lu d in g p o s itiv e g o o d w ill in th e a s s e ts and
am o rtizin g i t to income ap p ear to in d ic a te le s s e f f i c i e n t
management.
Net Income p er Share o f Common Stock
Net income p e r s h a re o f common s to c k i s v e ry im por
ta n t to th e s to c k h o ld e r. A p ro s p e c tiv e s to c k h o ld e r would
th in k th a t th e $3.90 e a rn in g s p e r sh a re i s a v e ry good buy.
A lso, th e $3.60 e a rn in g s p e r sh a re ap p ears to be th e n e x t
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110
b e s t s to c k to in v e s t in . Yet th e e a rn in g s p e r sh a re on
t h i s s to c k a re th e same. The d if fe re n c e s a re produced
b ecau se o f v a rio u s acco u n tin g tre a tm e n ts .
Stock E q u itv -A sset R atio
Stock e q u ity - a s s e t r a t i o i s o f co n cern to c r e d i to r s .
They a r e concerned w ith th e cu sh io n th e sto c k h o ld e rs *
e q u ity p ro v id es a g a in s t lo s s e s . The c r e d ito r s would th in k
t h a t th e a m o rtiz a tio n o f g o o d w ill o r th e im m ediate w r i te
o f f p ro v id e s le s s o f a cu sh io n . T his would be an erro n eo u s
assum ption because th e cu sh io n p ro v id ed i s th e same in a l l
c a s e s .
R atio o f S tockholders* E quity to F ixed A sse ts (n e t)
and R a tio o f Net S ales to F ixed A ssets (n e t)
R a tio o f s to c k h o ld e rs ' e q u ity to fix e d a s s e ts (n e t)
and r a t i o o f n e t s a le s to fix e d a s s e ts (n e t) can make a
re a d e r o f a sta te m e n t t h a t in c lu d e s g o o d w ill in p la n t
a s s e ts th in k th a t management has o v e rin v e s te d in a s s e ts .
A lso, th e r a t i o o f n e t s a le s to fix e d a s s e ts can make th e
re a d e r th in k th a t management has n o t p ro p e rly u t i l i z e d
c a p i t a l in v e ste d in fix e d a s s e ts . However, management i s
e f f i c i e n t in b o th c a s e s .
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Ill
Times Bond I n t e r e s t Earned
Times bond i n t e r e s t earn ed could le a d a c r e d i to r to
th in k t h a t a firm t h a t in c lu d e s g o o d w ill in a s s e ts and
am o rtizes g o o d w ill p ro v id es le s s o f a m argin o f s a f e ty f o r
bond i n t e r e s t paym ents. However, th e m argin o f s a f e ty i s
th e same in a l l o f th e c a s e s .
L im ita tio n s o f C o n so lid ated S tatem ents
The u se o f a g g re g a te s may co n c eal im p o rta n t i n d i
v id u a l d if f e r e n c e s . The c o n s o lid a te d b a la n c e s do n o t
r e v e a l th e in a d e q u a te w orking c a p i t a l p o s itio n o f a su b
s id ia r y o r o f a p a re n t. From th e ccxnbined sta te m e n t a lo n e ,
a common o r p r e f e r r e d sto c k h o ld e r cannot t e l l w hat th e
q uick p o s itio n o f h is own company i s , how much cash i t h as,
o r th e amount o f r e ta in e d ea rn in g s a v a ila b le f o r d iv id e n d s.
The same m ajor account c l a s s i f i c a t i o n i s n o t f o l
lowed by a l l th e com panies o f th e c o n s o lid a tio n . Adver
t i s i n g expense co u ld be tr e a te d as a c u rre n t expense by one
company and as a d e fe rre d ch arg e by a n o th e r company. Such
a tre a tm e n t would d i s t o r t th e c o n s o lid a te d b a la n c e s h e e t
and th e c o n s o lid a te d p r o f i t and lo s s s ta te m e n t.
The a s s e ts o f a l l th e ccsnpanies c o n s o lid a te d m ight
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112
n o t be v a lu e d on th e same b a s is . I t i s v e ry d i f f i c u l t to
p la c e an i n t e r p r e t a t i o n on th e c o n s o lid a te d f ig u r e f o r
in v e n to rie s i f th e in v e n to rie s a re v alu ed on d i f f e r e n t
b a se s, f i r s t - i n , f i r s t - o u t , l a s t - i n , f i r s t - o u t .
C re d ito rs o f a p a re n t ccxnpany o r i t s s u b s id ia r ie s
a re handicapped by c o n s o lid a te d s ta te m e n ts . The p r in c ip a l
a s s e ts shown may n o t be th o s e o f th e company whose c r e d i
to r s th e y a r e . Even i f th e t o t a l a s s e ts a r e more th an
enough to m eet th e claim s o f th e r e s p e c tiv e u n d e rly in g com
p a n ie s, th e ex cess on liq u id a tio n m ight be d is t r ib u t e d to
o u ts id e p r e f e r r e d sto c k h o ld e rs o f a s u b s id ia ry and n o t
become a v a ila b le to th e c r e d ito r s o f th e p a r e n t company.
I t i s d i f f i c u l t on a c o n s o lid a te d s ta te n e n t to
e x p la in lie n s s a t i s f a c t o r i l y . There i s th e p o s s i b i l i t y
th a t a p a re n t company co u ld p led g e th e s to c k o f a w holly
owned s u b s id ia r y under i t s own c o l l a t e r a l n o te s o r bonds.
From c o n s o lid a te d sta te m e n ts alo n e , i t i s n o t p o s
s ib l e to t e l l w hich companies a re o p e ra tin g a t a p r o f i t and
which a t a lo s s . A h ig h ly p r o f it a b le company can cover up
th e lo s s o f an u n p r o f ita b le one.
The u se o f s t a t i s t i c s i s d i f f i c u l t and fre q u e n tly
m isle a d in g i f c o n s o lid a te d fig u re s alo n e a r e a v a ila b le .
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113
A re a d e r cannot o b ta in a l l o f th e im p o rta n t i n f o r
m ation in w hich he i s in te r e s te d from a c o n s o lid a te d
b a lan ce s h e e t. I t is n o t d e s ir a b le to subm it c o n s o lid a te d
sta te m e n ts a lo n e . To do so would le a d to an in co m p lete and
in a c c u ra te p ic tu r e o f th e f in a n c ia l p o s itio n and o p e ra tio n s
o f a p a re n t company and i t s s u b s id ia r ie s .
O bviously th e b e s t p ro ced u re i s to p re s e n t a con
s o lid a te d sta te m e n t accom panied by th e f i n a n c ia l sta te m e n ts
o f each s u b s id ia ry , though few an n u al r e p o r ts fo llo w th is
p r a c tic e .
Summary
A ccounting se rv e s many groups and m ust be adapted
to m eet in c re a s in g r e s p o n s i b i l i t i e s . A ccounting has been
r e f e r r e d to as th e language o f b u sin e ss b ecau se i t p ro v id es
a means f o r th e v a rio u s phases o f b u s in e s s to conm unicate
w ith th e p u b lic .
There a re d i f f e r e n t acco u n tin g tre a tm e n ts which may
be a p p lie d to th e same tr a n s a c tio n . These v a rio u s t r e a t
m ents can produce d if f e r e n t r e s u l t s w hich can a f f e c t th e
d e c is io n s made by th e u s e rs o f th e r e p o r ts t h a t re c o rd
th e s e tr a n s a c tio n s .
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114
Hie groups o r in d iv id u a ls m ost in te r e s te d in f in a n
c i a l s ta te m e n ts have been d is c u s s e d . Of t h i s group, th e
fo llo w in g th r e e a re th e m ajor u s e rs o f f in a n c ia l s ta te m e n ts :
management, s to c k h o ld e rs , and c r e d i t o r s .
Management is in te r e s te d in f in a n c ia l sta te m e n ts
becau se th e s e sta te m e n ts p ro v id e th e b lu e - p r in t f o r
dec is io n -m ak in g .
In v e s to rs a re in te r e s te d in a b ro ad , o v e r - a ll p i c
tu r e . Hie b a la n c e sh e e t s e ts f o r th th e n e t a s s e ts u n d e r
ly in g t h e i r in v estm en ts and th e income sta te m e n t m easures
th e e f f e c tiv e n e s s o f th e o rg a n iz a tio n in which th e y have
in v e s te d .
C re d ito rs fin d f in a n c ia l s ta te m e n ts v ery in fo rm a
t i v e b ecau se th e s e c r e d ito r s a r e in te r e s te d in th e e a rn in g
power, th e s t a b i l i t y and th e b ack lo g o f a s s e ts su p p o rtin g
t h e i r lo a n .
The im portance of s e le c te d r a t i o s has been d i s
cu ssed . (What each r a t i o in te n d e d to m easure was brought
o ut--w as i t a m easure o f management * s e f f ic ie n c y ? a m easure
o f th e r a t e o f e a rn in g power on p r o p r ie ta r y in v estm en t?
o r was i t a m easure o f th e cu sh io n p ro v id ed c r e d ito r s
a g a in s t lo s s e s ? )
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115
An i l l u s t r a t i v e c a se has been p re se n te d to p o rtra y
th e e f f e c ts o f v a rio u s ac co u n tin g tre a tm e n ts on c e r t a in
r a t i o s im p o rta n t to u s e rs o f c o n s o lid a te d f i n a n c i a l r e p o r ts .
F in a lly , th e lim ita tio n s o f c o n s o lid a te d sta te m e n ts
have been c o n s id e re d . I t i s im p o ssib le to d eterm in e r e
ta in e d e a rn in g s a v a ila b le f o r d iv id en d s from a c o n s o lid a te d
b a lan ce s h e e t. At th e same tim e, a l l o f th e a s s e ts in th e
c o n s o lid a tio n m ight n o t be v a lu e d on th e same b a s is .
T h erefo re, c o n s o lid a te d s ta te m e n ts sh ould alw ays be acccxn-
p anied by f in a n c ia l s ta ta n e n ts from th e p a re n t and from th e
s u b s id ia r ie s .
Ttie r e l a t e d r a t i o s can g iv e an ap p earan ce o f mea
s u rin g th e e x te n t o f management e f f ic ie n c y , th e r a t e o f
ea rn in g power on p r o p r ie ta r y in v e stm en t, and th e cu sh io n
provided by sto c k h o ld e rs a g a in s t lo s s to c r e d i t o r s —b u t
such an a p p a re n t m easure may be in a c c u ra te and m isle a d in g
due to v a r ia tio n s in a c c o u n tin g .
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CHAPTER V
GENERAL TREATM ENT OF GOODW ILL
B Y REGULA TORY AGENCIES
P u b lic u t i l i t i e s have b a s ic a lly th e same le g a l and
m an ag eria l com p o sitio n as p r iv a te b u s in e s s . However, p u b lic
u t i l i t i e s have as t h e i r p r in c ip a l theme p u b lic i n t e r e s t and
th u s in c u r s e r v ic e o b lig a tio n s and f in a n c ia l r e s t r a i n t s .
These u t i l i t i e s have b o u n d aries as to "re a so n a b le " r a te s o r
charges f o r s e r v ic e . They can n o t e s ta b li s h t h e i r own
p ric e s and o b ta in boundless r e tu r n s . The a s p e c t o f "re a so n
a b le n e s s ," p e r ta in s c h ie f ly to th e p u b lic , w hich may n o t be
o v erch arg ed . I t a p p lie s a ls o to th e u t i l i t i e s them selves,
w hich a re e n t i t l e d to " f a i r r e tu r n s " on th e p r o p e r tie s
devoted to p u b lic u se .
P u b lic i n t e r e s t is re c o g n ize d as th e fundam ental
law o f th e la n d and was acknowledged fo rm a lly by th e
Supreme C ourt o f th e U nited S ta te s in 1876, in th e ca se
116
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117
o f îtom V. I l l i n o i s . ^ T his c a se e s ta b lis h e d th e d i f f e r
ences in r e la tio n s h ip to th e p u b lic betw een p u b lic u t i l i
t i e s and th e custom ary b u s in e s s . The p u b lic u t i l i t y ca n -
p an ies g e n e ra lly have s p e c ia l f r a n c h is e s , occupy a monopoly
p o s itio n , and f u rn is h community s e r v ic e . Hie Munn c a s e ,
d ecid ed by th e Supreme C ourt, ru le d th a t r a ilr o a d s and
w a te r com panies w ere " a ff e c te d w ith th e p u b lic i n t e r e s t . "
The Munn c a se as d e s c rib e d h e re was th e f i r s t s i g n i f i c a n t
pronouncem ent o f th e Supreme C ourt on th e p u b lic u t i l i t y
co n c ep t. Item s 1 and 6 o f t h i s ca se s t a t e th e fo llo w in g :
1. Under th e powers in h e re n t in ev ery s o v e re ig n ty
a governm ent may r e g u la te th e conduct o f i t s
c i tiz e n s tow ard each o th e r, and, when n e c e ss a ry
f o r th e p u b lic good, th e manner in w hich each
s h a l l u se h is own p ro p e rty .
6 . The lim ita tio n by l e g i s l a t i v e enactm ent o f th e
r a t e o f charge f o r s e rv ic e s ren d ered in a
p u b lic employment, o r f o r th e u se o f p ro p e rty
in which th e p u b lic has an i n t e r e s t , e s ta b
lis h e s no new p r in c ip l e in th e law b u t o n ly
g iv e s a new e f f e c t to an o ld o n e.^
Hie d e c is io n in th e Munn ca se reco g n ized f o r th e
f i r s t tim e th e economic power o f p ro p e rty grow ing o u t o f
economic c o n d itio n s , as d is tin g u is h e d from th e p h y s ic a l
Htunn V. I l l i n o i s , 94 U.S. R eports 113-114 (1876).
^ Ib id .
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118
power o f s o v e re ig n ty , o r fo rc e to in d u ce, e x e rc is e d on
b e h a lf o f c i t i z e n s as t h e i r p r iv ile g e o r " l i b e r t y . "
The S p rin g V alley c a se i s s im ila r to th e lÆinn c a se
b u t p e r ta in s to r a t e f ix in g , f o r th e p u b lic i n t e r e s t , o f
w a te r.
Laws r e q u ir in g gas com panies, w a te r com panies and
o th e r c o rp o ra tio n s o f l i k e c h a ra c te r to su p p ly t h e i r
custom ers a t p r ic e s fix e d by th e m u n ic ip a l a u t h o r i t i e s
o f th e l o c a l i t y , a r e w ith in th e scope o f l e g i s l a t i v e
power u n le s s p r o h ib ite d by c o n s titu t io n a l lim ita tio n o r
v a lid c o n tr a c t o b lig a tio n . The c o n s titu tio n o f a S ta te
p ro v id ed t h a t c o rp o ra tio n s m ight be form ed under
g e n e ra l law s, and sh o u ld n o t be c re a te d by s p e c ia l a c t,
except f o r m u n ic ip a l purposes and th a t a l l law s,
g e n e ra l and s p e c ia l, p assed p u rsu a n t to t h a t p r o v i
s io n m ight be from tim e to tim e a l te r e d and re p e a le d .
A g e n e ra l law was en acted by th e l e g i s l a t u r e f o r th e
fo rm a tio n o f c o rp o ra tio n s f o r su p p ly in g c i t i e s , coun
t i e s and towns w ith w a te r, w hich p ro v id ed t h a t th e
r a te s to b e charged f o r w ate r should be fix e d by a
board o f com m issioners to be ap p o in ted in p a r t by th e
c o rp o ra tio n and in p a r t by m u n ic ip a l a u t h o r i t i e s . The
C o n s titu tio n and laws o f th e S ta te w ere su b se q u e n tly
changed so as to ta k e away from c o rp o ra tio n s w hich had
been o rg a n iz e d and p u t in to o p e ra tio n under th e o ld
C o n s titu tio n and th e power to name members o f th e board
o f com m issioners, and so as to p la c e i n m u n ic ip a l
a u t h o r it ie s th e s o le power o f f ix in g r a t e s f o r w a te r:
Held, That th e s e changes v io la te d no p ro v is io n o f th e
C o n s titu tio n o f th e U nited S ta te s .^
Under th e s e circu m stan ces i t does n o t r e q u ir e a
p e rso n a l fa v o r o f th e re g u la to ry ag en cies in o rd e r to
3
S pring V alley Works v . S c h o tt1 e r, 110 U.S. R eports
347-348 (1883).
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119
r e g u la te r a t e s . The re g u la to ry body has a d u ty to e s ta b
l i s h r a t e s when c itiz e n s have engaged in a b u s in e s s upon
which o th e r c i tiz e n s depend f o r t h e i r l i b e r t y and p ro p e rty .
Ih e g ra n tin g o f a u th o r ity o v er p eo p le in r e g u la tin g r a te s
does n o t ccme f r a n th e re g u la to ry ag en cie s d i r e c t l y , b u t
i n d ir e c t l y frœ n th e ow nership o f a k in d o f p ro p e rty to
which t h a t economic power a tta c h e s .
R easonable r a te s a re th o se r a te s w hich w i l l fu rn is h
th e u t i l i t y th e n e c e ssa ry rev en u es to cover th e s u f f i c i e n t
c o s ts and w i l l b rin g a " f a i r r e tu r n " upon th e " f a i r v a lu e "
o f th e p r o p e r tie s u sed . Ih e e s ta b lish m e n t o f re a s o n a b le
r a te s in v o lv e s th e d e te rm in a tio n o f " f a i r v a lu e " and th e
f a i r r a t e o f r e tu r n . This inccm e c o n tro l i s th e m ajor d i f
fe re n c e betw een a re g u la te d p u b l i c - u t i l i t y and a p r iv a te
b u s in e s s . In p r iv a te b u s in e s s , th e re i s no p u b lic c o n tro l
o f ch arg es f o r s e rv ic e , and th e r e i s no le g a l r e s t r i c t i o n
upon th e amount o f income t h a t may be earn ed .
In th e p u b lic u t i l i t y , th e c a p i t a l sum and r a t e o f
r e tu r n m ust f i r s t be d eterm in ed b e fo re th e a llo w a b le income
can be f ix e d . Ih e r a te s a re b ased upon th e p r i o r d eterm in a
tio n o f c a p i t a l . This c a p i t a l i s th e u n d e rly in g b a s is o f
charges to be fix e d f o r th e p u b lic . The c a p i t a l concept
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120
f o r p u b lic u t i l i t i e s c o n s is ts o f th e " f a i r v a lu e " o f th e
p r o p e r tie s u sed to re n d e r s e rv ic e . The income c o n s is ts o f
th e f a i r r a t e o f r e tu r n a p p lie d to th e " f a i r v a l u e ." These
item s a re r a t e f a c to r s which m ust be determ ined by p u b lic
re g u la to ry a g e n cie s b e fo re re a s o n a b le r a te s can be e s ta b
lis h e d .
Method o f Computing R ate
I t i s alm o st im p o ssib le to a r r iv e a t a r a t e w hich
w i l l s a t i s f y a l l u t i l i t i e s . Hie b e s t th a t re g u la to ry agen
c ie s can do i s to p ro v id e a form ula which can be a p p lie d to
a l l u t i l i t i e s . T his form ula i s o u tlin e d by F e r tig , Is tv a n ,
and M o ttice in th e fo llo w in g m anner:
1. T o ta l owners* n e t in v estm en t x P U C -dictated
7 o r a t e o f r e tu r n on in v estm en t eq u als maximum
d ic ta te d ea rn in g s u t i l i t y company can e n jo y .
2. Maximum ea rn in g s p lu s o p e ra tin g expenses eq u als
maximum revenues allow ed to firm .
3. Maximum revenues allow ed d iv id e d by u n its o f
s e r v ic e ( e .g ., k ilo w a tt hours o f e l e c t r i c i t y )
s o ld to custom ers eq u als custom er r a t e p e r u n it
o f s e r v ic e .
4
Paul E. F e r tig , Donald F. Is tv a n , and Homer J .
M o ttice, Using A ccounting In fo rm atio n : An In tro d u c tio n
(New York: H arco u rt, B race and World, I n c ., 1965), p . 464.
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121
F e r tig , Is tv a n , and M o ttice c o n tin u e by e x p la in in g
why i t i s im p o rta n t th a t th e P u b lic U t i l i t y Commission
d ic ta t e s th e p r in c ip le s by which u t i l i t i e s sh o u ld account
f o r t h e i r c o s ts ( a s s e ts and ex p e n ses).
E xam ination o f th e above form ulas w i l l r e v e a l th a t
th e o n ly way th e owners can in c re a s e t h e i r r e tu r n on
in v estm en t w ith a g iv en r a t e o f r e tu r n would be to
in c re a s e th e re p o rte d d o lla r t o t a l o f t h e i r n e t i n
v estm en t (a s s e ts minus l i a b i l i t i e s ) , o r t h e i r re p o rte d
o p e ra tin g ex p en ses, f o r c a lc u la tio n p u rp o ses, b u t n o t
in f a c t . 5
U t i l i t i e s could m a n ip u la te th e r a t e by means o f
im proper a c co u n tin g p r in c ip le s . This i s th e re a so n th e
p ro p er tre a tm e n t o f g o o d w ill sh o u ld be g iv en c a r e f u l con
s id e r a tio n .
E s ta b lis h in g th e R ate o f R eturn
À f a i r r e tu r n i s n o t easy to d e fin e ; i t cannot be
th e same in ev ery in s ta n c e b u t changes w ith th e c o n d itio n s
and l o c a l i t i e s . The Wilcox c a se d e p ic ts t h i s in th e f o l
lowing sta te m e n t :
. . . th e r e tu r n which th e company i s e n t i t l e d to earn,
on th e c a p i t a l employed in th e b u sin e ss i s n o t
^ Ib id .
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122
determ ined by th e le g a l r a t e o f i n t e r e s t in th e s t a t e ,
b u t by th e lo c a l investm ents o f th e same d eg ree o f
s a f e ty .
In com puting th e r a t e o f r e t u r n , sh o u ld g o o d w ill be
in clu d ed in th e p ro p e rty ? I f g o o d w ill i s in c lu d e d , th e
u t i l i t y w i l l b e a b le to charge a h ig h e r r a t e . The W ilcox
case s t a t e s th e fo llo w in g :
In a s u i t by a gas company to e n jo in th e enforcem ent
o f a s t a t u t e o r re g u la tio n f ix in g th e r a t e to be
charged by such company f o r gas as u n reaso n ab le and
c o n fis c a to ry , w here th e company o p e ra te s under a f r a n
c h is e , i s re q u ir e d by law to f u r n is h gas to a l l who
demand i t , and enjoys a p r a c t i c a l monopoly in th e
t e r r i t o r y w hich i t se rv e s, i t h as no g o o d w ill in a
p ro p e rty s e n s e , a s id e from i t s fra n c h is e , which can
be c o n s id e re d as p ro p e rty in v e s te d in i t s b u s i n e s s . ^
When a p u b lic s e rv ic e c o rp o ra tio n has a monopoly
such as th a t o f su p p ly in g gas in a la r g e c i t y , ’’g o o d w ill"
cannot be c o n s id e re d as an elem ent o f th e v a lu e o f th e
p ro p e rty em ployed.
IMiform P ric in g
U t i l i t y com panies a re e n t i t l e d to re a s o n a b le e a rn
in g s. These e a rn in g s should be h ig h enough to p rev e n t
^W ilcox V. C onsolidated Gas C o .. 157 F ed e ra l
R ep o rter 850 (1908).
^ Ib id .
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123
c o n f is c a tio n o f t h e i r p ro p e rty and allow m aintenance o f
p ro d u c tio n .
Why i s th e com m ission concerned w ith un ifo rm
p r ic in g ? U niform ity o f p r ic e s p rev e n ts r a t e com parison.
A ll com m unities w i l l have th e same r a te , th u s e lim in a tin g
any d is c o n te n t.
C o s t-a llo c a tio n problem s a re avoided by uniform
p r ic in g . T roxel e x p la in s :
I f a s in g le g e n e ra tin g s ta tio n o r gas p ip e i s b u i l t
to se rv e a number o f tow ns, th e re i s a c o n d itio n o f
j o i n t p ro d u c tio n . The s in g le e l e c t r i c s t a t i o n o r gas
lin e , in s te a d o f s e p a r a te p la n ts o r lin e s f o r each
town, i s b u i l t b ec au se p ro d u ctio n econom ies can be
r e a liz e d . There a r e economies o f com posite o u tp u t, n o t
th o se o f s e p a ra b le p a r ts o f th e t o t a l o u tp u t. . . .
Uniform p ric in g a f f e c t s b o th th e d i s t r i b u t i o n o f
u t i l i t y s e rv ic e s and th e t o t a l o u tp u t o f th e s e rv ic e s .
When a ccsnpany s e l l s s e r v ic e a t th e same p r ic e s in a l l
com m unities, th e b u y e rs in sm all towns u s u a lly g e t
p r ic e re d u c tio n s a t th e expense o f th e c i t y b u y ers.
E ith e r th e sm all-to w n p r ic e s a re reduced more th an c i t y
p ric e s as uniform p r ic in g goes in to e f f e c t , o r l a t e r
th e u rb an s e rv ic e p ro v id e s m ost o f th e ex cess e a rn in g s
w ith which a l l r a t e s can be reduced.
COTjpanies w i l l be r e lie v e d o f e x p la in in g why some
community p ric e s a re h ig h e r, b i l l i n g c o s ts a re reduced and
th e Conm ission can a ls o c o n tr o l e a rn in g s.
Q
Emery T roxel, "The G eneral P a tte rn o f E arnings
R e g u la tio n ," Economics o f P u b lic U t i l i t i e s (New York :
R in eh a rt and Company, I n c ., 1947), pp. 234-235.
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124
Going V alue
Going v a lu e , a complement o f g o o d w ill, has been th e
f a v o r ite in ta n g ib le v a lu e o f p u b lic u t i l i t y com panies.
U t i l i t i e s have been in te r e s te d in in ta n g ib le s because i n
ta n g ib le s , added to ta n g ib le p ro p e rty , g iv e a h ig h e r r a t e
o f e a rn in g s . U t i l i t i e s co u ld u se going v a lu e and r e p r o
d u c tio n c o s ts to p re v e n t r a t e re d u c tio n s . However, when
th e r e is a s h i f t to th e o r i g i n a l - c o s t b a s is th e re g u la to ry
s t a t u s o f going v a lu e i s changed.
The m a jo rity o f th e u t i l i t y com panies have th e
g e n e ra l c h a r a c t e r i s t i c s o f a going co n cern . They seem to
have th o se c h a r a c t e r i s t i c s d e s c rib e d by J . R. Commons, in
h is I n s t i t u t i o n a l Economics :
A going co n cern i s a j o i n t e x p e c ta tio n o f b e n e f i
c i a l b a rg a in in g , m a n a g e ria l and r a tio n in g tr a n s a c tio n s ,
k ep t to g e th e r by "w orking r u le s " and by c o n tro l o f th e
changeable s t r a t e g i c o r " lim itin g " f a c to r s which a re
expected to c o n tro l th e o th e r s . When th e e x p e c ta tio n s
cease th en th e concern q u its going and p ro d u c tio n
s to p s .
The re g u la tio n o f p u b lic r a te s has n o t been p a r
t i c u l a r l y s a t i s f a c t o r y b ecau se o f u n c le a r p o lic y and
9
John R. CoOTnons, "M ethod," I n s t i t u t i o n a l Economics
(New York: The M acm illan Company, 1934), p . 58.
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125
in a d eq u ate a d m in is tra tiv e p ro v is io n s to c a rry o u t th e
p o lic y . The s t a t u t e s have g iv en th e com m ission th e re sp o n
s i b i l i t y to e s ta b li s h re a s o n a b le r a t e s w ith o u t a p ro p er
d e f i n i t i o n o f " re a s o n a b le ."
As has been p o in te d o u t, management w i l l want as
h ig h a r a t e as p o s s ib le and th e r e f o r e w i l l attem p t to i n
clu d e g o o d w ill in in ta n g ib le s . The Los A ngeles Gas Company
i l l u s t r a t e s th is p o in t when i t s t a t e s :
The going v a lu e th u s reco g n iz ed i s n o t to be con
fu sed w ith g o o d w ill, in th e se n se o f th a t "elem ent o f
v a lu e w hich in h e re s in th e fix e d and fa v o ra b le con
s id e r a tio n s o f custom ers a r is in g from an e s ta b lis h e d
and w ell-know n and w e ll conducted b u s in e s s ," and w hich,
as th e c o u rt has re p e a te d ly s a id , i s n o t to be con
s id e re d in d eterm in in g w hether r a t e s fix e d f o r p u b lic
s e rv ic e c o rp o ra tio n s a re c o n f is c a to r y . The concept o f
going v a lu e i s n o t to be used to escap e th e j u s t e x e r
c i s e o f th e re g u la to ry power in f ix in g r a te s , and on
th e o th e r hand t h a t a u th o rity i s n o t e n t i t l e d to t r e a t
a liv in g organism as n o th in g more th a n b a re b o n es.
C e rta in re g u la to ry ag en cies have assig n ed th e d u ty
o f s u p e rv is in g th e a c t i v i t i e s o f v a rio u s "p u b lic i n t e r e s t "
com panies. Such an agency i s th e F e d e ra l Power Commission,
a U nited S ta te s governm ent agency. This agency re g u la te s
th e r a te s o f e l e c t r i c power and n a t u r a l gas companies t h a t
^^lo s A ngeles Gas & E le c tr ic Corp. v . R ailro ad
Commission o f C a lif o r n ia , 289 U.S. R eports 313-314 (1933).
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126
engage in i n t e r s t a t e commerce and s e l l a t w h o le sa le fo r
l a t e r r e s a l e .
The m ost u n u su a l f e a tu r e o f th e F e d e ra l Power Com
m issio n acco u n tin g i s th a t which compels th e c o s t of e l e c
t r i c p la n t a c q u ire d be re c o rd e d a t o r ig in a l c o s t. O rig in a l
c o s t i s d e fin e d in th e F e d e ra l Power Commission system o f
acco u n ts as th e c o s t o f p ro p e rty to th e p e rso n f i r s t
d ev o tin g i t to p u b lic s e r v ic e .
This d e f i n it i o n o f c o s t i s c o n tra ry to g e n e ra lly
accep ted ac co u n tin g p r in c ip le s . The AICPA d e fin e s c o s t a s :
The i n i t i a l amount assig n ed to a l l ty p e s o f in ta n
g ib le s should be c o s t, in accordance w ith th e g e n e ra lly
ac c e p ted acco u n tin g p r in c ip le t h a t a s s e ts should be
s ta te d a t c o s t when th e y a re a c q u ire d . In th e case o f
n o n -cash a c q u is itio n s , a s, f o r exam ple, w here in ta n
g ib le s a r e a c q u ire d in exchange f o r s e c u r i t i e s , c o s t
may b e c o n sid e re d as b ein g e i th e r th e f a i r v a lu e o f th e
c o n s id e ra tio n g iv e n o r th e f a i r v a lu e o f th e p ro p e rty
o r r i g h t a c q u ire d , w hichever i s th e more c l e a r ly
e v id e n t.
The b e s t avenue to th e a p p lic a tio n o f th e o r ig in a l
c o s t approach i s th ro u g h th e a c tu a l p la n t acco u n ts p re
s c rib e d by th e F e d e ra l Power Commission. Ih e g e n e ra l-
le d g e r acco u n ts f o r e l e c t r i c p la n t a re as fo llo w s :
American I n s t i t u t e o f A ccountants, Committee on
A ccounting P rocedure, Accounting: R esearch B u lle tin No. 43
(New York: American I n s t i t u t e o f A cco u n tan ts, 1947),
p. 38.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
127
100 E le c tr ic P la n t (A b a la n c e -s h e e t account sum
m a riz in g accounts 100.1 to 1 0 0 .6 , in c lu s iv e )
100.1 E le c tr ic P lan t in S e rv ic e
100.2 E le c tr ic P lan t Leased to O thers
100.3 C o n stru c tio n Work in P ro g ress
100.4 E le c tr ic P lan t Held f o r F u tu re Use
100.5 E le c tr ic P lan t A c q u is itio n A djustm ents
100.6 E le c tr ic P lan t in P rocess o f R e c la s s i
f ic a tio n
100.7 E le c tr ic P la n t A djustm ents (A b a la n c e -s h e e t
acco u n t which is d esig n ed to show alm ost e x c lu
s iv e ly w rite -u p s o f e l e c t r i c p la n t)
Accounts 100.1 to 100.4 a re to be s ta te d on th e
b a s is o f o r ig in a l c o s t. Account 100.5 i s to
c o n ta in th e d if fe re n c e , w h eth er d e b it o r c r e d i t ,
betw een c o s t to th e ac co u n tin g u t i l i t y o f
a c q u irin g o p e ra tin g u n its and system s and th e
o r ig in a l c o s t th e re o f. Account 100.6 i s a
tem porary account which i s to h o ld th e e l e c t r i c
p la n t as reco rd ed in th e books as o f January 1,
1937, th e e f f e c tiv e d a te o f th e system o f
a c c o u n ts, u n t i l th e o r ig in a l c o s t th e re o f has
been d eterm in ed and an a c c e p ta b le p lan f o r
d i s t r ib u t i n g th e amount to o th e r accounts has
been d e v ise d . ^
This 100.5 acco u n t fo llo w s th e th e o ry and th e p r a c tic e o f
governm ental ac co u n tin g .
The amount in th e ad ju stm en t acco u n t i s to be d i s
posed o f as th e Commission may approve o r d i r e c t . This
account i s to be am o rtized so th a t th e d e p re c ia tio n
12
C harles W . Smith, "Uniform System o f Accounts o f
th e F e d e ra l Power Com m ission," A ccounting Review. X II
(June, 1937), 156.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
128
s t a t i s t i c s w i l l n o t be d i s t o r t e d .
Assuming f o r th e sak e o f argum ent t h a t th e s e p a ra
tio n o f t o t a l a c tu a l c o s t in to " o r ig in a l c o s t" and " a c q u i
s i t i o n ad ju stm e n t" i s j u s t i f i e d , a scheme f o r a n a ly z in g
and d e a lin g w ith acco u n t 100.5 in a re a s o n a b le way has been
o u tlin e d by W illiam A. P aton:
In a n a ly zin g th e t o t a l p ric e p a id f o r a mixed
a g g re g a te o f p ro p e rty th e f i r s t s te p c o n s is ts in l i s t
ing w ith ad eq u ate d e s c r ip tio n s a l l th e s o - c a lle d
p h y s ic a l o r ta n g ib le re so u rc e s which a r e a c q u ire d .
Next, e stim a te d v a lu e s a re a tta c h e d to th e item s in
t h i s l i s t based on c u r r e n t p ric e s f o r such f a c to r s i f
p u rch ased o r c o n s tru c te d s e p a ra te ly , ta k in g in to
acco u n t th e c o n d itio n and p ro b ab le l i f e o f th e a c q u ire d
f a c i l i t i e s as compared w ith new u n its , and w ith due
re c o g n itio n o f th e s p e c ia l c h a r a c te r i s t i c s o f th e r e
so u rce s a c q u ire d . In th e c a se o f item s w hich i t i s
co n tem p lated w i l l be s o ld o r o th e rw ise d isp o se d o f, th e
v a lu e a tta c h e d sh o u ld be th e e stim a te d n e t proceeds to
be r e a liz e d upon d is p o s itio n . For h ig h ly o b so le sc e n t
ite m s, which i t i s ex p ected w ill be u sed b u t a s h o rt
tim e, th e v a lu e to be a tta c h e d sh ould r e f l e c t th e
p re s e n t w orth o f th e e stim a te d n e t p ro ceed s upon r e
tire m e n t, i f any, p lu s th e s e rv ic e s a n tic ip a te d th ro u g h
th e s h o r t p e rio d o f ex p ected u se . For re a s o n a b ly u p -
to - d a te and s ta n d a rd s tr u c tu r e s and equipm ent, th e
c u r r e n t c o s t o f r e p la c in g such item s new, w ith due
allo w an ce f o r d e p r e c ia tio n , fu rn is h e s th e m ost ap p ro
p r i a t e e s tim a te o f v a lu e . For lan d and r e la t e d so u rces
an a p p ra ise d " f a i r m arket v a l u e ," based upon a l l s i g
n i f i c a n t ev id en ces, re p r e s e n ts th e p ro p e r approach.
1*5
W illiam A. P aton, "A ccounting P o lic ie s o f th e
F e d e ra l Power Commission—A C ritiq u e , " The J o u rn a l of
A ccountancy, LXXVII (June, 1944), 437-438.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
129
I h is m ethod adm its t h a t one way to g e t a b rea k down
o f t o t a l a c tu a l c o s t by acco u n ts i s "by some v a lu a tio n
p ro c e s s ." The com pletion o f t h i s m ethod would r e q u ir e a
lif e tim e . Ih e b e s t method would in v o lv e th e fo llo w in g .
When a company makes a p u rch ase o f p ro p e rty i t i s e s s e n t i a l
to have a c c e s s ib le a com plete in v e n to ry o f a l l p h y s ic a l
re s o u rc e s . Then a v a lu a tio n p ro c e ss can be e s ta b lis h e d .
D e p re c ia tio n sh o u ld b e computed on o r ig in a l c o s t.
In o rd e r to a r r iv e a t t h i s o r i g i n a l c o s t, th e commission
has s e t f o r th th e fo llo w in g in s t r u c tio n s in E le c tr ic P la n t
I n s tr u c tio n 2 o f th e Uniform System w hich p ro v id e s, in
p a r t, as fo llo w s :
A. Each u t i l i t y s h a l l c l a s s i f y i t s e l e c t r i c p la n t
as o f th e e f f e c t iv e d a te o f t h i s system o f
acco u n ts in acco rd an ce w ith th e e l e c t r i c p la n t
acco u n ts p re s c rib e d h e r e in . The c l a s s i f i c a t i o n
s h a l l be so made as to show b o th th e o r ig in a l
c o s t and th e c o s t to th e u t i l i t y o f i t s e l e c
t r i c p la n t.
B. The c o s t to th e u t i l i t y o f i t s e l e c t r i c p la n t
s h a l l be a s c e rta in e d by a n a ly s is o f th e
u t i l i t y ' s re c o rd s . In a s c e r ta in in g th e c o s t
i t i s n o t in te n d e d t h a t any c o r r e c tio n need be
made fo r d e p re c ia tio n o r a m o rtiz a tio n a p p l i
c a b le to o p e ra tin g u n its o r system s p re v io u s ly
a c q u ire d , w hether o r n o t such d e p re c ia tio n o r
a m o rtiz a tio n was re c o rd e d in th e books o f th e
ac co u n tin g u t i l i t y . I t i s lik e w is e n o t i n
ten d ed th a t ad ju stm en ts s h a l l be made to re c o rd
in e l e c t r i c p la n t acco u n ts amounts p re v io u s ly
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
130
charged to o p e ra tin g expenses in accordance
w ith th e un ifo rm system o f acco u n ts in e f f e c t
a t th e tim e o r in accordance w ith th e d i s
c r e tio n o f management as e x e rc ise d under such
uniform system o f ac co u n ts. ^
I h is method is used to p ro v id e th e re g u la to ry c a n -
m issio n and o th e r in te r e s te d p a r t i e s w ith th e in fo rm a tio n
th e y should have co n cern in g th e p r o p e r tie s . E le c tr ic p la n t
in s tr u c tio n 2 p ro v id es t h a t a l l p ro p e rty be c l a s s i f i e d and
p ro p e rly la b e le d as to k in d o f p ro p e rty in c lu d e d . A lso a
uniform b a s is m ust be used to d eterm in e th e am ounts. The
only uniform b a s is i s o r ig in a l c o s t.
In ta n g ib le Elem ent in Account 100.5
The in ta n g ib le elem ent in c lu d ed in t h i s account in
a p a r t i c u la r c a se should be d eterm in ed . A fte r t h i s elem ent
i s d eterm in ed , th e problem as to i t s n a tu re and p o s s ib le
breakdown a r i s e s . Paton p re s e n ts th e fo llo w in g :
1. I t may re p r e s e n t in w hole o r in p a r t th e c o s t
to th e p re s e n t owner o f th e o rg a n iz a tio n ,
fin a n c in g , and developm ent work accom plished
under p re d e c e sso r ow nership.
2. I t may re p re s e n t in w hole o r in p a r t th e c o s t
to th e p re s e n t owner o f p a r t i c u l a r fra n c h is e s
o r o th e r s p e c if ic r i g h t s .
14
S n ith , on. c i t . , p . 157.
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131
3. I t may re p re s e n t in whole o r in p a r t th e c o s t
to th e p re s e n t owner o f s u p e r io r ity o f e a rn in g
p ro sp e c ts a r is i n g from any economic and te c h
n ic a l c o n d itio n s w hich a re so interw oven th a t
i t would be im p ra c tic a b le to a p p ra is e th e n
s e p a ra te ly o r to a rra y them in term s o f d e f i
n i t e r e l a t i o n to s u p e rio r earn in g power and
hence to th e c o s t o f such s u p e r i o r i t y . ^
The im p o rtan t problem i s th e p ro p er tre a tm e n t in
su b seq u en t acco u n tin g o f th e p o r tio n o f th e t o t a l c o s t
w hich has been s e t a s id e as an in ta n g ib le . On t h i s to p ic
th e F e d e ra l Power Conm ission (FPC) system o f acco u n ts s e ts
up no r i g i d req u irem e n ts.
This opens th e door f o r v a rio u s a l t e r n a t i v e m ethods
and p la c e s u t i l i t y ac c o u n tin g in th e same p o s itio n as con
v e n tio n a l acco u n tin g . Now w hat happens to th e re a d e r o f
th e sta te m e n ts ? Are th e d e c is io n s made by th e re a d e r based
on th e b e s t a v a ila b le in fo rm a tio n ?
Paton, in h is c r i t i q u e o f th e acco u n tin g p o lic ie s
o f th e F e d e ra l Power Commission, p o in ts o u t t h a t th e
. . . Commission i s n o t c o n fin in g i t s e f f o r t s to a r b i
t r a r y a m o rtiz a tio n o f th e p o r tio n o f 100.5 w hich may
r e p r e s e n t th e in ta n g ib le s ; in s te a d th e u t i l i t i e s a re
b ein g asked to am o rtize th e e n t i r e amount o f 100.5
r e g a rd le s s o f i t s c h a r a c te r .
Paton, "A ccounting P o lic ie s o f th e F e d e ra l Power
Commission—A C r itiq u e ," pp. 440-441.
^^I b i d . , p. 441.
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132
To a c e r t a i n e x te n t, th e m a n u factu rin g firm s m ight
be in a more advanced acco u n tin g p o s itio n th a n th e u t i l i
t i e s . Ih e m an u factu rin g firm s e i t h e r am o rtize th e f u l l
amount o r th ey do n o t am o rtize i t . There i s no problem
re g a rd in g p o rtio n s o f th e amount.
C h arles Sm ith, one tim e C h ief o f th e FPC*s Bureau
of A ccounts, F in an ce and R ates, urg ed a m o rtiz a tio n o v er a
p e rio d n o t to exceed f i f t e e n y e a rs as a maximum. R esearch
shows th a t in m ost m an u factu rin g firm s , tw enty y ea rs i s th e
maximum. This d if f e r e n c e d e p ic ts th e co n tin u ed c o n f l i c t in
in fo rm a tio n p re s e n te d to re a d e rs o f th e f in a n c ia l s t a t e
ments .
Sm ith c o n tin u e s w ith th e s ta te n e n t, th e re a re
17
c a se s, w here im m ediate c h a rg e -o ff sh o u ld be made.
In t h i s c a se . Smith i s com plying w ith C hapter 5 o f
A ccounting R esearch B u lle tin No. 43.
However, to add to th e co n fu sio n , American W ater
Works n o t o n ly h as th e U t i l i t y P la n t A c q u is itio n .^vdjujtment
account b u t a ls o has th e acco u n t. Excess o f Cost o f I n v e s t
ments in S u b s id ia rie s Over Book E quity a t A c q u is itio n , b o th
l^Ibid.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
133
on th e same b alan ce s h e e t. I h is s it u a ti o n i s i l l u s t r a t e d
, 1 .18
below :
P ro p e rty , P la n t and Equipment
U t i l i t y P la n t—a t Cost $358,088,451
Less accum ulated d e p re c ia tio n 36.093.768
$321,994,683
U t i l i t y p la n t a c q u is itio n
ad ju stm e n ts, n e t 1,198,429
Excess o f c o s t o f in v estm en ts in
s u b s id ia r ie s o v er book e q u ity
a t a c q u is itio n 5.575.521
$328,768,633
The a c q u is itio n a d ju stm en t account i s c a r r ie d a t
n e t which in d ic a te s th a t i t i s b eing am o rtized . A thorough
in v e s tig a tio n o f th e an n u al r e p o r t o f American W ater Works
p re s e n ts no e x p la n a tio n show ing why two such s im ila r
accounts sh o u ld ap p ear. N e ith e r i s th e re any in fo rm a tio n
concerning a m o rtiz a tio n o f th e am ounts.
C iv il A ero n au tics Board
The C iv il A ero n au tics Board (CAB) has n o t e x e rte d
i t s e l f o v er much in c o n tr o llin g h ig h r a te s and, i n g e n e ra l.
1 8
American W ater Works, Annual R eport. 1964,
pp. 16-17.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
134
has uph eld th e p r in c ip le o f c o m p e titiv e r a te m aking. How
ev er th e CAB, in 1947, d id te m p o ra rily f ix m in im um carg o
r a te s to p r o te c t indep en d en t carg o o p e ra to rs from co m p eti
tio n from cargo lin e s t h a t co u ld s u b s id iz e t h e i r carg o
b u sin e ss from p assen g e r rev en u e s.
James G. Power, C h ief o f R eg u latio n s and R eports
D iv isio n Bureau o f Accounts and S t a t i s t i c s , s t a t e s th e
fo llo w in g about th e CA B and g o o d w ill:
The Uniform System o f Accounts and R eports f o r
c e r t i f i c a t e d a i r c a r r i e r s does n o t have a s p e c if ic
account f o r g o o d w ill. The Board has long had a firm
p o lic y a g a in s t th e in c lu s io n in th e investm ent b ase o f
a i r c a r r i e r s o f in ta n g ib le s r e f le c te d by th e excess
o f m arket v a lu e s ov er book v a lu e s o f th e a c q u irin g com
pany.
This sta te m e n t by James G. Power was made May 24,
1967 and i t ap p ears th a t th e C iv il A eronautics Board i s in
accord w ith th e o th e r r e g u la to ry ag e n cie s.
W ilcox e x p la in s th e m ain d ev o tio n o f th e C iv il
A ero n au tics Board in th e fo llo w in g p arag rap h :
The Board has dev o ted more a tte n tio n to d e term in in g
th e amounts to be p aid f o r c a rry in g th e m a il o r d i s
tr ib u te d as s u b s id ie s th a n to f ix in g r a te s and f a r e s .
19
C iv il A ero n au tics Board, P erso n al l e t t e r from
James G. Power, C hief R e g u la tio n s and R eports D iv isio n
Bureau o f Accounts and S t a t i s t i c s , May 24, 1967.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
135
I t e s ta b lis h e d two m ethods o f payment f o r a i r m a il:
a s e rv ic e r a t e and a need r a t e . The s e rv ic e r a t e i s
p a id to lin e s t h a t a re s e lf - s u p p o r tin g . I t i s b ased
on e s tim a te s o f c o s t p e r pound-m ile, in v o lv in g an
a llo c a tio n o f j o i n t c o s ts betw een m a il and o th e r
s e r v ic e s . A common f ig u re i s fix e d f o r a l l o f th e
lin e s in a g ro u p , and th o se th a t make a la r g e r p r o f i t
a re allow ed to keep i t . An in c e n tiv e i s th u s a ffo rd e d
f o r im provem ents in e f f ic ie n c y . Ih e need r a t e (p aid
by th e P o st O ffic e u n t i l 1953) went to c a r r i e r s t h a t
had to be s u b s id iz e d . I t was computed s e p a r a te ly f o r
each lin e by add in g to g e th e r a l l c o s ts , s u b tr a c tin g
a l l o th e r re v e n u e s, and adding a f a i r r e tu r n (fig u re d
p ro s p e c tiv e ly a t 8 p e r c e n t and r e tr o a c tiv e l y a t 7 p e r
c e n t) on a c tu a l in v e stm e n t. S u b sid ie s p a id by th e C A B
s in c e 1953 have been computed on th e same b a s is . I h is
method o f com pensation u n d e rw rite s a l l lo s s e s and
a ffo rd s no in c e n tiv e to e f f ic ie n c y .
The C iv il A ero n au tics Board i s n o t p ro p e rly
equipped to perfo rm th e n e c e ss a ry d u tie s needed to d e t e r
mine e f f ic ie n c y o f management. I t la ck s th e s t a f f to
s u p e rv is e th e work in d e t a i l .
The I n t e r s t a t e Commerce Commission (ICC) i s co n
cerned w ith j u s t and re a s o n a b le r a t e s to allo w a f a i r
r e tu r n upon th e a g g re g a te v a lu e o f th e p ro p e rty used in th e
s e rv ic e o f tr a n s p o r ta tio n . I h is p ro cess c o n s is ts o f d e t e r
m ining th e v a lu e o f th e r a ilr o a d p r o p e r tie s and what
c o n s titu te s a f a i r r e tu r n . Ih e T ra n s p o rta tio n Act o f 1920
^ ^ C la ir W ilcox, P u b lic P o lic ie s Toward B usiness
(R evised ed. ; Homewood, 111.: R ichard D. Irw in, I n c .,
1960), p . 681.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
136
re q u ire d th e I n t e r s t a t e Commerce Commission to d e te rm in e :
The c la s s e s o f p ro p e rty f o r which d e p r e c ia tio n
ch arg es may p ro p e rly be in c lu d e d u n d er o p e ra tin g ex
penses and th e p erce n tag es o f d e p re c ia tio n w hich s h a l l
be charged w ith re s p e c t to each o f such c la s s e s o f
p ro p e rty .
Ih e r a ilr o a d s wanted to u se th e p re s e n t v a lu e s f o r
t h e i r p r o p e r tie s , le s s "observed" d e p re c ia tio n , w h ile th e
I n t e r s t a t e Commerce Commission w anted to lim it th e v a lu
a tio n to c o s t le s s "accrued" d e p r e c ia tio n on a s t r a i g h t -
lin e b a s is .
There w ere argum ents co n cern in g d e p re c ia tio n
re tire m e n t acco u n tin g f o r s e v e ra l y ea rs a f t e r 1920. In
1922, th e N a tio n a l A sso c ia tio n o f R a ilro a d and U t i l i t i e s
Commissioners (NARUC) in i t s f i r s t sta n d a rd c l a s s i f i c a t i o n
gave ap p ro v al to re tire m e n t re s e rv e ac co u n tin g .
One o f th e m ajor com plaints o f th e acco u n tin g p ro
fe s s io n was th a t th e re g u la to ry com m issions d e p a rte d from
what was c o n sid e re d good acco u n tin g p r a c tic e to accom plish
s o c ia l o b je c tiv e s . By 1936, th e N a tio n a l A ss o c ia tio n o f
R ailro ad and U t i l i t i e s Commissioners had adopted th e
21
P e rc iv a l Brundage, " In flu e n c e o f Government
R eg u latio n on Development of T oday's A ccounting P r a c tic e s ,"
The Jo u rn a l o f A ccountancy, X C (November, 1950), 387.
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137
p r in c ip le o f d e p re c ia tio n acco u n tin g and iss u e d a re v is e d
c l a s s i f i c a t i o n o u tlin in g i t s view s.
The m ost re c e n t developm ent along th e lin e s o f
g o o d w ill by th e I n t e r s t a t e Conmerce Commission has been i t s
d e a lin g s w ith m otor c a r r i e r s . The m ost u n d e rs ta te d a s s e t
on th e b alan c e s h e e t o f th e m otor c a r r ie r s is f r a n c h is e ,
b e t t e r known as o p e ra tin g a u th o r ity . An e x p la n a tio n o f
o p e ra tin g a u th o rity p re s e n te d by E rn est J . Rua, J r . a t th e
Motor C a rrie rs * Forum in Chicago i s surmnarized as fo llo w s:
When o p e ra tin g a u th o r ity has been p u rchased o u t
r i g h t , th e amount p a id f o r such a u th o rity i s c a p i t a l
iz e d . Where a c a r r i e r a c q u ire s th e o u ts ta n d in g sto c k
o f an o th er c a r r i e r , u s u a lly th e d iffe re n c e betw een th e
purchase p r ic e and n e t a s s e ts o f th e a c q u ire d c a r r i e r s
i s assig n e d to o p e ra tin g a u th o rity and c a p ita liz e d
s in c e th e v a lu e o f th e a u th o r ity w i l l n o rm ally exceed
th e d i f f e r e n t i a l . . . .
During 1960 th e I n t e r s t a t e Commerce Conm ission
adopted a p r a c tic e w ith re s p e c t to o p e ra tin g r i g h t s
w hich was e q u iv a le n t to th e g e n e ra lly ac cep ted a c c o u n t
in g p r a c tic e s . A cquired a u th o rity i s c a r r ie d a t c o s t
u n t i l an ev en t ta k e s p la c e which in d ic a te s a lo s s o r
a lim ita tio n on i t s u s e f u l l i f e . When a c a r r i e r d e
c id e s th a t th e a u th o r ity may n o t co n tin u e to have v a lu e
d u rin g th e e n t i r e l i f e o f th e e n te r p r is e , i t may
am o rtize th e c o s t o f such a u th o rity by s y s te m a tic
charges a g a in s t incom e. G en erally accep ted a c c o u n t
ing p r in c ip le s f u r th e r p ro v id e such a u th o rity should
be w ritte n o f f when i t becomes rea so n ab ly e v id e n t t h a t
i t has become w o rth le s s . ^ 2
99
E rn e st J . Rua, J r . , "A nalyzing a Motor C a r r i e r 's
B alance S h e e t," F in a n c ia l A n aly sts Jo u rn a l, XXII (May-June,
1966), 58-59.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
138
P rio r to 1960 th e p r a c tic e adopted by th e ICC d id
n o t comply w ith g e n e ra lly acce p ted acco u n tin g p r a c t ic e s .
However, a f t e r 1960, th e p r a c tic e ad o p ted by th e ICC was
q u ite fa v o ra b le . The ICC uniform system o f acco u n ts l i s t s
o p e ra tin g a u th o r ity as an in ta n g ib le and th e method o f
tre a tm e n t com plies w ith C hapter 5 o f B u lle tin 43.
The re g u la to ry commission in th e l a s t q u a r te r o f
th e n in e te e n th c e n tu ry took th e p o s itio n th a t th e r a ilr o a d s
sh o u ld n o t r e c e iv e a f a i r r e tu r n on o r ig in a l c o s t b ecau se
o f th e h ig h i n i t i a l c o s t o f th e tr a n s c o n tin e n ta l r a ilr o a d s
and th e d e c lin e in th e g e n e ra l p r ic e le v e l d u rin g t h i s
p e rio d . The r a ilr o a d s w ere e n t i t l e d to a f a i r r e tu r n on
th e th e n p re s e n t v a lu e o f th e p ro p e rty . This method does
n o t appear to be fa v o ra b le to th e r a i l r o a d s . In some
in s ta n c e s i t is a f a i r r e tu r n on o r i g i n a l c o s t; in o th e rs
w here such a r e tu r n on o r ig in a l c o s t w i l l r e s u l t in an
ad v an tag e, th e p re s e n t v a lu e o f th e p ro p e rty i s u se d .
A p r in c ip le sh o u ld be e s ta b lis h e d and a p p lie d r e g a rd le s s
o f th e advantage o r d isad v an tag e o f i t s a p p lic a tio n .
The change by th e N a tio n a l A sso c ia tio n o f R a ilro a d
and U t i l i t i e s Commissioners in 1936 to d e p re c ia tio n
acco u n tin g d id n o t end th e c o n f lic tin g view s o f v a rio u s
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139
a u th o r ita tiv e b o d ie s . The AICPA s t a t e s :
Where th e c o s t to th e p a re n t o f th e in v estm en t in
a purchased s u b s id ia ry exceeds th e p a r e n t’s e q u ity in
th e s u b s id ia r y ’ s n e t a s s e ts a t th e d a te o f a c q u is itio n ,
as shown by th e books o f th e s u b s id ia ry , th e excess
should be d e a lt w ith in th e c o n s o lid a te d b a la n c e sh e e t
acco rd in g to i t s n a tu re . . . . To th e e x te n t th a t th e
d if fe re n c e i s c o n sid e re d to be a t t r i b u t a b l e to ta n g ib le
a s s e ts and s p e c if ic in ta n g ib le a s s e ts such as p a te n ts ,
i t should be a llo c a te d to them. Any d if f e r e n c e which
cannot be so a p p lie d should be shown among th e a s s e ts
in th e c o n s o lid a te d b a lan ce s h e e t u n d er one o r more
a p p ro p ria te ly d e s c r ip tiv e c a p tio n s .
However, th e S e c u ritie s and Exchange Commission
only re q u ire s th e re p o r tin g companies to d is c lo s e th e
amount and d is p o s itio n o f such d e b it d i f f e r e n t i a l s in con
s o lid a te d b a la n c e s h e e ts . The S e c u r itie s and Exchange
Commission’s r u le p e r ta in in g to in ta n g ib le a s s e ts fo llo w s:
(Rule 1 2 .0 8 ) Schedule V II.
In ta n g ib le A ssets (N ote).
Note 1. I f in th e accounts i t i s n o t p r a c tic a b le
to s e p a ra te in ta n g ib le a s s e ts from p ro p e rty , p la n t, and
equipm ent, th e in fo rm a tio n h e re re q u ire d may be i n
cluded in th e sch ed u le fo r p ro p e rty , p la n t, and eq u ip
m ent. In such ev en t s t a t e in th e b a la n c e sh e e t any
known amount o f in ta n g ib le s so in c lu d e d w ith an in d ic a
tio n t h a t a f u r th e r unknown amount o f in ta n g ib le s is
a ls o so in c lu d e d .
23
American I n s t i t u t e o f C e r tif ie d P u b lic A ccount
a n ts , Committee on A ccounting P rocedure, A ccounting
R esearch B u lle tin No. 51 (New York: AICPA, A ugust, 1959),
p. 43.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
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(Rule 12.08) Schedule VII. Intangible Assets (Note 1)*
For the (period)
COL. A COL. B COL. C COL. D
Deductions
Note 5
COL. E COL. F
(1) (2)
Description
(Note 2)
Balance at
beginning
of period
Additions
at cost
describe
Charge to Charge to
profit and other accounts
loss or describe
Other changes
debit and/or
credit
Balance at
close of
period
(Note 3) (Note 4) Income describe
*U.S. Securities and Exchange Commission, "Form and Content of Financial Statements,"
Regulation S-X. August 1, 1966, p. 58.
( / )
( / )
141
Note 2. Show by m ajor c l a s s i f i c a t i o n s , such as
p a te n ts , o r g oodw ill. I f such c l a s s i f i c a t i o n i s n o t
p re s e n t o r p r a c tic a b le , t h i s may be s ta te d in one
amount. Ih e a d d itio n s in c lu d e d in column C s h a ll , how
e v e r, be se g re g ate d in acco rd an ce w ith an a p p ro p ria te
c l a s s i f i c a t i o n . Item s o f m inor im portance may be i n
clu d ed under a m isce llan e o u s c a p tio n .
Note 3. The b a lan ce a t th e b eg in n in g o f th e p e rio d
o f r e p o r t may be as p e r th e ac co u n ts. I f n e i th e r th e
t o t a l a d d itio n s n o r th e t o t a l re d u c tio n s d u rin g th e
p e rio d amount to more th a n 1 0 p e r c e n t o f th e c lo s in g
b a la n c e and a sta tem en t to t h a t e f f e c t i s made, columns
B, C, D and E may be o m itte d by any company o th e r th a n
a p u b lic u t i l i t y company. Any in fo rm a tio n re q u ire d by
Note 4 o r 5 s h a ll, however, be g iv en and may be in
summarized form.
Note 4 . If th e changes in accounts in column C
re p r e s e n t an y th in g o th e r th a n a d d itio n s from a c q u is i
tio n s , s t a t e c le a r ly th e n a tu r e o f th e changes and th e
o th e r accounts a f f e c te d . I f c o s t o f a d d itio n s r e p r e
s e n ts o th e r th an cash e x p e n d itu re s , e x p la in . I f
a c q u ire d from an a f f i l i a t e a t o th e r th an c o s t to th e
a f f i l i a t e , show such c o s t, p ro v id ed th e a c q u is itio n by
th e a f f i l i a t e was w ith in two y e a rs p r io r to th e a c q u i
s i t i o n by th e person f o r w hich th e sta te m e n t i s f i l e d .
Note 5. I f p ro v is io n f o r d e p re c ia tio n and a m o rti
z a tio n o f in ta n g ib le a s s e ts i s c re d ite d in th e books
d i r e c t l y to th e in ta n g ib le a s s e t acco u n ts, th e amounts
s h a l l be s ta te d in column D w ith e x p la n a tio n s , in c lu d
ing th e amounts to which ch arg ed .
(Rule 12.09) Schedule V III.
R eserves fo r D e p re c ia tio n and A m o rtizatio n
o f In ta n g ib le A ssets (Note 1 ) .
Note 1. In so fa r as amounts fo r d e p re c ia tio n and
a m o rtiz a tio n a re c re d ite d to th e in ta n g ib le a s s e ts
ac c o u n ts, such amounts s h a l l be shown in t h i s sch ed u le
o f in ta n g ib le a s s e ts , as th e r e re q u ire d .
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
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(Rule 12.09) Schedule VIII. Reserves for Depreciation and Amortization of Intangible Assets (Note 1)
For the (period)
COL. A COL. B COL. C
Additions
COL. D COL. E
(1) (2)
Description Balance at Charged to Charged to Deductions Balance at
(Note 2) beginning profit and other from close of
of period loss or accounts reserves period
(Note 3) income describe describe
*U.S. Securities and Exchange Commission, "Form and Content of Financial Statements,
II
Regulation S-X, August 1, 1966, p. 59.
■ D
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143
Note 2. I f p r a c tic a b le , r e s e rv e s s h a l l be shown
to co rresp o n d w ith th e c l a s s i f i c a t i o n in th e r e la te d
sc h e d u le o f in ta n g ib le a s s e t s .
Note 3 . The b a la n c e a t th e b eg in n in g o f th e p e rio d
o f r e p o r t may be as p e r th e a c c o u n t s . 24
The d if fe re n c e h e re i s t h a t th e AICPA ad v ises an
a n a ly s is o f th e d e b it d i f f e r e n t i a l f o r th e purpose o f
m aking a s u i t a b l e c l a s s i f i c a t i o n o f th e ite m on th e f in a n
c i a l s ta te m e n ts . R atio s and d e c is io n s made from a s t a t e
ment p rep ared acco rd in g to th e r u le s o f th e AICPA would be
more m e an in g fu l. Under th e SEC recom m endations, th e i n
ta n g ib le s could be p re se n te d in so many d if f e r e n t ways th a t
r a t i o s would be m eaningless and d e c is io n s would n o t be
v a lid b ecau se th e re i s a v a r i e t y o f m ethods o f p r e s e n ta
tio n .
Governm ental R e g u la tio n as a Roadblock
in A ccounting
P e rc iv a l Brundage d e s c rib e s governm ental r e g u la
tio n as a ro ad b lo ck in a c c o u n tin g . He comments:
The r i g i d i t y o f th e I n t e r s t a t e Commerce Commission’s
acco u n tin g c l a s s i f i c a t i o n s has undo u b ted ly p rev en ted
24
U.S. S e c u ritie s and Exchange Commission, "Form
and C ontent o f F in a n c ia l S ta te m e n ts ," R eg u latio n S-X.
August 1, 1966, pp. 58, 59.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
144
r a ilr o a d a cc o u n tin g from d e v elo p in g as f a s t as in d u s
t r i a l a c c o u n tin g . The F e d e ra l Power Commission’s
co n cep t o f " o r ig in a l c o s t" has removed th e p la n t
account f ig u r e in th e u t i l i t y b a la n c e s h e e t as f a r as
p o s s ib le from any c u rre n t s ig n if ic a n c e . The l im i ta
tio n s on th e r a t e s o f our r a ilr o a d s u n d er governm ent
r e g u la tio n red u ced e x p e rim e n ta tio n w ith new develop
m ents t h a t m ight have p rev en ted p a r t o f th e d iv e rs io n
o f p a sse n g er and f r e ig h t t r a f f i c to p la n e s , b u sses,
and p r iv a te c a r s .
A lthough SEC r e g u la tio n has f o r th e m ost p a rt
follow ed c o n s tr u c tiv e lin e s , and th e Commission in
g e n e ra l has r e f r a in e d from la y in g down r e s t r i c t i v e
acc o u n tin g r u l e s , th e re n e v e rth e le s s has been a te n
dency to oppose in n o v a tio n s and new forms o f r e p o r ts .
M y su g g e stio n f o r improvement in t h i s f i e l d i s to u rg e
more l a t i t u d e in acco u n tin g tre a tm e n t to m eet changing
c o n d itio n s as th ey a r is e .
The m ain f a u l t o f th e F e d e ra l Power Commission u n i
form system , from th e p o in t o f view o f g e n e r a lly accepted
acco u n tin g p r in c ip le s , i s th e change in e n p h asis from th e
u s u a l id e a o f a c tu a l c o s t to th e p re s e n t owner to th e id e a
o f " o r ig in a l c o s t" to th e person by whom th e p ro p e rty was
f i r s t devoted to s e iv ic e . T his change lim its th e u s e f u l
n e ss o f th e a cc o u n tin g system to management. This change
a ls o d is c rim in a te s betw een in v e s to rs who have fin an c ed
funds to c o n s tru c t u t i l i t y a s s e ts and in v e s to r s who have
purchased th e s e a s s e ts from o th e r p a r t i e s . Such s p e c ia l
O C
P e rc iv a l Brundage, "Roadblocks in th e Paths o f
A cco u n tin g ," H arvard B usiness Review, XXIX (Septem ber,
1951), 116.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
145
acco u n tin g r u le s make changes in th e ow nership o f u t i l i t y
p r o p e r tie s u n f e a s ib le .
Summary
P u b lic u t i l i t i e s have as t h e i r p r in c ip a l theme
p u b lic i n t e r e s t and th e r e f o r e in c u r s e rv ic e o b lig a tio n s and
f in a n c ia l r e s t r a i n t s . H ib lic u t i l i t i e s cannot e s ta b li s h
t h e i r own p r ic e s . R eg u lato ry ag en cie s have a d u ty to
r e g u la te r a te s when c i ti z e n s a re engaged in a b u s in e s s upon
which o th e r c itiz e n s depend. T his income c o n tro l i s th e
m ajor d if fe re n c e betw een re g u la te d p u b lic u t i l i t i e s and
p r iv a te b u s in e s s .
R ib lie u t i l i t i e s have b o u n d aries on "re a so n a b le
r a te s " and " f a i r r e t u r n s ." R easonable r a t e s a re th o se
r a t e s which w i l l p ro v id e th e u t i l i t y th e n e c e ss a ry rev en u es
to co v er th e ad eq u ate c o s ts and to b rin g a " f a i r r e tu r n " on
th e " f a i r v a lu e " o f th e p r o p e r tie s u sed .
A f a i r r a t e o f r e tu r n i s d i f f i c u l t to d e f in e . I t
can n o t be th e same in ev ery in s ta n c e b u t changes w ith th e
c o n d itio n s and l o c a l i t i e s . The problem in com puting th e
f a i r r a t e o f r e tu r n re v o lv e s about w hether g o o d w ill sh o u ld
be in c lu d ed in th e p ro p e rty . U t i l i t i e s w i l l be a b le to
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
146
charge a h ig h e r r a t e i f g o o d w ill i s in c lu d e d . In some
firm s, going v a lu e and g o o d w ill a re th e same. The m a jo rity
o f th e u t i l i t i e s have th e g e n e ra l c h a r a c t e r i s t i c s o f a
going con cern .
The F e d e ra l Power Commission i s a governm ent agency
which r e g u la te s th e r a te s o f e l e c t r i c power and n a tu r a l gas
companies th a t engage in i n t e r s t a t e commerce and s e l l a t
w h o lesale f o r r e s a l e .
The FPC and o th e r re g u la to ry a g e n cie s have th e
u n u su al a c co u n tin g f e a tu r e o f re c o rd in g p la n t a c q u ire d a t
o r ig in a l c o s t. O rig in a l c o s t i s d e fin e d as th e c o s t o f
p ro p e rty to th e p erso n f i r s t d ev o tin g i t to p u b lic s e r v ic e .
However, th i s d e f i n i t i o n i s c o n tra ry to c o s t as d e fin e d by
th e American I n s t i t u t e o f C e r tif ie d P u b lic A cco u n tan ts.
The d if f e r e n c e betw een c o s t to th e u t i l i t y a c q u ir
ing o p e ra tin g u n its and th e o r ig in a l c o s t i s re c o rd e d in
an a c q u is itio n ad ju stm e n t ac c o u n t. This acco u n t i s to be
d isp o sed o f as th e Commission may approve o r d i r e c t .
The in ta n g ib le elem ent o f t h i s a c q u is itio n a d j u s t
ment account p re s e n ts a problem . Hie FPC has no r i g i d
req u irem e n ts co n cern in g th e p ro p e r tre a tm e n t in su b seq u en t
acco u n tin g o f th e p o rtio n o f th e t o t a l c o s t which has been
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
147
s e t a s i d e a s an i n t a n g i b l e . U t i l i t y a c c o u n tin g i s now i n
t h e sam e p o s i t i o n a s c o n v e n tio n a l a c c o u n tin g . Ih e d o o r h a s
b e e n o p en ed f o r v a r io u s a l t e r n a t i v e m e th o d s.
The I n t e r s t a t e Commerce Commission a t one tim e was
in c o n f l i c t w ith th e r a i l r o a d s . The ICC w anted to lim it
th e v a lu a tio n to c o s t le s s "accrued d e p r e c ia tio n " and th e
r a ilr o a d s w anted to u se p re s e n t v a lu e s f o r t h e i r p r o p e r tie s ,
le s s "ob serv ed " d e p r e c ia tio n . In 1936, th e N a tio n a l A sso c i
a tio n o f R a ilro a d and U t i l i t i e s Com m issioners adopted th e
p r in c ip l e o f d e p re c ia tio n acco u n tin g and is s u e d a re v is e d
c l a s s i f i c a t i o n o u tlin in g i t s view s.
R eg u lato ry b o d ie s a re n o t alo n e in t h e i r c o n f lic ts .
The American I n s t i t u t e o f C e r tif ie d P u b lic A ccountants and
th e S e c u r itie s and Exchange Commission a re n o t in ex act
agreem ent. The SEC only re q u ire s th e r e p o r tin g company to
d is c lo s e th e amount and d is p o s itio n o f th e d e b it d if f e r e n
t i a l in c o n s o lid a te d b a la n c e s h e e ts . The AICPA ad v ises an
a n a ly s is o f th e d e b it d i f f e r e n t i a l f o r th e purpose of
making a s u ita b le c l a s s i f i c a t i o n of th e ite m on th e f in a n
c i a l s ta te m e n ts .
U n c le a r p o l ic y and in a d e q u a te a d m i n i s t r a t i v e p r o v i
s io n s t o c a r r y o u t th e p o l ic y a r e r e a s o n s t h e r e g u l a t i o n
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148
o f p u b lic r a te s have n o t been p a r t i c u l a r ly s a t i s f a c t o r y .
Government r e g u la tio n has been c o n sid e re d a ro a d
b lo ck in acco u n tin g in t h i s r e s p e c t and th e re i s a tendency
to oppose in n o v a tio n s and new forms o f r e p o r ts . The m ain
f a u l t found w ith th e re g u la to ry agencies* ac c o u n tin g
methods is th e change in em phasis from th e u s u a l id e a o f
a c tu a l c o s t to th e p re s e n t owner to th e id e a o f " o r ig in a l
c o s t" to th e p erso n by whom th e p ro p e rty was f i r s t devoted
to s e rv ic e . This ty p e o f s p e c ia l acco u n tin g r u l e makes
change o f ow nership o f u t i l i t y p r o p e r tie s u n f e a s ib le .
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
CHAPTER VI
RECENT PRACTICES IN REPORTING A N D ACCOUNTING
FOR GOODW ILL
The o b je c tiv e o f t h i s stu d y i s to d is c u s s th e d i f
fe re n c e betw een c o s t p a id f o r a company and th e book v a lu e
o f t h a t company, and th e v a ry in g e f f e c t s t h i s d if fe re n c e
has on th e c o n s o lid a te d f in a n c ia l s ta te m e n ts . The p rev io u s
c h a p te rs p re s e n te d th e th e o r e t i c a l co n cep ts and government
re g u la tio n s f o r u t i l i t i e s . This c h a p te r w i l l p re s e n t
re c e n t ac co u n tin g p r a c tic e s f o r re p o r tin g p o s itiv e g o o d w ill
and n e g a tiv e g o o d w ill. The t h e o r e t i c a l co n cep ts and th e
p r a c t i c a l co n cep ts w i l l b e examined f o r p u rp o ses o f com
p a ris o n .
The f in a n c ia l s ta te m e n ts and th e n o te s th e re to o f
two hundred f o r ty U nited S ta te s C o rp o ratio n s w ere examined.
Two hundred f o r ty c o rp o ra tio n s w ere used b ecau se i t was
b e lie v e d th a t t h is number would c o n s titu t e a r e p r e s e n ta tiv e
sam ple o f th e U nited S ta te s c o rp o ra tio n s w hich a re re q u ire d
149
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150
to f i l e p u b lic sta te m e n ts o f t h e i r f i n a n c i a l c o n d itio n s
and o p e ra tio n s . I t i s th e w rite r* s b e l i e f th a t t h i s p a r
t i c u l a r number o f com panies w i l l be s u f f i c i e n t to p erm it
p ro p er com parison.
S e le c tio n o f th e Companies
Ih e F o rtu n e 500^ and th e 1964 D ire c to ry o f Ccxn-
p an ies F ilin g Annual R eports w ith th e S e c u r itie s and
2
Exchange Commission w ere u sed as th e so u rce s f o r th e
s e le c tio n o f th e com panies. The D ire c to ry o f th e S e c u ri
t i e s and Exchange Commission l i s t s a t o t a l o f 4,493 com
p an ies .
Ih e t o t a l number o f m an u factu rin g com panies l i s t e d
in th e D ire c to ry i s 2 ,1 4 5 . Of th e two hundred f o r ty com
p an ies s e le c te d , over two hundred a re m a n u factu rin g com
p a n ie s. The two hundred f o r ty companies co m p risin g t h i s
sam ple r e p r e s e n t ap p ro x im ately 1 0 p e r c e n t o f th e m anufac
tu rin g com panies l i s t e d in th e D ire c to ry .
^The F o rtu n e 500. Time, I n c ., 1965.
2
S e c u r itie s and Exchange Commission, D ire c to ry o f
Companies F ilin g Annual R eports w ith th e S e c u r itie s and
Exchange Commission (W ashington, D .C .: SEC, 1964).
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151
These two hundred f o r t y companies w ere s e le c te d on
th e b a s is o f t h e i r s iz e and im portance in th e econom ic and
f in a n c ia l environm ents. S iz e ta k e n h e re r e f e r s to th e
e s tim a te d d o lla r s o f an n u al s a l e s . The F o rtu n e 500 was
used as a b a s is f o r choosing com panies acco rd in g to s iz e .
A few c o m p a n ie s, n o t l i s t e d a s m a n u fa c tu rin g , w e re s e l e c t e d
b e c a u s e o f th e p e c u l i a r i t y o f t h e i r tr e a tm e n t o f a c c o u n tin g
f o r g o o d w ill.
Ih e groups and com panies w ith in th e s e groups w ere
s e le c te d on th e fo llo w in g c l a s s i f i c a t i o n c r i t e r i a :
F undam entally, th e in d u s try groups w ere based upon
th e c l a s s i f i c a t i o n as d ev elo p ed by th e o f f ic e o f
S t a t i s t i c a l Standards o f th e Bureau o f th e Budget,
E x ecu tiv e O ffice o f th e P re s id e n t, and p u b lis h e d in
1957 as th e "S tandard I n d u s tr ia l C la s s if ic a tio n
M anual."
The o rg a n iz a tio n o r u n i t c l a s s i f i e d c o n s is te d o f th e
company and a l l s u b s id ia r ie s in clu d ed in th e c o n s o li
d a ted f in a n c ia l s ta te m e n ts su b m itted to th e S e c u r itie s
and Exchange Commission.
In g e n e ra l each company was c l a s s i f i e d on th e b a s is
o f i t s m ajor a c t i v i t y w hich was determ ined by th e
p ro d u ct o r group o f p ro d u c ts produced o r h an d led , o r
s e rv ic e s ren d ered . The m ajo r lin e o f a c t i v i t y as
r e f le c te d by th e g ro ss rev en u es o f th e company was
th e p r in c ip a l c r i t e r i o n u sed in c la s s if y in g th e
company. ^
^ I b i d . , pp. i i - i i i .
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152
Collection of Data
The in fo rm a tio n u sed in t h i s stu d y was tak en from
th e annual f in a n c ia l r e p o r ts o f two hundred f o r ty com panies.
These an n u al r e p o r ts were re a d m o stly from m icro card s
a v a ila b le in th e B usiness A d m in is tra tio n L ib ra ry o f th e
U n iv e rs ity o f C a lifo rn ia a t Los A ngeles. I n te r p r e ta tio n s
and a n a ly se s o f th e s e d a ta a r e d is c u s s e d in th e rem aining
p a r ts o f t h i s c h a p te r.
E xcerpts from P u b lish ed Annual R eports
P o s itiv e G oodw ill
The fo llo w in g e x c e rp ts from th e annual r e p o r ts o f
c e r ta in firm s in d ic a te t h a t many o f th e problem s d is c u s s e d
in th e p re v io u s c h a p te rs have been reco g n ized in p r a c tic e .
C u rren t p r a c tic e , however, o f te n d e v ia te s from th e o ry .
An in te r e s ti n g p r e s e n ta tio n o f p o s itiv e g o o d w ill
o fte n ta k e s p la c e in th e In v estm en t and O ther A ssets s e c
tio n o f th e c o n s o lid a te d s ta te m e n t. Two in te r e s ti n g
approaches ap p ear in th e s ta te m e n ts o f th e H. J . Heinz
Company and th e Mead C o rp o ratio n .
The H. J . Heinz Company shows th e fo llo w in g e n try :
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153
Investments and Other Assets
Excess o f in v estm en ts in c o n s o lid a te d
s u b s id ia r ie s over n e t a s s e ts a t a c q u is i
tio n . 4
The Mead C o rp o ratio n annual r e p o r t c o n ta in s th e
fo llo w in g e n try :
Investm ents and O ther A ssets
E quity in n e t a s s e ts o f and advances to
a f f i l i a t e d companies (n o te A).
Note A. B asis o f C o n so lid a tio n .
Ih e acco u n ts o f d om estic s u b s id ia r ie s , a l l
o f which a re 1 0 0 % owned, a re c o n s o lid a te d
in th e acccxnpanying f i n a n c ia l s ta te m e n ts ;
f o re ig n s u b s id ia r ie s a r e n o t c o n s o lid a te d .5
I t w i l l be n o ted t h a t in th e H. J . Heinz c a se , th e
n a tu re o f th e a s s e t i s e x p lain e d w ith in th e body o f th e
b a lan ce s h e e t. However, th e Mead Company p ro v id es th e
re a d e r w ith ample e x p la n a tio n in a n o te . Ih e Heinz Company
le av es th e re a d e r in a s t a t e o f c o n fu sio n .
A nother approach i s to in c lu d e th e p o s itiv e good
w i l l in th e c o n s o lid a te d fix e d a s s e ts . T his method i n d i
c a te s th a t th e s u b s id ia r y 's ta n g ib le a s s e ts a re b e lie v e d
^H. J . Heinz Company, Annual R ep o rt. 1964,
pp. 16-17
5
pp. 28-32.
^Ihe Mead C o rp o ratio n , Annual R ep o rt. 1965,
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154
to be w orth more th a n th e book v a lu e a t d a te o f a c q u is itio n
o r t h a t such an account i s a co n v e n ien t p la c e to bury th e
ex c ess. This p r e s e n ta tio n i s i l l u s t r a t e d in th e H ertz
C o rp o ratio n an n u al r e p o r ts u n d er th e fo llo w in g h ead in g :
P ro p e rty , Equipment and I n ta n g ib le s , At C ost:
Cost o f in v estm en t in s u b s id ia r ie s in
excess o f u n d e rly in g e q u ity , b ein g amor
tiz e d .®
There was no fo o tn o te to th e H ertz f in a n c ia l s t a t e
m ent.
Some com panies change t h e i r method o f p re s e n tin g
g o o d w ill from one y e a r to a n o th e r. The Com P roducts Com
pany in 1962 re p o rte d g o o d w ill in th e fo llo w in g m anner:
O ther A ssets and D eferred Item s
G oodw ill, P a te n ts le s s a m o rtiz a tio n .^
However, in 1963, th e p r e s e n ta tio n was changed to
th e fo llo w in g :
O ther A ssets
G oodw ill, e t c . ^
^The H ertz C o rp o ratio n , Annual R ep o rt. 1965, p . 18.
^Com P roducts Company, Annual R eport, 1963, p. 10.
Q
Com P roducts Company, Annual R eport, 1962, p . 10.
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155
At l e a s t in 1963 th e d e fe rre d item s a re n o t b u rie d
along w ith in ta n g ib le s . A p ro p er a n a ly s is can be made i f
one has a need to u se th e 1963 p r e s e n ta tio n .
Most com panies d id n o t u se th e term g o o d w ill. Two
firm s who u sed a s e p a ra te g o o d w ill e n try in th e annual
r e p o r ts w ere th e Jew el Tea Company and th e P ills b u ry Com
pany. The Jew el Tea Company reco rd ed th e item sim ply a s ;
Goodw ill^
The P ills b u r y Company s e t f o r th th e item s e p a ra te ly
as fo llo w s :
G oodw ill a r is in g from c o n s o lid a tio n
(Note 1 ).
Note 1 r e f e r r e d to in th e above e x c e rp t re a d s as fo llo w s :
Note 1. P rin c ip le s o f c o n s o lid a tio n .
The c o n s o lid a te d f in a n c ia l sta te m e n ts i n
clu d e th e acco u n ts o f th e p a re n t company
and i t s dom estic and fo re ig n s u b s id ia r ie s .
The g o o d w ill a r is i n g upon c o n s o lid a tio n
re p re s e n ts th e excess o f c o s t over e q u ity
in u n d erly in g n e t a s s e ts a t d a te s o f a c q u i
s i t i o n . T his g o o d w ill i s n o t co n sid ered
to be s u b je c t to d im in u tio n in v a lu e and is
n o t b eing am o rtized .
9
Jew el Tea Company, Annual R eport, 1964, p . 12
10
P ills b u r y Company, Annual R eport, 1965, pp. 12, 14.
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156
Of th e s e two p re s e n ta tio n s , i t ap p ears t h a t th e
P ills b u r y Company p ro v id es th e re a d e r w ith more in fo rm a
tio n . Y et, e x c e p t in a v e ry few c a se s , a c c o u n ta n ts d id n o t
u se th e term g o o d w ill to d e s c rib e th e excess o f c o s t over
book v a lu e on th e fa c e o f th e c o n s o lid a te d b a la n c e s h e e t.
There w ere tim e s when th e e x p la n a tio n was p re s e n te d in th e
n o te s .
T able 2 p re s e n ts th e number o f m ethods u sed in
c la s s if y in g th e excess o f c o s t over book v a lu e on th e b a l
ance s h e e t. T w enty-six com panies have c l a s s i f i e d excess
c o s t over book v a lu e s in seven d if f e r e n t ways. H iis same
c l a s s i f i c a t i o n was ex p lain ed in th e n o te s to th e f in a n c ia l
sta te m e n t s ix te e n tim es. However, as seen in T able 3, th e
term "ex cess c o s t over book v a lu e " i t s e l f does n o t ap p ear
on th e b a la n c e s h e e t b u t i s re p re s e n te d by seven o th e r
c l a s s i f i c a t i o n s which s t a t e "See n o te ." A lthough t h i s term
has th e a p p ro v a l o f th e th e o r e tic ia n s , i t ap p ears th a t
s in c e i t i s p re se n te d u n d er so many d if f e r e n t m ethods,
re a d e rs would have a d i f f i c u l t tim e making an i n t e r p r e t a
tio n .
The m ethod of n o tin g c o s t in excess o f book v a lu e
i s i l l u s t r a t e d in th e b a la n c e s h e e ts o f S tandard Brands
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157
TABLE 2
VARIOUS CLASSIFICATIONS APPEARING O N THE BALANCE SHEET
UNDER W HICH EXCESS COST OVER BOOK VALUE APPEARS
C la s s if ic a tio n
Number
o f
Companies
Companies
S ta tin g
Amount
i s Being
A m ortized
Companies
S ta tin g
Amount is
Not Being
A m ortized
D eferred Charge 2
S e p a ra te ly S et F o rth 12 3 3
In ta n g ib le A ssets
5
1
D eferred Charge and
O ther A sse ts 1 1
O ther A sse ts 3
Investm ents and O ther
A ssets 2
P ro p erty P la n t and
Equipment and
In ta n g ib le s a t Cost 1
T o ta l 26 4 4
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158
TABLE 3
EXCESS COST OVER BO O K VALUE APPEARING IN THE NOTES
TO THE STATEMENTS BUT UNDER A DIFFERENT CAPTION
O N THE BALANCE SHEET
C la s s if ic a tio n
Number
o f
Companies
Companies
S ta tin g
Amount
i s Being
A m ortized
Companies
S ta tin g
Amount i s
Not Being
A m ortized
D eferred Charge 2 1
Goodwill Brands and
Trademarks 2 1
Goodwill and o th e r
In ta n g ib le s 1 1
O ther A ssets In ta n g ib le s 4 1 1
P la n t and Equipment 2
In ta n g ib le s 4 1
Goodwill 1
T o tal 16 3 3
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159
P ain t Company and S u b sid ia ry and C h ry sle r C o rp o ratio n s and
C o n so lid ated S u b s id ia rie s . Standard Brands P a in t Company
and S u b sid ia ry re p o rte d as fo llo w s:
Excess o f c o s t o f a c q u irin g s u b s id ia ry over r e la te d
book v a lu e o f n e t ta n g ib le a s s e ts (Note 1 ).
Note 1.
In J u ly 1961, th e company a c q u ire d a l l o f th e
o u tsta n d in g sto c k o f S tan d ard Brands P a in t
Company o f C a lifo rn ia (fo rm erly S tandard Brands
P ain t Company, I n c .) a t a t o t a l c o s t o f
$ 5 ,4 0 8 ,1 5 2 . The excess o f s a id c o s t over th e
book v a lu e o f th e acq u ired s u b s id ia r y ’ s n e t
ta n g ib le a s s e ts amounted to $ 2 ,8 2 0 ,7 5 5 . Since
th e re i s no in d ic a tio n t h a t th e liv e s o f th e
in ta n g ib le a s s e ts re p re s e n te d by such excess i s
lim ite d , management does n o t in te n d to am o rtize
s a id c o s t.
C h ry sler C o rp o ratio n and C on so lid ated S u b s id ia rie s re p o rte d
in t h i s m anner:
Excess o f Cost o f Investm ent in C o n so lid ated
S u b s id ia rie s Over E q u itie s in N et A ssets a t Dates
o f A c q u is itio n , bein g am ortized o v er p e rio d s n o t
exceeding 2 0 y e a rs .
The same item has been p re se n te d in th e c o n s o li
dated b a la n c e s h e e t under ap p ro x im ately th e same c a p tio n .
However, one company b e lie v e s th a t th e liv e s o f che in ta n
g ib le s re p re s e n tin g th is excess a re n o t lim ite d and i t
11
Standard Brands P ain t Company, Annual R eport,
1962, pp. 11, 12.
12
C h ry sle r C o rp o ratio n , Annual R eport, 1964, p. 18.
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160
does n o t in te n d to am o rtize th e c o s t. A notner b e lie v e s th e
excess should be am o rtized over a p e rio d n o t exceeding
tw enty y e a rs . I t i s im p o ssib le f o r a r e a d e r o f such s t a t e
ments to make p ro p e r d e c is io n s when com panies do n o t h an d le
th e same in fo rm a tio n in th e same m anner.
A few com panies u se th e c a p tio n " c o s t o f in vestm ent
in excess o f book v a lu e " b u t th e c l a s s i f i c a t i o n on th e b a l
ance sh e e t d i f f e r s . These companies c l a s s i f y p o s itiv e
g o o d w ill as d e fe rre d c h a rg e s. T his m ethod is d e p ic te d in
th e annual r e p o r ts o f H a r r is - I n te r ty p e C o rp o ratio n and th e
U nited S ta te s Rubber Company. H a r r is - I n te r ty p e C o rp o ratio n
reco rd s th e fo llo w in g :
D eferred Charges
C ost o f Investm ent in S u b s id ia rie s Over E quity
(U nam ortized p o r tio n ) . ^
The U nited S ta te s Rubber Company p re s e n ts th e same
in fo rm atio n in i t s b a la n c e sh e e t in th e fo llo w in g m anner:
14
D eferred Charges
13
H a r r is - I n te r ty p e C o rp o ratio n , Annual R eport,
1964, p. 20.
14
U nited S ta te s Rubber Company, Annual R eport,
1964, p. 24.
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161
The com position o f th e d e fe rre d ch arg e account was
n o t g iv en on th e b a la n c e s h e e t n o r was th e r e a fo o tn o te .
However, in th e n o te s to th e f in a n c ia l sta te m e n ts th e f o l
low ing ap p ears :
D eferred ch arg es in c lu d e $1,290,000 re p re s e n tin g
th e excess o f c o s t over n e t a s s e ts a t d a te s o f
a c q u is itio n f o r c e r t a in s u b s id ia r ie s .^ ^
Eastman Kodak Company does n e t r e f e r to p o s itiv e
g o o d w ill o f any ty p e on i t s c o n s o lid a te d b a la n c e s h e e t, b u t
in th e n o te s to th e f in a n c ia l sta te m e n ts th e fo llo w in g
ap p ears :
The company*s e q u ity in th e n e t a s s e ts o f th e
fo re ig n s u b s id ia ry com panies was $250,493,000,
and i t s e q u ity in t h e i r 1964 e a rn in g s was
$ 3 1 ,347,000.15
Only in two ca ses was th e re a re fe re n c e in th e
a u d ito rs * o p in io n about g o o d w ill. The a u d ito rs o f The
Baldwin M ontrose Chemical Company ex p ress th e fo llo w in g in
t h e i r o p in io n p arag rap h o f th e a u d ito rs * r e p o r t.
]h our o p in io n , s u b je c t to th e r e a l i z a t io n o f th e
in ta n g ib le a s s e t o f $ 2 ,004,154, d is c u s s e d in Note 5 to
th e c o n s o lid a te d f in a n c ia l s ta te m e n ts , th e accompany
in g c o n s o lid a te d b a lan c e sh e e t p re s e n ts f a i r l y th e
^^I b id ., p. 27.
Eastman Kodak Company, Annual R e p o rt. 1964, p. 34.
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162
f in a n c ia l p o s itio n o f Baldw in-M ontrose Chem ical Com
pany, In c o rp o ra te d and S u b s id ia rie s . . . .1 ?
Note 5 r e f e r r e d to in th e a u d ito rs * o p in io n o f
Baldw in-M ontrose i s as fo llo w s ;
Note 5. I n ta n g ib le A ssets A p p lic a b le to T alen t
Agency B u sin ess.
Ih e in ta n g ib le a s s e ts a p p lic a b le to th e Com
pany * s t a l e n t agency b u sin e ss in c lu d e $1,634,894
r e p r e s e n tin g th e excess o f c o s t o v er u n d erly in g
book v a lu e o f G eneral A r t is ts C o rp o ratio n com
mon s to c k w hich was purchased as o f O ctober 13,
1960. . . .
. . . R e a liz a tio n o f th e in ta n g ib le a s s e ts o f
$2,0 0 4 ,1 5 4 a p p lic a b le to th e t a l e n t agency
b u s in e s s i s dependent upon s u c c e s s fu l f u tu re
o p e ra tio n s o f th is b u s in e s s . These in ta n g ib le
a s s e ts a r e n o t p re s e n tly b ein g am o rtized .
On a few b a la n c e s h e e ts th e p o s itiv e goodw ill was
c l a s s i f i e d as o th e r a s s e t s . Under th e c a p tio n " o th e r
a s s e ts " th e p o s itiv e g o o d w ill was reco rd ed in two ways.
One method was as a s e p a r a te item . In th e second method,
p o s itiv e g o o d w ill was in c lu d e d w ith o th e r ite m s . The
excess of c o s t o v er book v a lu e as a s e p a ra te c a p tio n under
o th e r a s s e ts is p re s e n te d in th e b alan c e s h e e ts o f W esting-
house E le c tr ic C o rp o ratio n and S ig n al O il and Gas Company.
17
Baldwin M ontrose Chemical Company, Annual R eport,
1962, p. 12.
18
I b id . , p. 11.
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163
W estinghouse E le c tr ic C o rp o ratio n r e p o r ts as fo llo w s:
O ther A ssets
P urchase p r ic e o f going b u s in e s s e s acq u ired in
excess o f t h e i r n e t ta n g ib le a s s e ts . ^
S ig n al O il and Gas Company u se s th e same method as
W estinghouse b u t a n o te to th e f in a n c ia l sta te m e n ts is
used.
O ther A ssets
In ta n g ib le s (a t c o s t le s s accum ulated a m o rtiz a
tio n ) (Note 4 ).
Note 4 . In ta n g ib le s
In ta n g ib le s c o n s is t p r in c ip a lly o f th e un
am o rtized excess c o s t r e l a t i n g to th e G arret
a c q u is itio n and th e unam ortized excess c o s t o f
th e company’s investm ent in two s u b s id ia r ie s
o v er th e n e t a s s e ts o f such s u b s id ia r ie s a t
th e d a te s o f t h e i r a c q u is itio n . These in ta n
g ib le s a re b eing am ortized o v er tw e n ty -fiv e
y e a rs . A m o rtizatio n of a l l in ta n g ib le s during
1964 amounted to ap p ro x im ately $950,000.^0
H iere w ere o ccasio n s when th e excess o f c o s t over
book v a lu e was in c lu d e d w ith o th e r item s under th e c a p tio n
"o th e r a s s e t s . " I h is method i s ex p ressed in th e A llie d
Chemical C o rp o ra tio n ’s Balance Sheet.
19
W estinghouse E le c tr ic C o rp o ratio n , Annual R eport.
1964, pp. 23-25.
p. 26.
20
S ig n a l O il and Gas Company, Annual R eport. 1964,
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
164
Other Assets
P a te n ts , P ro c e sse s, Trade Marks, G oodw ill, e t c . ,
a t c o s t . 2 1
P ro c te r and Gamble d e p ic t th e same in fo rm a tio n in
th e fo llo w in g m anner:
O ther A ssets
Sundry In v estm en ts, lo a n s, and re c e iv a b le s
G oodw ill, p a te n ts , and lic e n s e s
P repaid expenses and d e fe rre d c h a r g e s .2%
Some w r ite r s a re o f th e o p in io n t h a t i f th e c o s t
to th e p a re n t i s g r e a te r th a n th e u n d e rly in g book v alu e
because o f th e s u b s id ia r y ’ s unbooked in ta n g ib le s , th e
amount may be charged to o th e r in ta n g ib le a s s e t s . A lso, i f
th e p a r e n t’s a c q u is itio n o f th e s u b s id ia ry w i l l p ro v id e th e
p a re n t w ith s u p e rio r ea rn in g power, th e amount may be
charged to in ta n g ib le s . However, c l a s s i f i c a t i o n as an i n
ta n g ib le ta k e s on v a rio u s form s.
For exam ple, a few b a la n c e s h e e ts in c lu d e d th e ca p
tio n , " in ta n g ib le s a t c o s t" b u t no eicp lan atio n o f th e
com position o f th e c a te g o ry was made. This method is
^ ^ A llied Chemical C o rp o ratio n , Annual R eport, 1962,
p. 18.
22
P ro c te r and Gamble Company, Annual R eport. 1964,
p. 1 2 .
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
165
d e sc rib e d in th e b a la n c e sh e e ts o f th e American B ro ad c ast
in g Company and th e Borden Company and C o n so lid ated Sub
s i d i a r i e s :
American B ro ad castin g Company
oo
I n ta n g ib le s , a t c o s t
Ihe Borden Company and C o n so lid ated S u b s id ia rie s
In ta n g ib le s ^ ^
B alance s h e e ts w ith a s e c tio n d e s ig n a te d as an
in ta n g ib le and in c lu d in g goodw ill along w ith o th e r item s
b u t as a s e p a r a te item a re p re se n te d in th e sta te m e n ts o f
G eneral Foods C o rp o ra tio n :
In ta n g ib le s
P a te n ts , L ice n ses, and Form ulas, le s s a m o rtiz a
tio n . G oodw ill (on a c q u is itio n s s in c e f i s c a l
195 4 ).2 5
In a n o th e r c a se goodw ill was lumped w ith o th e r
in ta n g ib le s u n d er th e c a p tio n , "G oodw ill and Other In ta n
g ib le s ." This method i s d e sc rib e d in th e b a la n c e s h e e t o f
th e American Can Company:
23
American B ro ad castin g Company, Annual R eport,
1964, p. 24.
24
The Borden Company, Annual R ep o rt, 1963, p. 12.
25
G eneral Foods C o rp o ratio n , Annual R eport. 1963,
p. 18.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
166
2 6
Goodwill and O ther In ta n g ib le A ssets
In s t i l l o th e r b a la n c e s h e e ts g o o d w ill was lumped
w ith o th e r in ta n g ib le s . T his method i s u sed by th e Ameri
can Tobacco Company :
27
Brands, tra d e -m a rk s, p a te n ts , g o o d w ill, e tc .
The Benrus Watch Company d e s c rib e s g o o d w ill under
th e fo llo w in g c a p tio n :
28
In ta n g ib le s o f S u b s id ia rie s A cquired.
C onfusion o f th e re a d e r o f th e s e sta te m e n ts is a l
m ost in e v ita b le . How does one d is tin g u is h betw een g o o d w ill
and th e o th e r in ta n g ib le s in some o f th e s e cases?
The Botany I n d u s tr ie s , In c. fo llo w a s im ila r p a t
te r n . However, Botany I n d u s tr ie s l i s t th e g o o d w ill as an
in ta n g ib le w ith an e x p la n a tio n p re se n te d in th e n o te s .
In ta n g ib le A sse ts--N o te 7 5,515,000
Note 7.
In ta n g ib le a s s e ts in c lu d e d $4,268,000 r e p r e
s e n tin g th e excess o f p u rch ase p r ic e over th e
u n d erly in g book e q u ity as a t th e d a te s o f
p. 16.
26
American Can Company, Annual R eport, 1963, p. 26.
27
American Tobacco Company, Annual R eport, 1963,
2 8
Benrus Watch Company, Annual R ep o rt. 1964, p . 18.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
167
a c q u is itio n o f s u b s id ia r ie s , le s s a m o rtiz a tio n .
The b a lan ce ($ 1 ,2 4 7 ,0 0 0 ) o f in ta n g ib le a s s e ts
r e p re s e n ts p r in c ip a lly p a te n ts (n e t o f a m o rti
z a tio n ) , trad em ark s and tra d e nam es.
P a te n ts a re g e n e ra lly c l a s s i f i e d as in ta n g ib le s and
a n o te r e f e r r in g to in ta n g ib le s as s p e c i f i c a l l y p a te n ts ,
trad em ark s, and tra d e names would seem in a p p ro p r ia te in a
d is c u s s io n o f g o o d w ill i f i t w ere n o t fo r th e fo llo w in g
c a p tio n in th e b ala n ce s h e e t o f th e I n te r n a tio n a l B usiness
Machines C o rp o ratio n :
30
P a te n ts and G oodw ill . . . le s s a m o rtiz a tio n .
Now a re a d e r o f th e sta te m e n ts sh o u ld b e th o ro u g h ly
co n fu sed . What should be in c lu d ed in in ta n g ib le a s s e ts and
w hat should b e o m itted i s d i f f i c u l t to d e term in e from th e s e
s ta te m e n ts .
T able 4 p re s e n ts f iv e d if f e r e n t m ethods by which
in ta n g ib le s p e r ta in in g to g o o d w ill have been p re s e n te d on
f in a n c ia l sta te m e n ts . T w enty-four companies u sed one of
th e s e f iv e m ethods.
W algreen Drug Company and O tis E le v a to r Company
27.
9 Q
Botany I n d u s tr ie s , Annual R eport, 1964, pp. 22,
30
I n te r n a tio n a l B usiness M achines, Annual R eport,
1965, p . 32.
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168
TABLE 4
THE VARIOUS M ETH O D S BY W HICH INTANGIBLES ARE PRESENTED
O N THE BALANCE SHEET
C la s s if ic a tio n
Number o f
Companies
In ta n g ib le s a t c o s t w ith e x p la n a tio n
co n cern in g co m position 6
S e ctio n d e s ig n a te d as an in ta n g ib le , and
g o o d w ill in c lu d e d as a s u b -s e c tio n 3
G oodw ill and o th e r in ta n g ib le s 6
In ta n g ib le s o f s u b s id ia r ie s ac q u ired 3
L is te d as in ta n g ib le a s s e ts and an
e x p la n a tio n p re se n te d in th e n o te s 6
T o tal 24
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
169
record p o sitiv e goodwill on th e balance sheet as $1 . 0 0 :
Walgreen Drug Company rep o rts as follow s :
Goodwill, Leaseholds, Leasehold Improvements,
e tc ., a t nominal amount—$1.00.3^
Otis E levator Company reported as follow s :
P aten ts, Trade Marks, Goodwill and Other
In tan g ib le A ssets--$1.00.^^
Thera are no notes to these fin a n c ia l statem ents
explaining th is nominal amount. Ihe read er is l e f t to
guess a t what has tran sp ire d . Accounting theory s ta te s
th a t goodwill is freq u en tly lis te d on published statem ents
a t one d o lla r. The explanation given is th a t a company
th a t has purchased goodwill may have a r b itr a r ily w ritte n i t
33
down to th is nominal fig u re . I t seems th a t both p ra c tic e
and theory here are a rb itra ry . What would prevent a r b i
tra ry w ritin g down p lan t a sse ts to the same nominal fig u re?
Negative Goodwill
Negative goodwill also presents a problem on th e
31
Walgreen Drug Company, Annual Report. 1964, p. 2.
32
O tis E levator Company, Annual Report, 1963, p. 32.
33
Wilbur E. Karrenbrock and Harry Simons, Advanced
Accounting (3rd e d .; N ew Rochelle, N.Y.: South-Western
Rablishing Company, 1961), p. 562.
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170
b alan ce s h e e t. However, n e g a tiv e g o o d w ill i s n o t p re se n te d
in a v a r ie ty o f m ethods. Ih e t r a d i t i o n a l th e o r e t i c a l
method o f p r e s e n tin g n e g a tiv e g o o d w ill as an o f f s e t a g a in s t
g o o d w ill, i f any, d id n o t appear in any o f th e annual r e
p o rts s e le c te d . Nor was th e method o f d is p o s in g o f nega
t i v e g o o d w ill as su rp lu s from c o n s o lid a tio n u se d in th e se
annual r e p o r ts . The f a i l u r e to fin d t h i s l a s t method is a
r e s u l t o f th e AICPA*s r e f u s a l to ac ce p t such a m ethod.
A ccounting th e o ry s t a t e s th a t i f a m a te r ia l c r e d it
amount can n o t be id e n tif ie d w ith s p e c if ic a s s e ts o f th e
s u b s id ia ry , th e amount should be c l a s s i f i e d in th e s to c k
h o ld e rs ' e q u ity s e c tio n o f th e c o n s o lid a te d b a la n c e sh e e t
as "excess o f book v a lu e over c o s t o f s u b s id ia r y s to c k ."
This method is d e p ic te d in th e c o n s o lid a te d b alan ce
sh e e t o f The C arp en ter S te e l Company:
S tockholders* E quity
Excess o f book amount o f a s s e ts o f s u b s id ia ry
a t d a te o f a c q u is itio n over in v e stm en t th e r e
in . 34
The C arp en ter S te e l Company sta te m e n t i l l u s t r a t e s
an agreem ent betw een th e o ry and p r a c tic e .
p. 15.
^^The C arp en ter S te e l Company, Annual R eport, 1965,
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171
A ccounting th e o ry a ls o s t a t e s t h a t th e c r e d i t
d i f f e r e n t i a l should be ta k en in to income on a re a s o n a b le
and a s y ste m a tic b a s is . The P h illip s -V a n Heusen Company
fo llo w s th i s m ethod. A p o r tio n o f i t s c o n s o lid a te d b a la n c e
s h e e t re a d s as fo llo w s :
D eferred C re d it. Note 1.
Note 1.
The excess o f th e u n d e rly in g book e q u ity o f
(1) th e c o r p o r a tio n 's in v estm en t in K ennedy's,
In c. and (2) th e in v estm en t o f K ennedy's, In c.
in a s u b s id ia ry a c q u ire d on Jan u ary 2, 1962,
over th e r e s p e c tiv e c o s ts o f th e s e in v e stm e n ts
has been in c lu d e d as a d e fe rre d c r e d i t in th e
accompanying c o n s o lid a te d b alan ce s h e e t; a
p o rtio n o f such d e fe rre d c r e d i t i s b e in g i n
clu d ed in c o n s o lid a te d income a n n u a lly .
Again, th e o ry and p r a c t i c e a re in ag reem en t.
W rite-O ff to R etained E arnings
The American I n s t i t u t e o f C e r tif ie d P u b lic A ccount
a n ts in B u lle tin 43 s t a t e s th e fo llo w in g :
Lump-sum w r ite - o f f s o f in ta n g ib le s sh o u ld n o t be
made to earned s u rp lu s im m ediately a f t e r a c q u i s i
tio n . I f n o t am o rtized s y s te m a tic a lly , in ta n g ib le s
should be c a r r ie d a t c o s t u n t i l an event h as tak en
35
8 .
P h illip s-V a n Heusen Company, Annual R ep o rt. 1962,
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
172
p la c e w hich in d ic a te s a lo s s o r a I m i t a t i o n on
th e u s e f u l l i f e o f th e in ta n g ib le s . °
However, th e annual r e p o r ts o f th e fo llo w in g two
firm s a re c o n tra ry to th e B u lle tin . In th e r e ta in e d e a rn
ings s e c tio n o f th e sta te m e n t o f The A utom atic C anteen
Company o f Am erica, th e fo llo w in g item ap p ears :
Less :
W rite -o ff o f c e r ta in in ta n g ib le s (Note 2 ).
Note 2. In ta n g ib le A ssets and R etain ed E arnings
"Through Septem ber 30, 1961, p r in c ip a lly d u rin g
th e two y e a rs th en ended, th e Company p u r
chased a la rg e number o f dom estic and fo re ig n
com panies r e s u lt in g i n th e payment o f s u b s ta n
t i a l amounts f o r g o o d w ill (excess o f c o s t o f
purchased s u b s id ia r ie s over a p p lic a b le p o rtio n
o f u n d e rly in g n e t a s s e ts ) and f ra n c h is e c o s ts .
At i t s m eeting on November 12, 1962, th e Board
o f D ire c to rs concluded t h a t such in ta n g ib le
a s s e ts in th e amount o f $11,600,366 no lo n g e r
co n tin u ed to have v a lu e and d ir e c te d t h a t such
in ta n g ib le s be e lim in a te d by a d i r e c t ch arg e
to r e ta in e d e a rn in g s as o f Septem ber 29, 1962.^^
The Sprague E le c tr ic Company has th e fo llo w in g in
i t s n o te s to th e f in a n c ia l sta te m e n ts :
36
American I n s t i t u t e o f A ccountants, Committee on
A ccounting P rocedure, A ccounting R esearch B u lle tin No. 43
(New York: American I n s t i t u t e o f A ccountants, 1947),
p . 40.
37
A utom atic Canteen Company o f Am erica, Annual
R ep o rt, 1962, pp. 16-17.
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173
Note 3. G oodw ill and R etain ed E arnings
G oodw ill a r is i n g in co n n ectio n w ith th e a c q u i
s i t i o n o f s u b s id ia r ie s d u rin g 1960 th ro u g h
1962, w hich p re v io u s ly had been charged o f f to
r e ta in e d ea rn in g s in th e y e a rs o f a c q u is itio n ,
has been r e in s t a te d r e tr o a c tiv e l y in th e
acco u n ts a t December 31, 1962, a t th e su g
g e s tio n o f th e S e c u r itie s and Exchange Com
m issio n .
In b o th ca se s th e re i s a w r i te - o f f to r e ta in e d
e a rn in g s. However, in one in s ta n c e th e amount charged to
r e ta in e d ea rn in g s has been r e in s t a te d r e tr o a c tiv e l y in th e
accounts a t th e su g g e stio n o f th e S e c u r itie s and Exchange
Commission. The Commission i s n o t c o n s is te n t in i t s r u lin g .
I t would seem th a t th e amounts should be r e in s t a te d in b o th
cases c ite d .
A m o rtizatio n o f Goodwill
There a re o th e r com panies t h a t am o rtize p o s itiv e
goodw ill b u t th e a m o rtiz a tio n i s to c u rre n t e a rn in g s .
These companies comply w ith th e AICPA^s r u lin g .
Ih e C h ry sle r C o rp o ratio n has In clu d ed in i t s con
s o lid a te d sta te m e n t o f n e t ea rn in g s th e fo llo w in g item as
an expense:
p. 29.
" ^ 8
Sprague E le c tr ic Company, Annual R eport. 1963,
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174
A m o rtizatio n o f ex cess o f c o s t o f in v e stm e n ts in
c o n s o lid a te d s u b s id ia r ie s over e q u itie s in n e t
a s s e ts a t d a te s o f a c q u is itio n .
I n te r n a tio n a l B usiness Machines u se s th e fo llo w in g
account in i t s c o n s o lid a te d sta te m e n t o f e a rn in g s
A m o rtizatio n o f g o o d w ill $ 3 ,0 0 0 ,0 0 0
In m ost c a ses i t was im p o ssib le to lo c a te th e amor
t i z a t i o n o f g o o d w ill in th e c o n s o lid a te d income sta te m e n t.
Even i f a n o te to th e f in a n c ia l sta te m e n ts s ta te d th a t
goodw ill was b ein g am o rtized , th e g o o d w ill a m o rtiz a tio n
expense was d i f f i c u l t to lo c a te . Good a c co u n tin g p r in
c ip le s o fte n speak o f f u l l d is c lo s u r e ; how ever, th e a m o rti
z a tio n o f g o o d w ill ap p ears to be a s e c r e t and i s b u rie d in
th e acco u n ts.
A d i s t o r t i o n to th e re a d e r r e s u l t s i f one company
am o rtizes g o o d w ill to n e t income and a n o th e r company does
n o t. An in v e s to r making a d e c is io n co n cern in g th e company
m ight be m isle d more by th e acco u n tin g tre a tm e n t than by
th e o p e ra tio n s o f th e company. Tables 2 and 3, pages 157
and 158, d e p ic t com panies a m o rtizin g g o o d w ill and th o se
39
C h ry sler C o rp o ratio n , Annual R ep o rt, 1965, p. 28.
^ ^ I n te r n a tio n a l B usiness M achines, Annual R eport.
1965, p. 31.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
175
n o t a m o rtizin g g o o d w ill.
For example, th e n e t income p e r sh a re o f th e Pet
M ilk Company i s $2 . 8 8 ; how ever, i f th e g o o d w ill i s amor
tiz e d to n e t income o v er a p e rio d o f tw enty y e a rs , th e n e t
income p e r sh a re i s $ 2 .7 7 . I f th e g o o d w ill i s am o rtized
o v er a p e rio d o f f i f t e e n y e a rs , th e n e t income p e r sh a re
i s $ 2 .7 4 . Ih is v a ria n c e i s th e r e s u l t o f th e a l t e r n a t i v e
tr e a tm e n ts .
Table 5 p o in ts o u t t h a t in m ost c a s e s , th e number
o f y e a rs o f a m o rtiz a tio n i s tw en ty . However, s e v e r a l com
p an ies d id n o t d e s ig n a te th e number o f y e a rs o f a m o rtiz a
tio n . Table 6 g iv e s th e com parison o f t o t a l a s s e ts , n e t
s a le s and n e t income o f th o s e com panies n o t a m o rtizin g th e
ex cess o f c o s t over in v e stm e n t. Ih e fo llo w in g p re s e n ts
th e c a p tio n s used by cœ npanies am o rtiz in g g o o d w ill and
th o s e s p e c i f i c a l l y s t a t i n g th e y do n o t am o rtize g o o d w ill.
Ccxnpanies A m o rtiz in g
C h ry sler C o rp o ratio n
Excess o f c o s t o f in v estm en ts in c o n s o lid a te d
s u b s id ia r ie s o v er e q u itie s in n e t a s s e ts a t
d a te s o f a c q u is itio n , b ein g am o rtized over
p e rio d s n o t exceeding tw enty y e a rs .^
41
C h ry sler C o rp o ra tio n , Annual R eport. 1965, p. 27.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
: : d
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TABLE 5
COMPARISON OF TOTAL ASSETS, NET SALES AND NET INCOME OF THOSE COMPANIES
AMORTIZING THE EXCESS OF COST OVER INVESTMENT
4 J o w
0
u
H
( / > 4) r t
o e (0 w a 0»
o u u 4 4 4 4 4 4 O 44 m o H t o m
w 0) O O J 4 4 O 4 4 O O " H w • H m
4 4 0) w w
I
6 O (0 4 J 8 m o
o > ( / ) 0) 44 O (0 o 44 r-4 W * J « o O r 4
d r-4 0 O O o d d r -4 < 3 d N u r - t C
( 0 H ( d < U 0 r - i d 4 4 0 0) 0) 0) 0 0)
I ^
woo a ) 1 w o 6 w
M O H S 5 M 44 % < 3 0 4 O H s s o s
J. I. Case 9,100,000 174,565,560 217,938,682
Chrysler
Corp. 57,498,277 2,420,774,258 4,287,348,113
Eversharp 1,850,941 41,062,522 47,669,017
I.B.M. 14,018,656 3,309,152,915 3,239,359,581
Studebaker
Corp. 5,690,748 136,653,993 261,755,634
6.3 13,158,557 700,000 5.2 5.3 20
4.9 213,770,302 3,781,113 2.3 1.7 20
8.6 3,845,614 1,025,813 4.5 26.6 -*
13.3 431,159,766 3,000,000 .4 .6 -*
3.08 8,064,937 1,163,694 4.2 14.4 15
*Not given in annual report.
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TABLE 6
COMPARISON OF TOTAL ASSETS, NET SALES AND NET INCOME OF THOSE COMPANIES
NOT AMORTIZING THE EXCESS OF COST OVER INVESTMENT
Company
Excess of
Cost Over
Investment
Total Assets Net Sales
Per cent
of
Net
Income
to Sales
Net Income
Per cent
of
Goodwill
to Total
Assets
Celanese Corp.
of America 19,768,000 1,072,327,000 700,771,000 7.8 54,920,000 1.8
Ford Motor Co, 279,238,125 6,459,295,037 9,670,765,706 5.2 505,641,710 4.3
National Dairy
Prod. Corp. 13,227,495 824,629,491 1,919,944,881 13.3 63,783,819 1.6
Pet Milk Company 4,268,518 120,699,854 290,955,098 1.9 5,743,128 3.5
Pillsbury Co. 3,1/4,005 199,128,652 443,445,119 2.3 10,356,697 1.5
Purex Co. 2,555,398 70,389,333 126,923,912 4.4 5,674,674 3.6
Saxon Paper Corp. 421,732 11,296,379 21,390,735 2.1 449,763 3.7
Schenley Industries,
Inc. 16,976,262 500,958,620 405,785,535 2.5 10,407,563 3.4
Warner Lambert Co. 281,173 91,613,603 204,671,903 2.5 17,413,445 .3
178
E versharp
Excess o f c o s t o f b u s in e s s a c q u ire d o v e r n e t
ta n g ib le a s s e ts le s s a m o rtiz a tio n .42
I n te r n a tio n a l B usiness Machines
P a te n ts and Goodw ill . . . Less a m o r tiz a tio n .43
S tu d eb ak er C o rp o ratio n
In ta n g ib le s Note C
Note C. In ta n g ib le s
In ta n g ib le s r e p r e s e n t p u rch ase c o s ts in
ex cess o f amounts a s c rib e d to ta n g ib le
a s s e ts o f b u s in e s s e s ac q u ired and a r e b ein g
am o rtized over p e rio d s ran g in g to f i f t e e n
y e a r s .44
Companies Not A m ortizing Goodw ill
Ford M otor Company
Excess o f c o s t o f in v estm en ts in c o n s o lid a te d
s u b s id ia r ie s over e q u itie s in n e t a s s e t s . 45
N a tio n a l D airy Products C o rp o ratio n
I n ta n g ib le s (See N ote)
E versharp C o rp o ratio n , Annual R eport. 1964, p. 16.
^ ^ I n te r n a tio n a l B usiness M achines, Annual R eport,
1965, p. 27.
44
S tudebaker C o rp o ratio n , Annual R eport, 1964,
pp. 1 2 , 13.
^^Ford M otor Company, Annual R eport, 1964, p . 32.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
179
N ote: In ta n g ib le s
In ta n g ib le s r e p r e s e n t th e excess o f th e
pu rch ase p r ic e s p a id over th e n e t book
v a lu e s o f th e ta n g ib le a s s e ts o f c e r t a i n
b u sin e sse s a c q u ire d s in c e 1955. The com
pany does n o t now in te n d to am o rtize item s
c a r r ie d in t h i s acco u n t.
P ills b u ry Company
Goodw ill a r is in g upon c o n s o lid a tio n (Note 1 ).
Note 1.
The g o o d w ill a r is in g upon c o n s o lid a tio n
re p re s e n ts th e ex cess o f c o s t ov er e q u ity
in u n d e rly in g n e t a s s e ts a t d a te s o f a c q u i
s i t i o n . I h is g o o d w ill is n o t c o n sid e re d to
be s u b je c t to d im in u tio n in v a lu e and is
n o t b ein g a m o rtiz e d .^7
Purex C o rp o ratio n L td.
In ta n g ib le A ssets a r is i n g from a c q u is itio n .
Note 2.
In ta n g ib le a s s e ts a r is in g from a c q u is itio n .
In th e o p in io n o f th e o f f ic e r s o f th e com
pany, a l l o f th e in ta n g ib le a s s e ts a r is i n g
from a c q u is itio n s have v a lu e o f in d e f i n i t e
d u ra tio n and no p ro v is io n f o r a m o rtiz a tio n
is re q u ire d a t th e p re s e n t tim e .^
4-6
N atio n al D airy P roducts C o rp o ratio n , Annual
R e p o rt, 1964, pp. 16, 19.
16.
^ ^ P ills b u ry Company, Annual R eport, 1964, pp. 14,
^^Purex C o rp o ratio n , L td ., Annual R eport, 1963,
pp. 16, 18.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
180
Saxon Paper C o rp o ratio n
Excess o f Cost o f Investm ent in S u b s id ia rie s
over Book V alue o f Net A ssets A cquired--
Note A.
Note A.
Ih e ex cess o f c o n s id e ra tio n g iven over
u n d e rly in g e q u ity in co n n e ctio n w ith th e
a c q u is itio n o f c e r t a in c o n s o lid a te d su b
s i d i a r i e s , am ounting to $421,732, is con
s id e re d by th e company to be an in ta n g ib le
a s s e t . In th e o p in io n o f management, th e re
is no p re s e n t in d ic a tio n t h a t th is in ta n
g ib le has a lim ite d l i f e , and in accordance
w ith g e n e ra lly accep ted acco u n tin g p r in
c i p le s , no a m o rtiz a tio n i s contem plated a t
t h i s tim e .49
Schenley I n d u s tr ie s , Inc.
B rands, Trade-M arks and G oodw ill
The amount by which th e c o s t o f th e com pany's
in v estm en t in Buckingham exceeded i t s e q u ity in
th e n e t a s s e ts o f th a t in d u s try a t d a te o f
a c q u is itio n , based on u n d e rly in g book v a lu e s ,
is in c lu d e d as "G oodw ill” in th e accompanying
b a la n c e s h e e t; no p ro v is io n has been made fo r
th e a m o rtiz a tio n o f such g o o d w ill. ^ 0
Warner Lambert Co.
G oodw ill, Form ulae, Tradem arks, e tc . Note 3.
49
Saxon Paper C o rp o ratio n , Annual R eport, 1964,
pp. 7, 11.
5 C
pp. 32, 35.
^^Schenley I n d u s tr ie s , I n c ., Annual R eport, 1965,
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181
Note 3. G oodw ill, Form ulae, Tradem arks, e tc .
G oodw ill in th e amount o f $281,172 a r is i n g
from th e a c q u is itio n o f L actona, In c. i s
expected to r e t a i n o r in c re a s e i t s v a lu e
and a c c o rd in g ly i s n o t b ein g am ortized
a g a in s t c u r r e n t o p e ra tio n s .
The sta te m e n ts can p ro b ab ly be u n d ersto o d only i f
one is a C e r tif ie d P u b lic A ccountant o r r e f e r s th e s t a t e
m ents o f com panies in which he i s in te r e s te d to an a u d itin g
firm fo r th e a u d i t o r 's o p in io n .
A D ecrease in G oodw ill and No E x p lan atio n
The in fo rm a tio n in T able 7 p re s e n ts f iv e com panies
which p re s e n t a d e c re a se in p o s it iv e g o o d w ill and one com
pany w ith an in c re a s e . However, th e r e i s no e x p la n a tio n
f o r th e change in th e n o te s to th e f in a n c ia l s ta te m e n ts .
How can a re a d e r i n t e r p r e t such a change? What in fo rm a tio n
does th e re a d e r have in o rd e r to i n t e r p r e t such a change?
A c tu a lly th e re a d e r has n o t been p re se n te d p ro p e r in fo rm a
ti o n and i t is alm ost im p o ssib le to d eterm in e th e re a s o n
f o r th e change. Can a p ro p er a n a ly s is o f f in a n c ia l s t a t e
m ents be made under such c irc u m sta n c e s? D o s o - c a lle d
pp. 16, 18.
^^Warner Lambert Company, Annual R eport. 1961,
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TABLE 7
NUMBER OF COMPANIES SHOWING THE AMOUNT OF INTANGIBLES
CHANGING BUT NO EXPLANATION AS TO THE CHANGE
Company Net Sales Net Income
Per cent
of Net
Income
to Sales
Total
Assets
Goodwill
Current
Year
Goodwill
Past
Year
Decrease
or
(Increase)
American Broad
casting Co. 386,729,000 7,385,000 1.9 213,296,000 15,214,000 14,900,000 (314,000)
Champion Papers 364,436,114 15,032,299 4.1 261,495,695 11,169,710 11,294,221 124,511
Colgate
Palmolive Co. 722,014,000 23,836,000 3.3 404,660,000 10,188,000 10,204,000 16,000
General American
Transportation 34^,426,001 27,626,410 8.2 566,089,983 8,578,992 6,607,034 28,042
Thomas J.
Lipton, Inc. 151,233,487 9,366,241 6.2 78,119,587 2,144,199 2,225,526 81,327
Rexall Drugs 280,511,000 11,951,000 4.2 219,923,000 11,287,000 11,397,000 110,000
00
N 5
183
" g e n e ra lly acce p ted acco u n tin g p r in c ip le s " work to th e
d isa d v a n ta g e o f th e re a d e r o f f in a n c i a l sta te m e n ts ?
U t i l i t i e s and R a ilro a d s
The u t i l i t i e s and th e r a ilr o a d s fo llo w th e recom
m endations o f th e th e o r e tic ia n s r a t h e r c lo s e ly . I t has
been su g g ested th a t when an amount has been p aid above
c o s t, th e ex cess sh o u ld be reco rd ed in an a c q u is itio n
ad ju stm en t a c c o u n t. The L o u is v ille and N a sh v ille R ailro ad
and th e S t. L ouis-S an F ra n cisc o R a ilro a d Company i l l u s t r a t e
approved m ethods :
L o u is v ille and N a sh v ille R a ilro a d re p o rte d as f o l
lows :
P ro p e rtie s
52
A c q u is itio n ad ju stm en t
S t. L ouis-S an F ra n cisc o R a ilro a d Company re p o rte d
as fo llo w s in th e a u d ito rs* o p in io n s e c tio n :
In our o p in io n , ex cep t th a t p ro v is io n has n o t been
made f o r th e p o s s ib le in c re a s e in income ta x e s o f
f u tu r e p e rio d s as s e t f o r th in Note 2 to th e f in a n
c i a l s ta te m e n ts , th e accompanying sta te m e n ts
p. 6 .
^ ^ L o u is v ille and N a sh v ille , Annual R eport, 1961,
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
184
examined by us p re s e n t f a i r l y th e f in a n c ia l p o s i
tio n o f S t. L ouis-San F ra n c isc o Railway Company
and r a il r o a d s u b s id ia r ie s c o n s o lid a te d a t Decem
b e r 31, 1964 and th e r e s u l t s o f t h e i r o p e ra tio n s
f o r th e y e a r, in co n fo rm ity w ith g e n e ra lly ac c e p te d
acco u n tin g p r in c ip le s a p p lie d on a b a s is c o n s is te n t
w ith th a t o f th e p reced in g y e a r, ex cep t fo r th e
d is p o s itio n o f th e form er A c q u is itio n A djustm ent
Account as d e s c rib e d in Note 4 .
Note 4 . P ro p e rtie s
Gross p r o p e r tie s a re s ta te d a t estim a te d o r i g i
n a l c o s t as determ ined by th e I n te r s t a t e Com
m erce Commission f o r re o rg a n iz a tio n purposes as
o f January 1, 1947, p lu s a d d itio n s and b e t t e r
m ents a t c o s t and le s s re tire m e n ts sin c e t h a t
d a te .
Very seldom w i l l th e re be a comment in th e o p in io n
sta te m e n t r e f e r r in g to goodw ill o r th e a c q u is itio n a d j u s t
m ent acco u n t. In o n ly two cases among m an u factu rin g com
p a n ie s was th e re a re fe re n c e in th e o p in io n s e c tio n to
c o n s o lid a te d g o o d w ill.
T able 8 p re s e n ts a summary o f th e v a rio u s t r e a t
m ents o f p o s itiv e and n e g a tiv e g o o d w ill. There were
tw e n ty -th re e d i f f e r e n t tre a tm e n ts o f p o s itiv e goodw ill in
n in e ty - f iv e com panies. There w ere th r e e d if f e r e n t c l a s s i
f ic a tio n s o f n e g a tiv e goodw ill made by s ix com panies. T V ? o
companies w rote o f f p o s itiv e g o o d w ill to re ta in e d e a rn in g s
C O
S t. L ouis-S an F ran cisc o R a ilro a d Company, Ann u a l
R ep o rt, 1964, pp. 22, 26.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
185
TABLE 8
S U M M A R Y OF THE CLASSIFICATION OF VARIOUS TREATM ENTS
OF POSITIVE OR NEGATIVE GOODW ILL
Number o f
C l a s s i f ic a t io n Companies
P o s itiv e G oodw ill
In v estm en ts and O ther A ssets 2
P ro p e rty Equipment and In ta n g ib le s a t Cost 1
As a D eduction in th e C o n so lid ated S ta te
ment o f R etain ed E arnings 1
A S e p a ra te Item Goodwill 4
Excess o f C ost Over Book V alue 17
D eferred Charge and O ther A sse ts 5
In th e N otes Only 7
In th e O pinion S ectio n 2
O ther A sse ts as a S ep a ra te C ap tio n 12
O ther A sse ts Included w ith O ther Item s 4
In a C ap tio n Which S ta te s P a te n ts and
O ther A sse ts Less A m o rtiza tio n ( a t c o s t) 3
In ta n g ib le s a t Cost
(No E x p lan a tio n Concerning C om position) 6
S e c tio n D esignated as an I n ta n g ib le , and
G oodw ill Included as a S u b -se c tio n 3
G oodw ill and O ther In ta n g ib le s 1
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186
TABLE 8--Continued
C la s s if ic a tio n
Number o f
Ccxnpanies
Recorded on B alance Sheet in V arious Ways
and R eferred to in th e Notes 3
L is te d as G oodw ill and O ther T angible A sse ts
But Not A m ortized 3
In Notes o f Company (o n ly ) 1
In Notes o f Company and S ta tin g How
I t Was Recorded 14
In clu d ed w ith O ther In ta n g ib le s 5
In ta n g ib le s o f S u b s id ia rie s A cquired 3
L is te d as I n ta n g ib le A ssets and an
E x p lan atio n P re se n te d in th e Notes 6
C aptioned as Tradem arks, C o p y rig h ts, G oodw ill
and e tc . 2 2
C a rrie s a t $1.00 14
W ritten O ff to R e tain ed E arnings 2
W ritten Off to O p eratio n s 6
Not W ritten O ff 3
Number o f Years W ritte n O ff I f D esignated
6
Number S p e c if ic a lly S ta te d That I t Should
Not Be W ritten Off 9
Number o f Companies Which Show In ta n g ib le s
and th e Amount D ecreasing in th e Subse
quent Y ear, b u t no E x p lan atio n C oncerning
th e D ecrease 6
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TABLE 8 —C ontinued
187
C la s s if ic a tio n
Number o f
Companies
N egative G oodw ill
S to ck h o ld ers E q u ity 2
An E x p lan a tio n in th e Notes 2
D eferred C re d it 2
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188
and s ix to o p e ra tio n s . Six com panies d e s ig n a te d th e number
of y ea rs g o o d w ill should be w r itte n o f f w h ile n in e s p e c i f i
c a lly s ta te d t h a t i t should n o t be w r itte n o f f . Six com
p an ies d e p ic t d e c re a sin g in ta n g ib le s b u t th e r e was no
e x p la n a tio n co n cern in g th e d e c re a se .
A ll o f th e s e v a rio u s m ethods re p r e s e n t th e t r e a t
ment o f one tr a n s a c tio n . One cannot fin d p r in c ip le s of
accounting to su p p o rt a l l o f th e s e v a rio u s tre a tm e n ts .
T h erefo re, th e sta te m e n ts d e s c rib e d by th e s e v a rio u s
methods can h a rd ly be o f as much u se to t h e i r u s e rs as they
should in t h i s r e s p e c t.
G oodw ill Dependent Upon Method o f
C osting Investm ents
I t i s in te r e s ti n g to n o te th a t th e amount o f good
w ill can depend upon th e method o f c o s tin g in v estm en ts th a t
is used by th e p a re n t. There a re fo u r m ethods w hich can be
a p p lie d : th e av erag e c o s t, f i r s t - i n f i r s t - o u t , l a s t - i n
f i r s t - o u t , and th e s p e c if ic i d e n ti f i c a t io n . The average
c o s t method i s n o t a c c e p ta b le f o r ta x purposes b u t i t is
su p e rio r to th e o th e r methods when a s a le by th e p a re n t
re p re s e n ts th e d is p o s itio n o f a p ro p o rtio n a te p a r t o f th e
t o t a l in v estm en t.
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189
Goodwill from c o n s o lid a tio n r e s u ltin g from th e u se
o f th e fo u r methods w i l l be i l l u s t r a t e d on th e b a s is o f th e
in fo rm a tio n in Table 9.
From th e ccxnputations p re se n te d in T ables 10-14,
g iv in g th e fo u r methods o f c o s tin g th e sh are s s o ld and
d e p ic tin g th e b alan ce r e ta in e d in th e in vestm ent acco u n t,
th e ex cess o f c o s t over book v a lu e i s looked upon as o f
dubious s ig n ific a n c e . G oodw ill from c o n s o lid a tio n s v a r ie s
from $7,350 to $10,600 m erely b ecau se o f th e method o f
c o s tin g in v e stm en ts. From t h i s in fo rm a tio n , i t i s easy to
u n d e rsta n d why goodw ill from c o n s o lid a tio n may be i n t e r
p re te d as a mere plug f ig u r e by some re a d e rs .
Summary
A t o t a l o f 240 an n u al r e p o r ts were s e le c te d on th e
b a s is o f t h e i r s iz e and im p o rtan ce in th e economic and
f in a n c ia l environm ents. S ize tak en h e re r e f e r s to th e
e s tim a te d d o lla r s of an n u al s a le s . The F ortune 500 was
used to s e le c t companies ac co rd in g to s iz e . The com panies
w ere s e le c te d from among th o s e l i s t e d in th e 1964 D ire c to ry
o f Companies F ilin g Annual R eports w ith th e S e c u r itie s and
Exchange Commission.
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TABLE 9
INFORMATION USED TO ILLUSTRATE THE FOUR METHODS
OF COSTING INVESTMENTS
Purchase
and
Sales
Shares
Cost
Per
Share
Proceeds
Per
Share
Total Equity of
Number of
Shares
Subsidiary
Retained
Earnings
Purchased
Capital
Stock
Purchased Sold
First Purchase 200 150 30,000 400 2,000 40,000
Second Purchase 90 160 14,400 400 16,000 40,000
Third Purchase 60 175 10,500 400 32,000 40,000
Sale 70 175 (12,250) 400 36,000 40,000
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TABLE 10
FIRST-IN, FIRST-OUT
Purchaoe
and
Sales
Shares Cost
Per Share
Proceeds Total
Equity of Subsidiary Purchased
Purchased Sold Retained Earnings
Per Share Amount
Capital Stock
Per Share Amount
First Purchase 200 150 200 30,000 5 1,000 100 20,000
Second Purchase 90 160 90 14,400 40 3,600 100 9,000
Third Purchase 60 175 60 10.500 80 4.800 100 6.000
350 350 54,900 9,400 35,000
Sale 70 150 10,500 -70 -10.500 5 - 350 -7.000
Balance 280 44,400 9,050 28,000
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TABLE 11
LAST-IN, FIRST-OUT
Purchase Shares Cost Proceeds Total
Equity of Subsidiary Purchased
and
Purchased Sold
Per Share Retained Earnings Capital Stock
Sales
Per Share Amount Per Share Amount
First Purchase 200 150 200 30,000 5 1,000 100 20,000
Second Purchase 90 160 90 14,400 40 3,600 100 9,000
Third Purchase 60
350
175 60
350
10.500
54,900
80 4.800
9,400
100 6.000
35,000
Sale 60 175 10,500 60 -4,800 100 -6,000
Balance
10 160 1.600 riO
280
-12.100
42,800
12
- 400
4,200
100
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28,000
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TABLE 12
AVERAGE COST
Purchase
and
Sales
Shares
Purchased Sold
Cost
Per Share
Proceeds Total
Equity of Subsidiary Purchased
Retained Earnings Capital Stock
Per Share Amount Per Share Amount
First Purchase 200 150 200 30,000 5 1,000 100 20,000
Second Purchase 90 160 90 14,400 40 3,600 100 9,000
Third Purchase
m
60 10.500
80
4.800 100 6.000
350 1 5 7 * 350 54,900 2 7 * 9,400 100 35,000
Sale 70 157 10,500
= J 0
-10.990 27 -1.890 100 -7.000
Balance 157 280 43,910 27 7,510 100 28,000
*Nearest dollar.
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TAULE 13
SPECIFIC IDENTIFICATION
Purchase
and
Sales
Shares Cost
Per Share
Proceeds Total
Equity of Subsidiary Purchased
Retained Earnings Capital Stock
Purchased Sold
Per Share Amount Per Share Amount
First Purchase 200 150 200 30,000 5 1,000 100 20,000
Second Purchase 90 160 90 14,400 40 3,600 100 9,000
Third Purchase 60 175 60 10.500 80 4.800 100 6.000
350 350 54,900 9,400 35,000
Sale 70* 160 11,200
z M
-11.200 -2,800 -7.000
Balance 280 43,700 6,600 28,000
*The shares sold were from the second purchase.
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TABLE 14
COMPARATIVE SUMMARY OF THE FOUR METHODS OF COSTING
Cost of
Investment
in
Subsidiary
Equity of Subsidiary Purchased
Retained Capital
Earnings Stock
Total Goodwill
From
Consolidation
First-In, First-Out 44,400 9,050 28,000 37,050 7,350
Last-In, First-Out 42,800 4,200 28,000 32,200 10,600
Average Cost 43,910 7,510 28,000 35,510 8,400
Specific Identification 43,700 6,600 28,000 34,600 9,100
M
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196
Many o f th e problem s d isc u sse d in th e p rev io u s
c h a p te rs have been reco g n ized in p r a c tic e . Some o f th e s e
problem s w ere d isc u sse d by means o f e x c e rp ts from an n u al
r e p o r ts . Some o f th e c a p tio n s un d er which p o s itiv e good
w i l l appears a r e as fo llo w s :
1. Excess o f c o s t over book v a lu e .
2. O ther a s s e ts as a s e p a ra te item .
3. O ther a s s e ts in c lu d ed w ith o th e r ite m s.
4 . G oodw ill.
5. I n ta n g ib le s .
6 . In th e n o te s to th e f in a n c ia l s ta te m e n ts .
7. G oodw ill and o th e r ta n g ib le a s s e ts b u t n o t
am o rtized .
8 . Tradem arks, C o p y rig h ts, G oodw ill.
T w enty-six com panies c l a s s i f i e d th e item , ex cess o f
c o s t over book v a lu e , in seven d i f f e r e n t ways. The same
item appears in th e n o te s to th e f in a n c ia l sta te m e n ts
s ix te e n tim es and i s re p re s e n te d on th e b a la n c e s h e e t by
seven d if f e r e n t c l a s s i f i c a t i o n s w hich s t a t e "See n o t e . "
Tw enty-four com panies p re se n te d in ta n g ib le s in
v a rio u s ways. A few o f th e methods a re as fo llo w s :
1. In ta n g ib le s a t c o s t no e x p la n a tio n as to com
p o s itio n .
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197
2. In ta n g ib le s o f s u b s id ia r ie s a c q u ire d .
3. L is te d as in ta n g ib le a s s e ts and an e x p la n a tio n
p re se n te d in th e n o te s .
N egative g o o d w ill was p re s e n te d under th r e e h ead
in g s :
1. S to ck h o ld ers e q u ity .
2. An e x p la n a tio n in th e n o te s .
3. D eferred c r e d i t.
Very few com panies c a r r ie d n e g a tiv e goodw ill on
t h e i r f in a n c ia l s ta te m e n ts .
Ih e Committee on A ccounting P rocedure o f th e Am eri
can I n s t i t u t e o f C e r tif ie d P u b lic A ccountants is o f th e
o p in io n t h a t lump-sum w r ite - o f f s o f in ta n g ib le s sh ould n o t
be made, im m ediately a f t e r a c q u is itio n , to r e ta in e d e a rn
in g s . However, two companies d id so anyway. In one o f
th e s e ca ses th e amount was r e i n s t a te d r e tr o a c tiv e l y in th e
acco u n ts a t th e su g g e stio n o f th e S e c u r itie s and Exchange
Commission.
In m ost cases i t was im p o ssib le to lo c a te th e am or
t i z a t i o n o f g o o d w ill in th e c o n s o lid a te d income s ta te m e n t.
^^A ccounting R esearch B u lle tin No. 43. p. 40.
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198
F u ll d is c lo s u r e was o m itted in t h i s in s ta n c e .
C aptions employed by com panies t h a t am ortized good
w i l l and by th o s e th a t d id n o t am o rtize g o o d w ill were
p re se n te d in an e f f o r t to c o n tin u e to i l l u s t r a t e how d i f f i
c u l t i t i s f o r a re a d e r to an a ly ze th e f in a n c ia l sta te m e n ts
p ro p e rly .
The com panies under th e r u le s o f r e g u la to r ag en cies
appear to fo llo w th e th e o ry o f th e agency q u ite w e ll by
u sin g th e a c q u is itio n ad ju stm en t account as a s u b s t itu te
f o r a g o o d w ill acco u n t.
Four m ethods o f c o s tin g in v estm e n ts w ere p re se n te d ,
average c o s t, f i r s t - i n f i r s t - o u t , l a s t - i n f i r s t - o u t , and
th e s p e c if ic i d e n t i f i c a t i o n m ethod. These methods were
used to show t h a t th e amount o f g o o d w ill co u ld v ary a c c o rd
ing to th e m ethod used in th e e v a lu a tin g o f in v estm en ts and
scm etim es seems to be a mere p lu g f ig u r e .
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
CHAPTER V II
SU M M A R Y , CONCLUSIONS, A N D RECO M M EN D A TIO N S
Summary
G oodw ill was fo rm erly th o u g h t o f as having r e f e r
ence e x c lu s iv e ly to custom er r e l a t i o n s . Today th e word is
used in a f a r b ro a d e r m anner. G oodw ill encompasses alm o st
any in ta n g ib le f a c t o r o f economic v a lu e to a firm .
Businessm en know t h a t r e p u ta tio n , custom er lo y a lty , p ro d u c t
q u a lity , to g e th e r w ith f r ie n d ly and harmonious r e l a t i o n
sh ip s p erm it some firm s to earn more th a n a norm al r a t e o f
r e tu r n . H e firm which i s a b le to earn excess p r o f i t s i s
s a id to p o ssess th e in ta n g ib le a s s e t c a lle d g o o d w ill. In
most ca se s th e s te p s used in e s tim a tin g th e amount o f good
w ill in v o lv e th e fo llo w in g :
1. D eterm in atio n o f th e e a rn in g s p e rio d to be used
f o r p r o je c tio n .
2. E stim atio n o f th e av erag e annual n e t income
a n tic ip a te d .
199
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200
3. S e le c tio n of an a p p r o p r ia te r a t e o f r e tu r n .
4 . D eterm in atio n o f th e ex cess annual e a rn in g s .
5. C a p ita liz a tio n a t s e le c te d r a t e o f ex cess
an n u al earn in g s to d eterm in e th e e stim a te d
p re s e n t v a lu e o f g o o d w ill.
Income was thought o f as b elo n g in g to th e owner
( p ro p r ie to r) o r to th e e n te r p r is e ( e n t i t y ) . Ih e p r o p r ie
ta r y co n cep t view s income as th e in crem en ts in w e a lth which
can be c o n sid e re d to be th e i n t e r e s t o f p r o p rie to r s o n ly .
The e n t i t y co n cep t views income as th e increm ent in w ea lth
of th e e n t i r e e n te r p r is e . A ccountants e x p la in th e s e w ealth
changes by m atch in g p a s t exchange v a lu e s w ith th e i n c r e
ments in w e a lth w hich th e se v a lu e s have h elp ed to c r e a te .
Ih e view s o f a u th o r ita tiv e b o d ie s w ere p re s e n te d in
p rev io u s c h a p te rs o f th is stu d y to e s ta b li s h fix e d lim its
to th e fundam ental theorem s and p o s tu la te s on which
acco u n tin g p r a c tic e s are c o n s tru c te d . The American I n s t i
t u t e 's Committee on A ccounting P rocedure c l a s s i f i e s in ta n
g ib le a s s e ts in to two broad c a te g o r ie s —th o se w ith a
lim ite d term o f e x is te n c e (which sh o u ld be am o rtized by
charges to income over th e e s tim a te d p e rio d o f u s e fu ln e s s )
and th o se h av in g no such lim ite d term o f e x is te n c e . The
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201
Committee i s o f th e o p in io n th a t u n d er no circ u m sta n ces
should p u rch ased g o o d w ill be w r itte n o f f by ch arg es to
c a p ita l s u rp lu s .
Ihe I n te r n a l Revenue Law o f 1934 c o n sid e re d good
w i l l as an a s s e t in d eterm in in g g a in o r lo s s . The law
p ro v id es t h a t a g a in o r lo s s from th e s a le o f g o o d w ill
r e s u l t s o n ly when th e b u sin e ss to w hich g o o d w ill a tta c h e s
i s s o ld . The 1RS has h e ld th a t g o o d w ill a m o rtiz a tio n o r
w rite-dow n may n o t, under any c irc u m sta n c e s, be deducted
from income f o r inccm e ta x p u rp o ses.
The S e c u r itie s and Exchange Commission a t one tim e
was o f th e o p in io n t h a t g o o d w ill sh o u ld be e lim in a te d from
a l l b alan ce s h e e ts f i l e d w ith th e Commission. This p o lic y
i s no lo n g e r su p p o rted by th e Commission. The S e c u r itie s
and Exchange Commission re q u ire s r e p o r tin g com panies to
d is c lo s e th e amount and d is p o s itio n o f th e d e b it d i f f e r e n
t i a l (excess o f c o s t over book v a lu e ) in c o n s o lid a te d b a l
ance s h e e ts . However, th e SEC does n o t r e q u ir e th e a n a ly
s i s o f th e d e b it d i f f e r e n t i a l to conform to recom m endations
o f th e AICPA Committee on A ccounting P ro ced u res.
The ex cess o f c o s t over book v a lu e may be due to :
1. The e x tra o rd in a ry e a rn in g power o f th e s u b s id i
a ry .
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202
2. The u n d e r c a p ita liz a tio n o f a s s e ts on th e books
o f th e s u b s id ia ry .
3. The p u rch ase having been made d u rin g an i n f l a
tio n a ry p e rio d .
4. A premium having been p a id to a c q u ire c o n tro l
o f th e s u b s id ia ry .
The ex cess o f book v a lu e over c o s t may be due to :
1. The low earn in g power o f th e s u b s id ia ry .
2. A b a rg a in p u rch ase by th e p a re n t company.
3. An o v e rv a lu a tio n o f th e a s s e ts on th e s u b s id i
a r y ’ s books.
The a c c o u n ta n t’ s r e s p o n s i b ilit y is to an aly ze th e
d i f f e r e n t i a l betw een c o s t and book v a lu e and make th e
p ro p er c l a s s i f i c a t i o n on th e c o n s o lid a te d b a la n c e s h e e t.
The o p in io n o f th e m a jo rity i s th a t goodw ill
acq u ired i s q u ite d i s t i n c t from th e g o o d w ill w hich r e p r e
s e n ts th e s k i l l and e ffic ie n c y of th e new owner and manage
m ent. This new ly acq u ired g o o d w ill sh ould be reco rd ed as
an a s s e t so t h a t th e e ffe c tiv e n e s s o f th e new management
may be s e p a r a te ly e v a lu a te d .
Most a u th o r itie s b e lie v e th a t g o o d w ill should n o t
be w r itte n o f f d i r e c tl y to r e ta in e d e a rn in g s . S ev eral
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203
erroneous im p lic a tio n s a re p o s s ib le i f g o o d w ill i s su b
je c te d to a d i r e c t w r ite - o f f . These im p lic a tio n s a re th a t
goodw ill i s n o t an expense, a d iv id e n d , a g i f t , c a p i ta l
c o n tra c tio n , o r c o rre c tio n of p r i o r y e a r s ’ incom e.
T r a d itio n a l b a la n ce sh e e t p r e s e n ta tio n s o f th e
d e b it d i f f e r e n t i a l between c o s t and book v a lu e may be sum
m arized as fo llo w s :
1. Excess o f c o st over book v a lu e o f sto c k p u r
c h ase d . (Most a u th o rs en d o rse t h is m eth o d .)
2. A d e d u c tio n from th e r e ta in e d e arn in g s o f th e
p a re n t company.
3. G oodw ill.
D iffe re n c e s in th e concepts o f g o o d w ill have r e
s u lte d in d if f e r e n c e s in th e tre a tm e n t o f g o o d w ill as
e ith e r an a s s e t to be charged to r e ta in e d e a rn in g s o r to
o p e ra tio n s . Because goodw ill i s h an d led in so many v a ry in g
ways th e d e b it d i f f e r e n t i a l m ust v a ry a cco rd in g to th e
method used in t r e a ti n g g o o d w ill.
The tre a tm e n t of th e c r e d i t d i f f e r e n t i a l betw een
c o s t and book v a lu e may be summarized as fo llo w s:
1. A c r e d i t to c a p i ta l s u r p lu s . (This method is
n o t now co n sid ered a c c e p ta b le .)
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204
2. "N eg ativ e g o o d w ill" to be o f f s e t a g a in s t
reco rd ed g o o d w ill, i f any.
3. "Excess o f Book V alue Over C ost o f S u b sid ia ry
S to c k ," p re s e n te d in th e sto c k h o ld e rs e q u ity
s e c tio n o f th e c o n s o lid a te d b a la n c e s h e e t.
There i s no one way to d isp o s e o f book v a lu e o v er
c o s t in c o n s o lid a tio n . The c r e d i t d i f f e r e n t i a l sh ould be
c l a s s i f i e d on th e c o n s o lid a te d b a la n c e s h e e t in acco rd an ce
w ith th e ev e n ts su rro u n d in g th e in v e stm e n t.
Proponents o f n o t am o rtizin g g o o d w ill p re se n te d th e
fo llo w in g argum ents: I t i s o v e rly c o n s e rv a tiv e to am o rtize
g o o d w ill. The com putation o f th e a m o rtiz a tio n o f g o o d w ill
cannot be d eterm in ed a c c u ra te ly . I t i s n o t n e c e ssa ry to
re c o rd th e d e c lin e in goodw ill b ecau se th e p r o f it- a n d - lo s s
re c o rd is th e b e s t in d ic a tio n o f th e e x is te n c e o f g o o d w ill.
P roponents o f am o rtizin g g o o d w ill p re se n te d th e
fo llo w in g : I t i s no more d i f f i c u l t to a m o rtize g o o d w ill
a c c u ra te ly th an i t i s to compute a c c u ra te d e p re c ia tio n on
p la n t a s s e ts . A m ortizing g o o d w ill com plies w ith th e co n
c e p t o f m atching c o s t and rev en u e. I t i s c o n s e rv a tiv e to
am o rtize g o o d w ill.
A ccounting se rv e s many groups and has been r e f e r r e d
to as th e language o f b u sin e ss b ecau se i t p ro v id es th e
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205
means by w hich b u sin e ss can communicate w ith th e p u b lic .
However, one p a r t i c u l a r b u s in e s s tr a n s a c tio n can have d i f
f e r e n t ac co u n tin g tre a tm e n ts . These v a rio u s tre a tm e n ts
can produce d i f f e r e n t r e s u l t s which can a f f e c t th e d e c i
sio n s made by th e u s e rs o f th e r e p o r ts t h a t reco rd th e s e
tr a n s a c tio n s . An i l l u s t r a t i v e case was p re se n te d to p o r
tr a y th e e f f e c ts o f v a rio u s acco u n tin g tre a tm e n ts on c e r
t a i n r a t i o s im p o rta n t to u s e rs o f c o n s o lid a te d f in a n c ia l
r e p o r ts . The r e la te d r a t i o s r e f e r r e d to in th is ca se w ere
p re se n te d in such a way as to g iv e th e appearance o f
m easuring th e e x te n t o f management e f f ic ie n c y , th e r a t e o f
earn in g power on p r o p r ie ta r y in v e stm e n t, and th e cu sh io n
provided by sto c k h o ld e rs a g a in s t lo s s to c r e d ito r s . How
ev er, i t was p o in te d o u t th a t such an a p p a re n t m easure may
be in a c c u ra te and m isle a d in g b ecau se o f v a r ia tio n s in
acco u n tin g .
P u b lic u t i l i t i e s have as t h e i r p r in c ip a l theme
p u b lic i n t e r e s t and th e r e f o r e in c u r s e r v ic e o b lig a tio n s and
f in a n c ia l r e s t r a i n t s . P u b lic u t i l i t i e s cannot e s ta b lis h
t h e i r own p r ic e s . They have b o u n d aries e s ta b lis h in g
"re a so n a b le r a te s " and " f a i r r e t u r n s ." R easonable r a te s
a re th o se w hich p ro v id e th e u t i l i t y w ith th e n e c e ssa ry
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206
revenues to cover th e adequate c o s ts and to b rin g a " f a i r
r e tu rn " on th e p r o p e r tie s u sed . The problem in e s t a b l i s h
ing " f a i r r e tu r n " i s , "Should g o o d w ill be in c lu d e d in th e
p ro p e rty ? " I f g o o d w ill is in c lu d ed in th e p ro p e rty , u t i l i
t i e s w ill r e c e iv e a h ig h e r r a t e .
The f in a n c ia l c o n d itio n and th e n o te s th e r e to o f
two hundred f o r ty c o rp o ra tio n s w ere exam ined. These com
p an ies w ere s e le c te d on th e b a s is o f t h e i r s iz e and im por
ta n ce in th e economic and f in a n c ia l environm ents. Of th e
two hundred f o r ty com panies s e le c te d , over two hundred
f i f t e e n a re m an u factu rin g com panies. The s e le c tio n o f th e
companies com prising t h i s group r e s u lte d in a sam ple o f
approxim ately 1 0 p e r cen t o f th e m an u factu rin g com panies.
C onclusions
As a r e s u l t of th e a n a ly s is o f th e fin d in g s in t h i s
study i t i s p o s s ib le to draw s e v e r a l co n clu sio n s co n cern in g
goodw ill a r is in g from c o n s o lid a tio n . B efore l i s t i n g any
of th e c o n c lu sio n s, i t is n e c e ssa ry to r e c a l l th a t th e p u r
pose of th is endeavor is to d eterm in e i f th e c o n s o lid a tio n
of a c o rp o ra te e n te r p r is e r e s u l t s in g o o d w ill, and i f good
w ill does a r is e , w hether i t is a tem porary o r a perm anent
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207
portion of total assets.
An attem p t was made to id e n tif y th e t h e o r e t i c a l and
p r a c tic a l c o n s id e ra tio n s which have guided a c co u n ta n ts in
accounting f o r th e s e item s. The c o n c lu sio n s were a r r iv e d
a t as a r e s u l t o f th e fin d in g s o f t h i s re s e a rc h and t h e i r
im p lic a tio n s w ith in th e e x is tin g framework o f acco u n tin g
th e o ry .
1. Excess o f c o s t o v er book v a lu e . - -The fin d in g s
h e re a re th a t tw e n ty -six com panies have c l a s s i f ie d t h i s
c a p tio n in seven d if f e r e n t ways. The same c a p tio n ap p eared
in th e n o te s to th e f in a n c ia l s ta te m e n t s ix te e n tim es and
was re p re se n te d by seven o th e r c l a s s i f i c a t i o n s on th e b a l
ance sh e et which s ta te d "See n o t e . ” These lead to th e
co n clu sio n th a t th e companies a re as confused in c l a s s i f y
ing "excess o f c o s t over book v a lu e , " which s u b s t itu te s f o r
goodw ill, as th ey a re in c la s s if y in g "g o odw ill" i t s e l f .
2. I n ta n g ib le s . —I t was found t h a t p o s itiv e good
w ill was a ls o c l a s s i f i e d as an in ta n g ib le o f some ty p e .
Tw enty-four companies c l a s s i f ie d p o s it iv e goodw ill as some
form of in ta n g ib le . An in ta n g ib le was in v o lv ed u n d er t h i s
c l a s s i f ic a ti o n th ro u g h fiv e d i f f e r e n t m ethods. T his
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208
co n fu sio n a ls o le ad s to th e co n c lu sio n t h a t a c c o u n ta n ts a re
n o t c o n s is te n t in th e p ro p er c l a s s i f i c a t i o n o f g o o d w ill.
There seems to be no p a r tic u la r g u id e lin e s to fo llo w . The
c l a s s i f i c a t i o n ten d s to fo llo w one o f s e v e r a l custom ary
p r a c tic e s r a t h e r th a n lo g ic a l re a s o n in g .
3. N egative g o o d w ill.--N e g a tiv e g o o d w ill was n o t
handled in such a v a r ie ty o f ways. Perhaps t h i s m ight be
due to th e lim ite d cases o f n e g a tiv e g o o d w ill. In some o f
th e cases w here n e g a tiv e g o o d w ill d id ap p e ar, th e t h e o r e t i
c a l method t h a t th e c r e d i t d i f f e r e n t i a l sh ould be ta k en
in to income on a re a so n a b le and a s y s te m a tic b a s is was f o l
lowed. I t does n o t seem t h a t th e th e o r e t i c a l method i s
e n t ir e ly d e s ir a b le . Such a method im p lie s t h a t income has
been e a rn e d --a n erroneous assum ption. A s a le in th e o r d i
n ary co u rse o f b u sin e ss has n o t been made; th e r e f o r e ,
income has n o t been earn ed . For t h i s re a so n i t is con
cluded th a t th e firm s fo llo w in g th i s p ro ced u re a re r e c o r d
ing income w hich has n o t been e a rn e d .
Because o f such acco u n tin g tre a tm e n ts f o r n e g a tiv e
g o o d w ill, th o se firm s p re se n te d a more fa v o ra b le f in a n c ia l
p o s itio n th a n firm s n o t u sin g t h i s m ethod. The b e t t e r
f in a n c ia l p o s itio n in r e a l i t y d id n o t e x i s t b u t was c re a te d
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209
by th e acco u n tin g tre a tm e n t u sed .
4. A m o rtiza tio n o f g o o d v ill .--T he fin d in g s i n d i
ca te d th a t th e re was com plete co n fu sio n on th e a m o rtiz a tio n
o f p o s itiv e g o o d w ill. G oodw ill was p re se n te d as d e c re a sin g
from one p e rio d to a n o th e r w ith no e x p la n a tio n o f th e d e
c re a s e . Most com panies d id n o t am o rtize g o o d w ill. Of
th o se am o rtizin g g o o d w ill, th e re was no u n ifo rm ity as to
th e p e rio d o f tim e in which th e a m o rtiz a tio n should tak e
p la c e . This le a d s to th e c o n c lu sio n t h a t re a d e rs o f th e
f in a n c ia l sta te m e n ts have been m isled co n cern in g th e o p e r
a tio n s o f a company becau se o f th e acco u n tin g tre a tm e n t
employed, and th e y m ight p o s s ib ly be unaw are o f th e a c tu a l
e f f ic ie n c y o f management o r th e p r o f i t a b i l i t y o f th e firm .
To add to th e co n fu sio n , i t was d i f f i c u l t to d eterm in e i f
th e a m o rtiz a tio n o f g o o d w ill was to r e ta in e d ea rn in g s o r
c u r r e n t o p e ra tio n s . Those firm s a m o rtiz in g g o o d w ill s ta te d
th a t goodw ill was b ein g am o rtized , b u t th e account charged
f o r th e a m o rtiz a tio n was n o t re v e a le d . In v ery few cases
was th e re an account in th e income s ta te m e n t, a m o rtiz a tio n
o f c o s t over book v a lu e , o r some s im ila r t i t l e .
P o s itiv e g o o d w ill was p re se n te d in tw e n ty -th re e
d if f e r e n t m ethods by n in e ty - f iv e com panies. Six companies
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210
c l a s s i f i e d n e g a tiv e g o o d w ill by th r e e d i f f e r e n t m ethods.
A few companies am o rtized goodw ill to r e ta in e d earn in g s and
some charged i t o f f to o p e ra tio n s . These v a rio u s methods
re p re s e n t th e tre a tm e n t o f one tr a n s a c tio n . The fin d in g s
le a d to th e c o n c lu sio n t h a t th e re seems to be l i t t l e e f f o r t
to fo llo w any c le a r p r in c ip le , b u t t h a t w hich is co n v en ien t
u nder th e circu m stan ces seems to be ad o p ted .
5. Goodw ill a plug f i g u r e . - - I t was found th a t th e
amount o f g o o d w ill co u ld depend upon th e method o f c o s tin g
in v e stm e n ts. Four m ethods were a p p lie d : averag e c o s t,
f i r s t - i n f i r s t - o u t , l a s t - i n f i r s t - o u r , and s p e c if ic i d e n t i
f i c a t i o n . Goodw ill v a rie d from $7,350 to $10,600 because
o f th e method o f c o s tin g in v e stm e n ts. From th is i t m ight
be concluded th a t g o o d w ill from c o n s o lid a tio n is o fte n a
m ere "plug" f ig u re .
A ccounting th e o ry re co g n izes t h a t th e excess o f
c o s t over book v a lu e may n o t, a t a l l tim e s, be g o o d w ill.
I f th is excess re p re s e n ts e x tra o rd in a ry e a rn in g power o f
th e s u b s id ia ry , i t i s co n sid ered tr u e g o o d w ill. However,
i f th i s excess r e p re s e n ts u n d e r c a p ita liz a tio n o f a s s e ts on
th e books o f th e s u b s id ia ry , c o s t in c u rre d d u rin g an i n f l a
tio n a ry p e rio d , o r a premium p aid to a c q u ire c o n tro l of
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211
a s u b s id ia r y , th e n th e excess i s n o t c o n sid e re d g o o d w ill.
A ccounting p r a c tic e on th e whole avoids t h i s is s u e . Very
seldom , i f any, w ere th e re tim es when a canpany p re s e n te d
a break-dow n showing t h a t c e r t a in amounts o f th e excess
re p re s e n te d an u n d e r c a p ita liz a tio n o f a s s e ts o r one o f th e
o th e r re a so n s and a p o rtio n re p re s e n te d tr u e g o o d w ill. For
t h i s re a s o n i t i s concluded th a t t h i s la c k o f a breakdown
i l l u s t r a t e s why th e account "excess of c o s t over book
v a lu e " was c l a s s i f i e d on th e b a la n c e s h e e t in so many d i f
f e r e n t w ays. Such methods a re cam ouflage, a means o f
av o id in g th e is s u e . The f a c t t h a t n in e ty - f iv e com panies
p re se n te d tw e n ty -th re e d if f e r e n t m ethods a ls o su p p o rts t h i s
c o n c lu sio n .
A ccounting a u t h o r it ie s a re n o t in accord on th e
is s u e as to w hether p o s itiv e g o o d w ill i s a tem porary o r a
perm anent p o r tio n o f t o t a l a s s e ts . I t is b e lie v e d t h a t
th o se who th in k p o s itiv e g o o d w ill i s tem porary, and t h a t i t
should be am o rtized , have th e s tro n g e r c a se . T his o p in io n
i s based on th e rea so n in g t h a t th e businessm an made a p ay
ment f o r ex cess p r o f i t s as a r e s u l t o f th e momentum o f
e a rn in g power o f th e going b u sin e ss as i t e x is te d a t th e
tim e o f th e p u rch ase. T h erefo re, s in c e ac co u n tin g i s based
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212
on a m atching co n cep t, th e c o s t o f purchased goodw ill
sh ould be m atched a g a in s t th e income i t b rin g s in . This
m atching can be accom plished o n ly by am o rtizin g g o o d w ill.
However, in acco u n tin g p r a c t ic e , a m a jo rity o f th e firm s
do n o t am o rtize g o o d w ill.
Recommendations
As a r e s u l t o f th e f in d in g s , and th e c o n c lu sio n s
reach ed on th e b a s is o f th e s e f in d in g s , recom m endations a re
su b m itted in th e p arag rap h s w hich fo llo w :
1. That th e se n te n c e in p arag rap h 8 o f B u lle tin
No. 51 which s t a t e s , "to th e e x te n t th e d if fe re n c e , d e t e r
mined as in d ic a te d in p arag rap h 7 is co n sid ered to be
a t t r i b u t a b l e to s p e c if ic a s s e ts , i t should be a llo c a te d to
them . . . in u n u su a l c irc u m sta n c e s th e re may be a rem ain
in g d if f e r e n c e . . . w hich o r d in a r ily would be tak en in to
income in f u tu re p e rio d s on a re a s o n a b le and sy ste m a tic
b a s i s , b e re v is e d .
In ac co u n tin g when a c r e d i t b alan ce i s tak en in to
American I n s t i t u t e o f C e r tif ie d P u b lic A ccount
a n ts , Committee on A ccounting P rocedure, A ccounting
R esearch B u lle tin No. 51 (New York: AICPA, A ugust, 1959),
p. 44.
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2 1 3
income t h i s c r e d i t b a la n c e re p re s e n ts a g a in in th e norm al
o p e ra tio n s o f th e b u s in e s s . Since t h is c r e d it amount in
p a ra g rap h 7 i s n o t a g a in in th e norm al o p e ra tio n o f th e
b u s in e s s , i t i s su g g ested t h a t th e Committee on A ccounting
P rocedure o f th e American I n s t i t u t e o f C e r tif ie d P u b lic
A ccountants conduct a re s e a rc h study to a s c e r ta in a p ro p er
d is p o s a l o f t h is p a r t i c u l a r c r e d it amount.
2. That p o s itiv e g o o d w ill should be am ortized in
o rd e r to comply w ith th e m atching c o n cep t. I f g o odw ill
re p re s e n ts excess e a rn in g s over a p e rio d o f tim e, th en t h a t
g o o d w ill should be m atched a g a in s t th e expected e a rn in g s.
3. That only one method o f c o stin g th e investm ent
account should be a c c e p ta b le . (This would be a n o th e r way
to p re v e n t goodw ill from b ein g a g a p - f i l l e r . )
4. That when g o o d w ill is am ortized i t should be
a b le to be tra c e d to th e expense s e c tio n of th e income
s ta te m e n t. Ihe i te n should n o t be b u rie d . F u ll d is c lo s u r e
of th e a m o rtiz a tio n should be made in o rd e r to p re s e n t th e
re a d e r a d e ta ile d view o f th e c o n so lid a te d tr a n s a c tio n s .
5. Ih a t th e v a rio u s o th e r methods o f p re s e n tin g
g o o d w ill should be abandoned. This recom mendation would
a ls o h e lp p rev e n t goodw ill from becoming a g a p - f i l l e r .
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2 1 4
Therefore th e d ifferen ces in judgment would be narrowed
and in th is way a l l th e accountants could a t le a s t be
making the decisions on a common b a sis. The amount should
be properly described and fu lly d isclo sed .
6. That a member of the reg u lato ry agencies should
always be included in the membership of the Accounting
P rin cip les Board. Such a member could a s s is t w ith the
form ulation of accounting p rin cip le s and procedures of
regulated companies.
7. That a l l a u th o rita tiv e bodies adopt some agree
ment about the same business tra n sa c tio n . The S ecu rities
and Exchange Commission requires only th a t th e rep o rtin g
companies d isc lo se the excess of co st over book value and
the d isp o sitio n in consolidated balance sh eets. The M e ri-
can I n s titu te of C e rtified Public Accountants recommends an
analysis of th e excess of cost over book v a lu e .
If our nation is going to continue i t s economic
growth and achieve i t s n atio n al goals, i t w ill be necessary
for the accountant to r e la te the fin a n c ia l tran sactio n s as
they are and as he honestly views them. Once th is has been
accomplished the profession can narrow the areas of d if f e r
ence and inconsistency in the preparation and presen tatio n
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215
o f f in a n c ia l in fo rm a tio n ; th e re fo r e , b e t t e r d e c is io n s can
be made as b u sin e ss a tte m p ts to reac h th e s e g o a ls .
I t i s g e n e ra lly recommended t h a t f u tu r e re s e a rc h
s tu d ie s along t h i s l i n e be made. Such s tu d ie s could p o s
s ib ly throw some l i g h t on th e a m o rtiz a tio n o f g o o d w ill.
I t is hoped th a t th e fin d in g s , c o n c lu sio n s , and recommenda
tio n s o f th i s stu d y w i l l in flu e n c e th e A ccounting P rin c ip le s
Board to is s u e an o p in io n which would h e lp to re s o lv e some
o f th e d i f f i c u l t problem s in v o lv ed .
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BIBLIO G R APH Y
216
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
B I B L IO G R A P H Y
Books
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F inney, H. A ., and M ille r, H. E. P rin c ip le s o f A ccounting:
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M ilroy, R. R ., and Walden, R. E. A ccounting Theory and
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Staub, W alter A. " In ta n g ib le A s s e ts ," Contem porary
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W ilson, G. L. ; H errin g , J . M . ; and Euts 1 e r, R. B. P ublic
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Yang, J . M . G oodw ill and O ther I n ta n g ib le s . New York :
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221
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"Roadblocks in th e Paths o f A cco u n tin g ," H arvard
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'Some Shortcom ings in C o n so lid ate d S tatem en ts,
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222
Grady, P aul. "A ccounting f o r F ixed A ssets and T h eir
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1950), 12.
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L o rig , A rthur N. "Some B asic Concepts o f A ccounting and
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223
Lyons, James R. "V alu atio n o f G oodw ill and Covenant Not
to Compete; How to D is tin g u is h Between Ihem, " Jo u rn a l
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May, George 0. "B usiness Com binations : An A lte rn a tiv e
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McDonald, R obert J . "G oodw ill and th e F e d e ra l Income Tax, "
V ir g in ia Law Review, XLV (June, 1959), 645-683.
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A ccounting Review, XXVIII (O ctober, 1953), 491-492.
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Power Commission--A C r itiq u e ," J o u rn a l o f A ccountancy,
LXXVII (June, 1944), 437-438.
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J o u rn a l o f A ccountancy. LXVIII (Septem ber, 1939), 169-
180.
"G oodw ill in A ccountancy," J o u rn a l o f A ccount
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Rua, E rn e st J . , J r . "A nalyzing a Motor C a r r i e r 's B alance
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224
Sprouse, R o bert. "A ccounting f o r I'Jhat-Y ou-M ay-C all-Its, "
Jo u rn a l o f A ccountancy, CXXII (O ctober, 1966), 46-49.
S tan s, M . H. "How New S tandards o f F in a n c ia l R ep o rtin g
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Trum bull, W . P. "Case Study in W ritin g Off I n ta n g ib l e s ,"
A ccounting Review, XXI (O ctober, 1956), 599-607.
W alker, George T. "A ccountants* P re sen t Concept o f Good
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A ccountancy, XCI (Jan u ary , 1951), 100-103.
"N on-Purchased G o o d w ill," A ccounting Review,
X III (Septem ber, 1938), 253-259.
W em tz, W illiam W . "Some Problems as to P aren t Companies,
J o u rn a l o f A ccountancy, IXVII (June, 1939), 337-341.
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and Learned S o c ie tie s
American I n s t i t u t e of A ccountants, Committee on A ccounting
P ro ced u re. A ccounting R esearch B u lle tin No. 4 3 . New
York: American I n s t i t u t e o f A ccountants, 1947.
American I n s t i t u t e o f C e r tif ie d P ublic A ccountants, Com
m itte e on A ccounting P rocedure. A ccounting Research
B u lle tin No. 1 . New York : American I n s t i t u t e o f
C e r tif ie d P u b lic A ccountants, Septem ber, 1939.
_________. A ccounting R esearch B u lle tin No. 51. New York:
American I n s t i t u t e o f C e r tif ie d P u b lic A ccountants,
A ugust, 1959.
A sso c ia tio n o f I n t e r s t a t e Commerce Commission P r a c ti
tio n e r s . A Manual o f P ra c tic e and Procedure B efore
th e I n t e r s t a t e Commerce Commission. W ashington, B.C.
A sso c ia tio n o f I n t e r s t a t e Commerce Commission P r a c ti
tio n e r s , 1960.
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225
M oonitz, M aurice. The B asic P o s tu la te s o f A cc o u n tin g :
A ccounting R esearch Study No. 1. New York: 1961.
N a tio n a l Committee on G overnm ental A ccounting. M unicipal
A ccounting and A u d itin g . Chicago : N a tio n a l Committee
on G overnm ental A ccounting, 1951.
S e c u r itie s and Exchange Commission. A ccounting S e rie s
R e le a se s, R elease No. 50, 1956.
_________. D ire c to ry o f Companies F ilin g Annual R eports
w ith th e S e c u r itie s and Exchange Commission. W ashing
to n , D.C. : 1964.
_________. "Form and Content o f F in a n c ia l S ta te m e n ts,"
R e g u la tio n S-X. August 1, 1966.
Annual R eports
A llie d Chem ical C o rp o ratio n . Annual R eport, 1964.
American B ro ad castin g Company. Annual R ep o rt, 1964.
American Can Company. Annual R ep o rt, 1962.
A utom atic C anteen Company o f Am erica. Annual R eport, 1962.
American Tobacco Company. Annual R ep o rt, 1963.
American W ater Works Co., In c. Annual R eport, 1961.
Baldwin M ontrose Chemical Company, In c. Annual R eport,
1964.
Benrus Watch Company. Annual R ep o rt, 1964.
The Borden Company. Annual R e p o rt, 1963.
Botany I n d u s tr ie s . Annual R ep o rt, 1964.
The C a rp e n ter S te e l Company. Annual R eport, 1965.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
226
C h ry sle r C o rp o ratio n . Annual R eport, 1964.
Com P roducts Company. Annual R eport, 1962.
_________. Annual R ep o rt, 1965.
Eastman Kodak Company. Annual R eport, 1964.
Ford M otor Company. Annual R ep o rt, 1964.
G eneral Foods C o rp o ratio n . Annual R ep o rt, 1963.
H a r r is “I n t e r ty p e C o rp o ra tio n . Annual R eport. 1964.
H. J . Heinz Company. Annual R eport, 1964.
The H ertz C o rp o ratio n . Annual R eport, 1965.
I n te r n a tio n a l B usiness M achines, Corp. Annual R ep o rt,
1965.
L o u is v ille and N a sh v ille , R a ilro a d Co. Annual R e p o rt,
1961.
The Mead C o rp o ratio n . A nnual R eport, 1965.
N a tio n a l D airy P roducts C o rp o ra tio n . Annual R ep o rt, 1964
O tis E le v a to r Company. Annual R eport. 1963.
P et M ilk Company. Annual R ep o rt. 1964.
R iillip s -V a n Heusen, C o rp o ra tio n . Annual R ep o rt, 1962.
P ills b u r y Company. Annual R ep o rt. 1964.
_________. Annual R eport, 1965.
P ro c te r and Gamble Company. Annual R eport, 1964.
Purex C o rp o ratio n , L td. Annual R eport, 1963.
Saxon Paper C o rp o ratio n . Annual R eport, 1964.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
227
Schenley I n d u s tr ie s , In c o rp o ra te d . Annual R eport. 1951.
S ig n al O il and Gas Company. Annual R ep o rt. 1964.
Sprague E le c tr ic Company. Annual R eport. 1963.
S t. L o u is-S an F ra n cisc o R a ilro ad Ccmpany. Annual R eport,
1964.
S tandard Brands P a in t Company. Annual R eport. 1962.
Studebaker C o rp o ratio n . Annual R eport. 1964.
U nited S ta te s Rubber Company. Annual R eport, 1964.
W algreen Drugs Company. Annual R eport, 1964.
W arner-Lam bert Company, P h arm aceu tical Company. Annual
R e p o rt, 1961.
W estinghouse E le c tr ic C o rp o ratio n . Annual R eport. 1964.
Court Cases
Broad y . J o ll y f e , 79 Ihe E n g lish R eports 509 (1907).
Ihe Com m issioners o f Inland Revenue v . M u ller, Ih e Law
R eports 217 (1901).
C ru ttw e ll V. L y le, 34 Ihe E n g lish R eports 129 (1903).
Hitchman Coal and Coke Co. v . M itc h e ll, 245 U.S. 229
(1918).
Los A ngeles Cas & E le c tr ic Corp. v . R a ilro a d Commission o f
C a lif o r n ia . 289 U.S. R eports 313 (1933).
Munn V. I l l i n o i s , 94 U.S. R eports 113 (1876).
Red Wing M alting Co. v . W illc u ts , 8 F e d e ra l R ep o rter
2d S e rie s 180 (1926).
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
228
Spring V aliev Works v . S c h o tt1 er, 110 U.S. R eports 347-348
(1883).
Wilcox V. C o n so lid ated Gas C o., 212 U.S. R eports 22 (1908).
M iscellaneous
C iv il A ero n au tics Board. P erso n al l e t t e r from James G.
Power, C hief, R eg u latio n s and R eports D iv isio n , Bureau
of Accounts and S t a t i s t i c s , May 24, 1967.
S e c u r itie s and Exchange Commission. P erso n al l e t t e r from
Lindsey J . M illa rd , A sso c ia te C hief A ccountant, May 8,
1967.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
APPENDIX A
LISTS OF COM PANIES INCLUDED IN THE STUDY
(A lp h a b e tic a l L is t o f Companies Included in th e Study)
229
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
Alphabetical
1. Abbey Rents
2. A bbott L a b o ra to rie s
3. A dm iral C o rp o ratio n
4 . AGF I n d u s tr ie s , Inc.
5. Alco P ro d u cts, Inc.
6 . A llie d Chem ical C o rp o ratio n
7. A lpha P o rtla n d Cement Company
8 . Aluminum Company o f America
9. A n erican A ir lin e s , In c.
10. A nerican B ro ad castin g Company
11. American Can Company
12. American Cement C o rp o ratio n
13. Am erican Consumer I n d u s tr ie s , In c.
14. Am erican P otash and Chem ical C o rp o ratio n
15. American P re sid e n t L ines
16. Am erican Telephone and T elegraph Company
17. Am erican Tobacco Company
18. Am erican W ater Works Co., Inc.
19. Armco S te e l C o rp o ratio n
20. Armour and Company
21. A utom atic Canteen Company o f America
22. Baldw in M ontrose Chem ical Company, In c.
23. Bank o f America
24. Benrus Watch Company
25. Bethlehem S te e l Company
26. B oeing Company (The)
27. Bond I n d u s tr ie s , Inc.
28. Borden Company (The)
29. Botany In d u s trie s
30. B risto l-M y e rs Company
31. Budd Company (The)
32. Canada S outhern Petroleum , L td.
33. C a rp e n te r S te e l Company (The)
34. C a rte r Products
35. Case Company (J. I . )
230
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231
36. Cela n e s e C o rp o ratio n o f America
37. Champion P apers, In c.
38. Chase M anhattan Bank (The)
39. Chock P u ll O’Nuts C o rp o ratio n
40. C h ry sle r C o rp o ratio n
41. C itie s S erv ice Company
42. C ity Products C o rp o ra tio n
43. Clopay C orporation
44. Coca-Cola Company
45. C o lg ate-P alm o liv e Company
46. Columbia B ro ad c astin g System, Inc.
47. Columbia P ic tu re s C o rp o ratio n
48. Commercial D iscount C o rp o ra tio n
49. Commonwealth Edison Company
50. C o n tin e n ta l Can Company
51. C o n tin e n ta l O il Company
52. Copper Range Company
53. C om P ro d u c ts Company
54. Crane Company
55. C ro w n -Z e lle rb a c h C o r p o r a tio n
56. C u tte r L a b o ra to rie s In c o rp o ra te d
57. Dana C orporation
58. Dan R iver M ills, In c.
59. Decca Records, In c o rp o ra te d
60. Deere & Company
61. Devoe & Reynolds Company, Inc.
62. D in er’ s Club, Inc.
63. Douglas A ir c r a f t Company, Inc.
64. Eastman Kodak Company
65. Empire L ife In su ra n ce Company
66. E versharp. Inc.
67. Ford Motor Company
68 . F rid e n , In c o rp o ra ted
69. G eneral American T ra n s p o rta tio n Corp.
70. G eneral Baking Company
71. G eneral C igar Company, In c.
72. G eneral E le c tr ic Company
73. G eneral Dynamics C o rp o ratio n
74. G eneral Foods C o rp o ratio n
75. G eneral Motors C o rp o ratio n
76. G eneral Outdoor A d v e rtisin g Company
77. G eneral T ire and Rubber Company
78. G lidden Company (The)
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
232
79. G lobe-VJemicke I n d u s tr ie s , Inc.
80. G oodrich Company (B. F .)
81. G rant Company (W . T. )
82. G reat A nerican In su ran ce Company
83. Greyhound C o rp o ratio n
84. G ulf O il C o rp o ratio n
85. H a r r is - I n te r ty p e C o rp o ratio n
86. H art, S c h a ffn e r & Marx Company
87. Heinz Company (H. J . )
88. H ersney C hocolate C o rp o ratio n
89. H ertz C o rp o ratio n (The)
90. H ilto n I n te r n a tio n a l Company
91. Hiram W alker-Gooderham & W orts, L im ited
92. H olly Sugar C o rp o ratio n
93. H o lt, R in eh a rt & W inston, Inc.
94. Hunt Foods and In d u s tr ie s
95. Honeywell, In c o rp o ra te d
96. George A. Hormel and Company
97. Household F inance C o rp o ratio n
98. I n te r n a tio n a l B usiness Machines Corp.
99. I n te r n a tio n a l H a rv e ste r Company
100. I n te r n a tio n a l House o f Pancakes, In c o rp o ra te d
101. I n te r n a tio n a l Paper Company
102. Ja n tz e n , In co rp o ra te d
103. Jew el Tea Company, In c.
104. John Hancock ü i t u a l L ife In su ran ce Company
105. Jo se ly n M anufacturing and Supply Company
106. Joy M anufacturing Company
107. K aiser Aluminum and Chem ical C o rp o ratio n
108. K ellogg Company
109. K ennecott Copper C o rp o ratio n
110. K resge Company (S. S .)
111. Kress and Ccxapany (S. H. )
112. L ig g e tt and l^ e r s Tobacco Company
113. L io n e l C o rp o ratio n (The)
114. Thomas J . Lip to n . Inc.
115. L itto n I n d u s tr ie s , In c.
116. Lockheed A ir c r a f t C o rp o ratio n
117. Loews T h eatres In c o rp o ra te d
118. L o u is v ille and N a sh v ille R ailro ad Co.
119. McKesson Robbins, In co rp o ra te d
120. Maremont C o rp o ratio n
121. Max F a c to r and Company
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
233
122. Mead C o rp o ratio n (The)
123. M innesota Mining and M anufacturinc Aompany
124. M iles L a b o ra to rie s , In c.
125. M is s ile Systems Corp.
126. Mobil O il Company, In c .
127. Montgomery Ward and Company, In co rp o ra ted
128. N atio n al B is c u it Company
129. N a tio n a l Can C o rp o ratio n
130. N a tio n a l Cash R e g is te r
131. N a tio n a l D airy P ro d u c tio n s C o rp o ratio n
132. N a tio n a l D i s t i l l e r s & Chem ical C o rp o ratio n
133. N a tio n a l Gypsum Company
134. N a tio n al Lead Company
135. N a tio n a l Old Line In su ra n ce Company
136. N a tio n a l Rubber M achinery Company
137. Newberry & Company (J . J . )
138. New York B usiness and Development C o rp o ra tio n
139. New York Times (The)
140. North American Cement C o rp o ratio n
141. N orth American A v ia tio n Company
142. N orthrop C o rp o ratio n
143. O cc id en ta l L ife o f C a lif o r n ia
144. O cc id en ta l Petroleum C o rp o ratio n
145. O tis E le v a to r Company
146. O w e n s-Illin o is G lass Company
147. P a c ific F inance C o rp o ra tio n
148. Paramount P ic tu re s
149. P en n sy lv an ia R a ilro a d (The)
150. Pet M ilk Company
151. P e tro la n e Gas S e rv ic e , In c.
152. Phelps Dodge C o rp o ratio n
153. I h ila d e lp h ia and Reading R a ilro a d C o rp o ratio n
154. F n ilco C o rp o ratio n
155. H iilip M o rris, In c o rp o ra te d
156. R iillip s -V a n Heusen C o rp o ratio n
157. P ills b u r y Company
158. Pitney-B ow es, In c o rp o ra te d
159 - Plough, In c .
160. P o la ro id C o rp o ratio n
161. P o tte r In stru m en t Company, In c.
162. P ro c te r and Gamble Company
163. P ru d e n tia l In su ra n ce Company o f America
164. P ublic S erv ice E le c tr ic & Gas Company
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
234
165. P are O il Company
166. Purex C o rp o ratio n , L td.
167. Radio C o rp o ratio n o f America
168. R ais to n -P u rin a Company
169. Remington Arms Company
170. R e x all Drug and Chemical Company
171. Reynolds Tobacco Company (R. J . )
172. R ichardson M e r r ill, In c.
173. R ic h fie ld O il C o rp o ratio n
174. R epublic S te e l C o rp o ratio n
175. Ronson C o rp o ratio n
176. Royal Crown Cola Company
177. Royal-McBee C o rp o ratio n
178. Safeway S to re s , In c o rp o ra te d
179. Saxon Paper C o rp o ratio n
180. Schenley I n d u s tr ie s , In c o rp o ra te d
181. S c o v ill M anufacturing Company
182. Screen Gems, In c.
183. Screw and B o lt C o rp o ratio n o f America
184. Seaboard F inance Company
185. Seagram & Sons, In c. (J. E .)
186. Sears Roebuck and Company
187. S e c u rity F i r s t N atio n a l Bank
188. SC M C o rp o ratio n
189. S h e ll O il Company
190. Sherw in-W illiam s Company (The)
191. S ig n al O il and Gas Company
192. Simmons Company
193. S inger Company (The)
194. Sprague E le c tr ic Company
195. Square "D" Company
196. S t. Joseph Lead Company
197. S t. L ouis-San F ra n c isc o R a ilro a d Company
198. S tandard Brands P a in t Company
199. S tandard O il o f C a lif o rn ia
200. S tandard O il Company (New J e rs e y )
201. S te r lin g Drug, In c.
202. S tudebaker C o rp o ratio n
203. S w ift and Company
204. Technic o l o r , In c .
205. Texaco, Inc.
206. Texas Company
207. T h riftim a rt, In c.
208. T idew ater O il Company
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
235
209. Time, Inc.
210. Toledo S cale C o rp o ratio n
211. Trans-W orld A ir lin e s , Inc.
212. T w entieth C entury Fox Film Corp.
213. Union O il Company o f C a lif o r n ia
214. U nited A ir L ines
215. U nited B is c u it Company o f America
216. U nited F r u it Company
217. U nited S ta te s Consumer Products
218. U nited S ta te s Pipe and Foundry Company
219. U nited S ta te s Plywood Company
220. U nited S ta te s Rubber Company
221. U nited S ta te s S te e l C o rp o ratio n
222. U n iv ersal-C y clo p s S te e l C o rp o ratio n
223. Upjohn Company
224. W algreen Drug Company
225. Walt Disney P ro d u ctio n s
226. Warner B ro th ers P ic tu re s
227. W arner-Lam bert P h arm aceu tical Company
228. W aste King C o rp o ratio n
229. W estern Union T elegraph Company
230. W estinghouse E le c tr ic C o rp o ratio n
231. W eyerhaeuser Lumber Company
232. W heeling S te e l C o rp o ratio n
233. W hirlpool C o rp o ratio n
234. W aite Motor Company
235. IVhite Company (S. S .)
236. Woolworth Company (F. W.)
237. W orthington C o rp o ratio n
238. Xerox C o rp o ratio n
239. Youngstown Sheet and Tube Company (The)
240. Zenith Radio Corporation
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
APPEmiX B
LETTERS RECEIVED
236
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
CIVIL AERONAUTICS BOARD
W A S H IN G T O N , D .C . 20428
IN REPLY RQ^ER TO;
B-42(a)
May 24, 1967
AIR MAIL
Mr. I. C. Tillman
Assistant Accounting Professor
East Los Angeles College
5357 E. Brooklyn Avenue
Los Angeles, California 90022
Lear Mr. Tillman:
This is in response to your inquiry concerning the current
practice of the CAB in accounting for goodwill arising from con
solidation.
The Uniform System of Accounts and Reports for certificated
air carriers does not have a specific account for goodwill. The
Board has long had a firm policy against the inclusion in the
investment base of air carriers of intangibles reflected by the
excess of market values over book values of the acquiring company.
We have enclosed for your reference the initial decision of
the hearing examiner in the Western-Pacific Northern Merger case.
We have also included applicable excerpts from the recommended
decision of the hearing examiner in the Eastern-Mackey Merger
case.
Very truly yours,
\
/ ^James G. Power, Chief
Regulations and Reports Division
Bureau of Accounts and Statistics
Enclosure:
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
O F F I C E O F
T H E C H I E F A C C O U N T A N T
SE C U R ITIES AND EXC HANGE C O M M IS S IO N
WASHINGTON 0 . C. 20549
May 8, 1967
Mr. T. C. Tillman
Assistant Accounting Professor
East Los Angeles College
5357 E. Brooklyn Avenue
Los Angeles, Calif. 90022
Dear Mr. Tillman:
In your letter received May 1, 1967, you ask for information regarding
goodwill arising from consolidation and the effects of various treatments
on financial statements.
The following references may help you:
SEC Accounting Series Release No. 50 (1945).
SEC Regulation S-X, Intangible Assets.
William W. Wemtz, Intangibles in Business Combinations,
Journal of Accountancy. May 1957.
Andrew Barr, Accounting Aspects of Business Combinations,
Accounting Review. April 1959.
L. Schachner, Equitable Accounting for Goodwill upon Merger,
Financial Executive. March 1966.
M. Schiff and S. Arbesfeld, Goodwill a Make-or-buy Approach
(suitability of approaches in the accounting for acquisition) ,
Management Accounting. August 1966.
D. P. Hylton, Implications of the Direct Write-off of Goodwill,
New York Certified Public Accountant. December 1966.
Louis Rappaport, SEC Accounting Practice and Procedure. Second
Edition, Revised Printing, 1966.
The first two items mentioned above probably can be found in one of the
nine depository libraries in Los Angeles. Three of these nine are: Los
Angeles Public Library, University of Southern California Librairy and
California State College at Los Angeles.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
Mr. T. C. Tillman - 2 - May 8, 1967
Additional references probably can be found in the Accountants* Index
and the Business Periodicals* Index.
Sincerely yours.
Y- / / /
Lindsey J. Millard
Associate Chief Accountant
N3
W
VO
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This dissertation has been
microfümed exactly as received
68-720]
TILLMAN, Jr., Talma(%e Calvin, 1925-
A CBITICAL ANALYSIS OF GOODWILL ARISING FROM
CONSOLIDATION AND THE VARYING EFFECTS ON
FINANCIAL STATEMENTS.
University of Southern California, D.BA.,, 1968
Accounting
University Microfilms, Inc., Ann Arbor, Michigan
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
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Asset Metadata
Creator
Tillman, Talmadge Calvin, Jr
(author)
Core Title
A critical analysis of goodwill arising from consolidation and the varying effects on financial statements
School
Graduate School of Business Administration
Degree
Doctor of Business Administration
Degree Program
Accounting
Degree Conferral Date
1968-01
Publisher
University of Southern California
(original),
University of Southern California. Libraries
(digital)
Tag
business administration, accounting,OAI-PMH Harvest
Language
English
Contributor
Digitized by ProQuest
(provenance)
Advisor
Crum, William F. (
committee chair
), Loschen, Leslie R. (
committee member
), Yost, Robert C. (
committee member
)
Permanent Link (DOI)
https://doi.org/10.25549/usctheses-c17-179925
Unique identifier
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6807201.pdf (filename),usctheses-c17-179925 (legacy record id)
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6807201.pdf
Dmrecord
179925
Document Type
Dissertation
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TILLMAN, TALMADGE CALVIN, JR.
Type
texts
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University of Southern California
(contributing entity),
University of Southern California Dissertations and Theses
(collection)
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Repository Name
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Tags
business administration, accounting