Goodwill (accounting)

“ A method of valuing good-will which makes it represent the difference between the value of tangible assets contributed or purchased and the par value of the stock issued cannot be countenanced at all. This use of good-will to cover up a capital deficiency is not only improper and misleading but often fraudulent. ”

“ As was stated above on page 330, all intangible assets should be examined carefully by a prospective purchaser as to the values at which they are being carried.
Good-will, because of the improper and misleading uses to which it has so often been put, is never above suspicion and its value should not be taken without close investigation. If it really exists, the profit and loss record will show it. That should guide as to its valuation and not the value carried on the balance sheet. ”

“ But plainly, we think, the valuation of the property and the amount of the depreciation were to be determined not upon the basis of latent and occult intrinsic values, but upon considerations that affect market value and have their influence upon men of affairs charged with the management of the business and accounting of corporations that are organized for profit and are engaged in business for purposes of profit. ”

“ Similar to a stock donation is a stock assessment. In cases of reorganization or of impending bankruptcy, a pro rata assessment is levied on the outstanding shares. Being a donation, it constitutes a proprietorship increase item and becomes a part of the margin. This method is frequently used for the purpose of wiping out a deficit, an impairment of capital, and is, of course, a real profit as distinguished from a book profit. ”

“ It is, of course, apparent that the valuation of good-will for prospective purchase is largely dependent upon the individual judgment of the buyer and that seldom will any two men arrive at the same valuation. As a matter of prudence, under either method the average profits for the past few years should be used rather than those of the last year. ”

“ If there is a large outstanding liability which cannot be settled, the partners will estimate that, and it will not be considered as part of the profits. If there is a large outstanding possible loss, and there is a large sum due to a client, then you would provide for that. But in ascertaining what is really actually divisible for the year fairly, you would take the cash account as it stands.” In the light of such mental obtuseness and obliquity, one cannot wonder at the occasional reluctance of business to entrust the determination of important matters to the courts. ”

“ While there is a sense in which expected future performance as indicated above, may be an element in the determination of good-will and may be legitimately paid for as such, as a usual thing the essence of good-will lies in the ability to make a profit in excess of the normal. ”

“ A similar problem involving the handling of good-will is encountered when a member of an existing firm sells out his interest, including a share of the good-will, to one who takes his place in the firm. ”

“ There are undoubtedly circumstances in which appreciation in value can be properly recognized and should be taken into the accounts not only of public utility properties but also of industrial concerns. ”

“ Throughout the period, as the profit accrues, the proprietor may have drawn against it for personal use, as shown in his Personal account. To show the amount of profit remaining in the business, the balance of the Profit and Loss account is transferred to the Personal account, the balance of which then gives the amount of undrawn or overdrawn profit. ”

“ The fixed assets of the business are constantly depreciating in value; merchandise tends to become out of date, shopworn, stale, or soiled; some merchandise has been sold, while some is still on hand; some of the accounts receivable may prove uncollectible, and some of the notes receivable may be dishonored. Also, at the end of the period liabilities such as taxes, salaries, rent, and the like may have been incurred, but because there is no creditor’s invoice or other business paper as evidence of such liability they are not usually entered on the books until payment is made. ”

“ Treatment of Good-Will upon Liquidation by Sale.—When dissolution is brought about by the sale of the entire business, it may happen that the amount realized on the assets is smaller than their book value, and the difference must be treated as a loss in accordance with the principles previously stated. Similarly, where the assets are sold and the price realized is larger than their book value, the excess constitutes a profit and must be distributed among the partners in profit and loss ratio. ”

“ Inasmuch as every profit made must be reflected in a corresponding increase of some asset or the decrease of a liability, and, conversely, every expense incurred is reflected as a decrease of assets or increase of liabilities, it is apparent that profits determination is largely a question of the valuation of assets and liabilities and therefore rests upon the principles already established. Thus the amount of gross profit is not determinable until the value of the stock of merchandise on hand is known. ”

“ A further consideration in the matter of intangible values is the fact that they all partake more or less of the nature of "good will," and the question very properly arises, in the case of a purchase by the public, or of a rate-making valuation: "Should the public be compelled to pay for its own good will?" In the case of such a corporation as a street-railway company in a large city, any value arising from a surplus of earnings is due to the franchise, established business, or going value, or good will of the citizens of that city. ”

“ The important point from the commercial and accounting standpoint is to secure a fair and equitable charge to each unit of product, regardless of whether or not the burdens of each fiscal period are equal. This is particularly evident when wear and tear from use is the effective factor in depreciation—and it is also contended that the factors of obsolescence and inadequacy may be as successfully and relevantly estimated in terms of business output as in years. ”

“ In view of the special language employed in section 207, obviously for the purpose of avoiding appreciated valuations of assets over and above cost, the argument that such value is as real as cost value, and that in the terminology of corporation and partnership accounting 'capital and surplus' mean merely the excess of all assets at actual values over outstanding liabilities, and 'surplus' means the intrinsic value of all assets over and above outstanding liabilities plus par of the stock, is beside the mark. ”

“ If a careful accounting is made of the profit or loss at the time of the sale of each piece of property and these profits and losses together with the dissolution expenses are summarized and distributed to the partners’ capital accounts, those accounts will of course show the claims of the various partners on the net assets of the business after all assets have been converted into cash and all liabilities paid. ”

“ Under such circumstances, the graduate list can hardly be categorized as an asset exhausted by the passage of time. In short, we have nothing more than unsupported opinions, to which we give little credence, in the record to show that the assets in question had limited useful lives. [FN6]
Moreover, an asset of this type generally constitutes goodwill, i.e., the expectancy of continued patronage to the taxpayer who acquires the asset. Cf. Boe v. Commissioner, 307 F.2d 339 (9th Cir. 1962) . Goodwill is not a depreciable asset. Section 1.167 (a) -3, Income Tax Regs. ”

“ As time passes, more complete knowledge may indicate insufficient or excessive estimates of such items as depreciation, bad debts, provision for contingent liabilities, and similar reserve items, the valuation of which must be corrected for an accurate showing of earning capacity. Thus a distinction must be made between summaries compiled to show the current profit and loss results and those which give a true index of earning capacity over a longer period. ”

“ It should be pointed out, as a corollary to the above statement that only those elements which are transferable and are transferred can be disposed of for a price. Thus, when a business goes to the new owner, if there is apt to be a very appreciable shrinking in profits—as is the case in the transfer of some professional businesses—or if the favorable location on which in some cases depends the ability to earn excess profits cannot be turned over to the purchaser because of the expiration of the lease or other reason, good-will may not be worth much to a prospective purchaser. ”

“ It offers a much more attractive field to the investor who desires to place his surplus funds in productive enterprises and share in their profits without having the burdens of active management or the risk of losing his private fortune to satisfy the claims of business creditors should the undertaking prove unsuccessful. ”

“ Trade goodwill varies with the nature of the business with which it is connected, but there are two rights which, whatever the nature of the business may be, are invariably associated with it, viz. the right of the purchaser to represent himself as the owner of the business, and the right to restrain competition. For the purposes of the Stamp Act, the goodwill of a business is property, and the proper duty must be paid on the conveyance of such. ”

“ In this way, while the purpose of the Profit and Loss account is to summarize the temporary proprietorship accounts, some proprietorship items may be omitted for the sake of making the summary of greater value to the proprietors. Such a method of handling does not conflict with principles previously laid down, but rests upon the general principle that accounting methods and forms must be flexible in order [Pg 316] to conform to the requirements of particular cases; else they fail in fulfilling their full purpose. ”

“ Of course where a company has been in operation for years and is continually advertising its business, its good-will often is its greatest asset and has often been built up by the greatest expenditure of money. For instance, in buying a successful newspaper, the value does not lie in the real-estate, presses, etc., but in the good-will of the newspaper, the result of years of work and expensive advertising. ”

“ But questions as to what constitutes a profit, whether all profits are applicable to dividends, the proper treatment of capital profits, the relation of capital losses to profits and dividends, the differentiation of the classes of reserves, and finally the manner of showing and explaining the periodic changes in net worth by means of the supplementary statement of profit and loss—all these and other similar questions are closely related to the problem of valuation and, as indicative of the financial policy of a business, may directly affect all going concern values. ”

“ The accountant is, however, treading on somewhat uncertain ground when he attempts to incorporate any element of profit in the consolidated inventory. Conservative management as adopted by some of our largest corporations eliminates all elements of profit, and that should be the standard practice. Only under unusual circumstances and after a very careful consideration of all the conditions should the consolidated inventory be carried at any other valuation than that of full manufacturing cost. ”

“ The solution of the problem of poverty consists thus in elevating accounting science to a higher expression, in setting up the records of society, in establishing the assets and the liabilities of each institution, taking as general accounts or divisions of the social ledger, no longer terms of ordinary accounting, Capital, Funds, General Merchandise, Bills and discounts, etc.; but those of philosophy, legislation and politics: Competition and Monopoly, Property and Community, Citizen and State, Man and God, etc. ”

“ Profits realized on sales of fixed assets should be first applied to make good estimated depreciation (if any) in other fixed assets not resulting from the ordinary conduct of the business. If there is no such depreciation, such profits may be distributed as dividends, but should be distinguished from the operating profits.
3. A sufficient surplus should be accumulated (in addition to the provisions required to maintain wasting capital assets) for the purpose of making good losses due to shrinkage in values of fixed assets arising from causes other than the ordinary operations of the company. ”

“ Whether capitalized good-will (including "franchise" if necessary) is to be rated as a credit extension is a nice question that can apparently be decided only on a legal technicality. In any case so much seems clear - that good-will is the nucleus of capitalization in modern corporation finance. In a well financed, flourishing corporation, good-will, indeed, constitutes the total remaining assets after liabilities have been met, but the total remaining assets may not nearly equal the total market value of the company's good-will ”

“ If we are approaching such a limitation, it is the more important that the public should be educated to the fact—not theory, for it is a fact—that going value, or going concern value, is a real element of cost, covering an outlay in effort and money on the part of the corporation, and as such is as much entitled to earn a return (interest and profit) as is the other capital invested in plant. ”

“ And the promise to pay interest or rent, or the expectancy of dividends upon stock, the amount of such payments, the past and prospective regularity of the payments, and other elements bearing upon the expectation of the receipt of income affect the value of any income producing property. But these elements are not separately valued in appraising the worth of the asset at any given time. It is the uniform practice to value the asset as an entirety, taking into consideration all the elements that go to give it value in the market. ”