November 21, 2017
of accounting for goodwill under U.S. GAAP and China GAAP
It has internationally reached a consensus
that goodwill “is an asset representing the future economic benefits arising
from other assets acquired in a business combination that are not individually
identified and separately recognized”1.
However, accounting for goodwill differs significantly from country to country
because of their different economic and accounting systems. This issue takes
U.S. generally accepted accounting principles (GAAP) and China GAAP as an
example to illustrate the differences in accounting treatment for goodwill.
In U.S., foreign firms which listed on a
U.S. exchange are required to reconcile financial statements to U.S. GAAP. For
example, generally, in addition to China GAAP financial statements, Chinese companies
traded on the New York Stock Exchange (NYSE) also prepare financial statements under
IFRS and provide a limited reconciliation to U.S. GAAP as part of a Form 20-F
filing. The alternative accounting practices make it possible to compare
accounting treatment under two different sets of accounting standards. Several examples
will be introduced to as follows.
To begin with, let’s talk about
calculation of goodwill. Under U.S. GAAP, goodwill is defined as an intangible
asset and recognized based on the difference the consideration transferred,
including the amount of any non-controlling interests in the acquiree and the
acquisition-date fair value of any previous equity interest in the acquiree
over the fair value of the identifiable net assets. Specifically, fair value of total assets
acquired regards to entire net assets of acquiree, including share of
non-controlling interest(NCI). Under China GAAP, the initial cost of
goodwill represents the excess of cost of acquisition over the acquirer’s
interest in the fair value of the identifiable net assets of the acquire under
a business combination not involving entities under NCI. The purchase
consideration excludes NCI part of purchase price, that is to say, goodwill
under China GAAP is equal to purchase consideration minus identifiable fair
value of net assets.
instant, in 2009, PetroChina Company Limited (which traded in both Shanghai
and New York) acquired 90% of the share capital in Singapore
Petroleum Company Limited for consideration of Singapore Dollars S$2915 through
PetroChina International (Singapore) Pte. Ltd. (an indirectly wholly owned
subsidiary of the company), which means fair value of NCI was S$324. In
addition to NCI, the consideration transferred was S$3,239 million
(approximately RMB 15,296 million). At the date of acquisition, the fair value
of the net assets in Singapore Petroleum Company Limited
was S$2,668 million, therefore, acquirer’s interest in the fair value of net
assets was S$2,402. Consequently, under China GAAP, goodwill of S$514(2,915-2,402)
million was recognized. However, under U.S. GAAP, the goodwill for this
acquisition was S$571(3,239-2,668) million. The impact of the goodwill
adjustment to U.S. GAAP usually increases or stabilizes goodwill because U.S.
GAAP includes share of NCI in consolidated financial statements.
Actually, as NCI shareholders are not
engaged in the process of merger and do not have control over acquiree, NCI ‘s
share of goodwill value is approximate to zero and few synergies is recognized
between NCI and subsidiaries. Moreover, the fair value of NCI shareholders’
equity, especially that of non-listed company’s measurement is hard to
accurately estimated. Therefore, the method of China GAAP that identified goodwill
without NCI share is more reasonable.
Secondly, accounting treatments for
bargain purchase under U.S. GAAP and China GAAP are also different. Under U.S.
if all acquisition-date valuations are appropriate, the acquirer recognizes
gain on bargain purchase at the date of acquisition. The amount of gain is
equal to excess of the net identifiable assets acquired and fair value. While,
China GAAP records the gain form bargain purchase to deferred debit. The gain
will be “amortized” into several periods. That is to say, result of bargain
purchase will be converted into gain more slowly. For the same company, the
profit under China GAAP is lower but smoother than that under U.S. GAAP.
Thirdly, for the impairment of goodwill,
both U.S. GAAP and Chinese GAAP don’t amortize goodwill and only record impairment
loss when necessary. For frequency, U.S. GAAP requires goodwill to be reviewed
for impairment each year. Under China GAAP, goodwill impairment reviews are
undertaken on an annual basis regardless whether there exists any indicators of
impairment tests under two GAAPs are different in several ways: First, Under U.S.
goodwill is on disposal of an entity(a reporting unit), whereas China GAAP is on
disposal of an asset group or a set of asset groups. The reporting unit is an
integral part of the company(group), which mainly requires three
characteristics: its economic activities leads to income or expense; the headquarter
of the group monitors its operations and makes decides; it has the discretion
of financial information. For example, an insurance company with three
divisions: household insurance, auto insurance and other insurance. If under
each division more than one subsidiaries are set up, then the agency can
implement the goodwill impairment test as a reporting unit. The definition of
an asset group is the minimum portfolio that an enterprise can identify. The
cash inflow generated by this combination should be independent of other assets
or asset groups. For example, a fashion enterprise has three factories
separately for kid, women and men. If all three factories are independent in
management and accounting, then each factory is an asset group. We can’t deny
that U.S. GAAP regulates testing units to a narrow and explicit scope without
any confusions. Apparently, the economy and market in U.S. is more mature, more
complicated and more developed than that in China, therefore, accounting standard
would be more completed after a large number of practices.
Besides, the impairment measurements under
two GAAPs differs. U.S. GAAP divides the test into two steps4,
first, the fair value of the reporting unit is compared with its carrying
amount. If the fair value of the reporting unit exceeds its carrying amount,
the goodwill of that reporting unit is considered unimpaired. Then, if the
carrying amount of the reporting unit exceeds its fair value, an impairment of
the reporting unit’s goodwill is implied. The
amount of the reporting unit’s goodwill impairment is measured as the excess of
the carrying amount of the unit’s goodwill over the implied value of its
goodwill. The implied value of its goodwill is determined as the excess of the
fair value of the reporting unit as a whole over the fair value of its net
assets excluding goodwill. Under China GAAP, recoverable amount is compared with
the carrying amount. According to Chinese accounting standard No. 8, when the
recoverable amount is less than the carrying amount, the impairment loss will
be recorded. The recoverable amount is the higher of value-in-use calculations
and difference of fair value and disposal expenses. The fair value is
determined by the amount of the sales agreement in the fair transaction. The value-in-use
calculations use pre-tax cash ?ow projections based on financial budgets
approved by management. The discount rates used are pre-tax and re?ect specific
risks relating to the cash generating unit.
Let’s take an example in annual report of
China Telecom Group (which traded in both Shanghai and New York). On 1st
October 2008, the Group acquired the CDMA mobile communication business and 99.5%
equity interests of Unicom Huasheng Telecommunications Technology Company
Limited (collectively the “CDMA business”). The purchase price was RMB43,800
million, which was fully settled as at 31 December 2010. Under China GAAP, the
recoverable amount of the Group’s telecommunications business is estimated
based on the value in use model, which considers the Group’s financial budgets
covering a five-year period and a pre-tax discount rate of 9.4% (2015: 9.7%).
Cash flows beyond the five-year period are projected to perpetuity at annual
growth rate of 1.5%. Management performed impairment tests for the goodwill at
the end of the reporting period and determined that goodwill was not impaired.
Management believes any reasonably possible change in the key assumptions on
which the recoverable amount is based would not cause its recoverable amount to
be less than carrying amount. Under U.S. GAAP, China Telecom Group still takes recoverable
amount as fair value of goodwill. Therefore, no adjustment will be made.
Though using different methods, in
impairment of goodwill, U.S. GAAP and China GAAP reached an accordance. We can
say both the two method are trying to compare current value with book value, so
the two methods have no essential differences. If there is an active market,
the market price is the best proof of fair value, which should be the basis for
the measurement of fair value. If market prices do not exist, assessment of
fair value should be based on the most sufficient information available,
including the transaction price of similar assets or liabilities and the
results obtained from other stock price methods. Value-in-use calculation is
usually a proper technology to estimate the fair value of a company’s net
assets. However, the two GAAPs are not playing words. The difference in the
development of capital market leads to the gap between two GAAPs. As a country
with highly developed capital markets, the United States generally adopts fair
value as the basis of measurement. Fair value in China is mainly assessed by
appraisal institution. Because Chinese capital market is lack of mechanism in
the assessment, the real “fair” could not be guaranteed especially to
All in all, accounting for goodwill under
U.S. GAAP and China GAAP mainly differs in three aspects: Calculation, U.S.
GAAP includes NCI in calculation of goodwill, China GAAP doesn’t; Bargain
purchase, U.S. GAAP recognized gain when bargain purchase occurs, China GAAP
defers the gain; Impairment, U.S. GAAP deals impairment in reporting units and
China GAAP use asset units. Though using different calculation in impairment
test, both GAAP aims to reflect fair value of goodwill.
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1 “ASC 350-20-35-79.”
3 “ASC 350-20-35-79.”
4 Christensen E. Theodore. Advanced Financial
Accounting. New York: McGraw-Hill Education