If we look for the answer to the question that why goodwill is an asset, then there is no specific explanation given in two of the renowned accounting frameworks i.e. IFRSs and US GAAPs. Although, the term goodwill has been defined and accounting treatment of goodwill has been under heavy discussion but not much is written about why it is even an asset at first place.
But we can take some help from conceptual framework and before asking ourselves why goodwill is an asset we have to remind ourselves what is an asset?
IASB Framework defines asset as:
Resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity
Before something is even considered as an asset, it has to fulfill the definition of asset given by IASB framework. The above definition has two important conditions
- Resource must be controlled by the entity
- Future economic benefits are expected flow to the entity
If goodwill is an asset then it must fulfill these two conditions. But first lets see what goodwill is. IFRS 3 defines goodwill as:
An asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised.
If we were looking for evidence whether IFRSs treat goodwill as asset or not then it is crystal clear that goodwill IS an asset. But we are here for reasons that why goodwill is an asset?
Lets analyse the definition of goodwill and then go back to the definition of asset to see if we can find something.
In goodwill’s definition that goodwill basically represents future economic benefits that arise from assets OTHER than assets acquired in a business combination i.e. other than such tangible and intangible assets which can be identified in their entirety.
In simple words goodwill arises from such assets which are not identifiable and thus cannot be recognized separately. For example, market knowledge, repute among customers, product expertise etc. All these things are with the entity and cannot be separated. For example one entity cannot sell its reputation.
Even more interesting question ask is what economic benefits flow to entity because of goodwill? This needs some explanation. And first question in this context is what is meant by economic benefits and how they flow to the entity?
In short, future economic benefits embodied in an asset is basically the capability of an asset to contribute to cash flow generation of an entity.
Goodwill however, cannot cause cash flows directly but it does play an important role in combination with other assets of the company. For example, a good repute among customers will enable the entity to sell products at higher price.
So we understood that goodwill does offer future economic benefits to the entity.
But according to asset’s definition, a resource must also be controlled by the entity. This is easy to understand. Whoever controls the interest of an entity also owns the goodwill attached to such entity because it is not separable from the entity. It can also be said that as entity is in control of all the assets and its capabilities therefore it is also controlling such assets which are not even identifiable like goodwill.
So it is established that goodwill is an asset. But here is one important thing that we must not ignore.