Is Goodwill Amortization No Longer Necessary? A Review of Accounting Systems That Could Provide a Tail-Wind for Startups

In recent years, the Japanese government has been focusing on fostering startups, and one of the areas receiving attention as part of this effort is the review of accounting practices for "goodwill." While it may sound complicated, this movement has the potential to significantly change the environment surrounding Japanese startups. In this article, we will explain its significance in simple terms.

What is goodwill?

"Goodwill" is the amount paid by a company during an M&A (merger and acquisition) that exceeds the value of the company being acquired. For example, when acquiring a startup, if the company's net assets are 1 billion yen but it is acquired for 2 billion yen due to its future potential and brand strength, the 1 billion yen difference is recorded as "goodwill." Goodwill is considered a payment for intangible value (intangible assets). Originally, in Japan, the term came from the practice of referring to trust and customer relationships as "noren" (goodwill) when taking over a shop. In English, it is "goodwill," which generally means benevolence or kindness, but in accounting terms, it refers to business rights, goodwill, or intangible assets.

Why is this relevant to startups?

For startups, M&A is an important "exit strategy." By selling their company to another firm, founders and investors can recoup their profits and obtain funds for their next challenge.

However, there is an issue in Japan where M&A is not actively pursued. As of 2020, 76% of startup exits in Japan were through IPOs (initial public offerings), while M&A accounted for only 24% (if they fail, they go out of business). In contrast, M&A accounts for 90% in the United States and 67% in Europe.

What is the difference from international accounting standards?

Under Japanese accounting standards, "goodwill" must be amortized periodically (recorded as an expense in installments) over a maximum of 20 years. This puts pressure on a company's profits and is one of the reasons why companies become reluctant to make acquisitions.

On the other hand, under International Financial Reporting Standards (IFRS) and US accounting standards, "goodwill" is not amortized but is subject to "impairment testing" only when its value declines. In other words, the goodwill recorded at the time of acquisition remains on the books and is less likely to affect profits.

What is the significance of aligning with global standards?

The government's Regulatory Reform Promotion Council is currently proposing a system change to "make goodwill amortization unnecessary" or "allow companies to choose between amortization and non-amortization."

The following benefits are expected from this change:

Startup M&A will become more active

The accounting burden on the acquiring side will be reduced, making it easier for more companies to acquire startups.

M&A will become generalized as an exit strategy

By expanding the path of selling beyond just IPOs, the growth of startups and the circulation of funds will be encouraged.

The international competitiveness of Japanese companies will increase

Consistency with international accounting standards will be achieved, and it is expected that evaluations from overseas investors will also improve.

Consideration for investors and management is also necessary

Of course, there is also concern that by not amortizing, "losses can be postponed." Since there is a risk of recording a large loss at once if the performance of the acquired company deteriorates, annual impairment tests and appropriate information disclosure will be required.

Summary

The review of accounting treatment for goodwill may seem like a modest institutional change, but it is a significant step forward in terms of fostering Japanese startups and strengthening international competitiveness. As Japan aims to become a 'major investment power,' updating these rules holds great significance.

I hope that this will serve as an opportunity for M&A to become a more accessible option and for a society where it is easier to start a business to spread.

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