SiyaoLiuHeidiBlakeway-Phillips ACCT404November 21, 2017 Comparisonof accounting for goodwill under U.
S. GAAP and China GAAP It has internationally reached a consensusthat goodwill “is an asset representing the future economic benefits arisingfrom other assets acquired in a business combination that are not individuallyidentified and separately recognized”1.However, accounting for goodwill differs significantly from country to countrybecause of their different economic and accounting systems. This issue takesU.S. generally accepted accounting principles (GAAP) and China GAAP as anexample to illustrate the differences in accounting treatment for goodwill.
In U.S., foreign firms which listed on aU.S.
exchange are required to reconcile financial statements to U.S. GAAP. Forexample, generally, in addition to China GAAP financial statements, Chinese companiestraded on the New York Stock Exchange (NYSE) also prepare financial statements underIFRS and provide a limited reconciliation to U.S.
GAAP as part of a Form 20-Ffiling. The alternative accounting practices make it possible to compareaccounting treatment under two different sets of accounting standards. Several exampleswill be introduced to as follows.To begin with, let’s talk aboutcalculation of goodwill.
Under U.S. GAAP, goodwill is defined as an intangibleasset and recognized based on the difference the consideration transferred,including the amount of any non-controlling interests in the acquiree and theacquisition-date fair value of any previous equity interest in the acquireeover the fair value of the identifiable net assets. Specifically, fair value of total assetsacquired regards to entire net assets of acquiree, including share ofnon-controlling interest(NCI).
Under China GAAP, the initial cost ofgoodwill represents the excess of cost of acquisition over the acquirer’sinterest in the fair value of the identifiable net assets of the acquire undera business combination not involving entities under NCI. The purchaseconsideration excludes NCI part of purchase price, that is to say, goodwillunder China GAAP is equal to purchase consideration minus identifiable fairvalue of net assets. Forinstant, in 2009, PetroChina Company Limited (which traded in both Shanghaiand New York) acquired 90% of the share capital in SingaporePetroleum Company Limited for consideration of Singapore Dollars S$2915 throughPetroChina International (Singapore) Pte. Ltd. (an indirectly wholly ownedsubsidiary of the company), which means fair value of NCI was S$324.
Inaddition to NCI, the consideration transferred was S$3,239 million(approximately RMB 15,296 million). At the date of acquisition, the fair valueof the net assets in Singapore Petroleum Company Limitedwas S$2,668 million, therefore, acquirer’s interest in the fair value of netassets 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 thisacquisition was S$571(3,239-2,668) million. The impact of the goodwilladjustment 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 notengaged in the process of merger and do not have control over acquiree, NCI ‘sshare of goodwill value is approximate to zero and few synergies is recognizedbetween NCI and subsidiaries. Moreover, the fair value of NCI shareholders’equity, especially that of non-listed company’s measurement is hard toaccurately estimated. Therefore, the method of China GAAP that identified goodwillwithout NCI share is more reasonable.
Secondly, accounting treatments forbargain purchase under U.S. GAAP and China GAAP are also different. Under U.S.
GAAP2,if all acquisition-date valuations are appropriate, the acquirer recognizesgain on bargain purchase at the date of acquisition. The amount of gain isequal to excess of the net identifiable assets acquired and fair value. While,China GAAP records the gain form bargain purchase to deferred debit. The gainwill be “amortized” into several periods.
That is to say, result of bargainpurchase will be converted into gain more slowly. For the same company, theprofit 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 impairmentloss when necessary. For frequency, U.S. GAAP requires goodwill to be reviewedfor impairment each year. Under China GAAP, goodwill impairment reviews areundertaken on an annual basis regardless whether there exists any indicators ofimpairment. However,impairment tests under two GAAPs are different in several ways: First, Under U.
S.GAAP3,goodwill is on disposal of an entity(a reporting unit), whereas China GAAP is ondisposal of an asset group or a set of asset groups. The reporting unit is anintegral part of the company(group), which mainly requires threecharacteristics: its economic activities leads to income or expense; the headquarterof the group monitors its operations and makes decides; it has the discretionof financial information. For example, an insurance company with threedivisions: household insurance, auto insurance and other insurance.
If undereach division more than one subsidiaries are set up, then the agency canimplement the goodwill impairment test as a reporting unit. The definition ofan asset group is the minimum portfolio that an enterprise can identify. Thecash inflow generated by this combination should be independent of other assetsor asset groups. For example, a fashion enterprise has three factoriesseparately for kid, women and men. If all three factories are independent inmanagement and accounting, then each factory is an asset group. We can’t denythat U.S.
GAAP regulates testing units to a narrow and explicit scope withoutany confusions. Apparently, the economy and market in U.S. is more mature, morecomplicated and more developed than that in China, therefore, accounting standardwould be more completed after a large number of practices.
Besides, the impairment measurements undertwo GAAPs differs. U.S. GAAP divides the test into two steps4,first, the fair value of the reporting unit is compared with its carryingamount. If the fair value of the reporting unit exceeds its carrying amount,the goodwill of that reporting unit is considered unimpaired. Then, if thecarrying amount of the reporting unit exceeds its fair value, an impairment ofthe reporting unit’s goodwill is implied. Theamount of the reporting unit’s goodwill impairment is measured as the excess ofthe carrying amount of the unit’s goodwill over the implied value of itsgoodwill. The implied value of its goodwill is determined as the excess of thefair value of the reporting unit as a whole over the fair value of its netassets excluding goodwill.
Under China GAAP, recoverable amount is compared withthe carrying amount. According to Chinese accounting standard No. 8, when therecoverable amount is less than the carrying amount, the impairment loss willbe recorded.
The recoverable amount is the higher of value-in-use calculationsand difference of fair value and disposal expenses. The fair value isdetermined by the amount of the sales agreement in the fair transaction. The value-in-usecalculations use pre-tax cash ?ow projections based on financial budgetsapproved by management. The discount rates used are pre-tax and re?ect specificrisks relating to the cash generating unit.
Let’s take an example in annual report ofChina Telecom Group (which traded in both Shanghai and New York). On 1stOctober 2008, the Group acquired the CDMA mobile communication business and 99.5%equity interests of Unicom Huasheng Telecommunications Technology CompanyLimited (collectively the “CDMA business”). The purchase price was RMB43,800million, which was fully settled as at 31 December 2010. Under China GAAP, therecoverable amount of the Group’s telecommunications business is estimatedbased on the value in use model, which considers the Group’s financial budgetscovering 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 annualgrowth rate of 1.5%. Management performed impairment tests for the goodwill atthe end of the reporting period and determined that goodwill was not impaired.Management believes any reasonably possible change in the key assumptions onwhich the recoverable amount is based would not cause its recoverable amount tobe less than carrying amount. Under U.S. GAAP, China Telecom Group still takes recoverableamount as fair value of goodwill. Therefore, no adjustment will be made.
Though using different methods, inimpairment of goodwill, U.S. GAAP and China GAAP reached an accordance. We cansay both the two method are trying to compare current value with book value, sothe 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 forthe measurement of fair value. If market prices do not exist, assessment offair value should be based on the most sufficient information available,including the transaction price of similar assets or liabilities and theresults obtained from other stock price methods. Value-in-use calculation isusually a proper technology to estimate the fair value of a company’s netassets. However, the two GAAPs are not playing words. The difference in thedevelopment of capital market leads to the gap between two GAAPs. As a countrywith highly developed capital markets, the United States generally adopts fairvalue as the basis of measurement.
Fair value in China is mainly assessed byappraisal institution. Because Chinese capital market is lack of mechanism inthe assessment, the real “fair” could not be guaranteed especially tominor enterprises.All in all, accounting for goodwill underU.S. GAAP and China GAAP mainly differs in three aspects: Calculation, U.
S.GAAP includes NCI in calculation of goodwill, China GAAP doesn’t; Bargainpurchase, U.S. GAAP recognized gain when bargain purchase occurs, China GAAPdefers the gain; Impairment, U.S. GAAP deals impairment in reporting units andChina GAAP use asset units. Though using different calculation in impairmenttest, both GAAP aims to reflect fair value of goodwill. Bibliography “ASC 350-20-35-79.
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