Understanding the Impact of Goodwill Adjustments on Net Income

Introduction Case 2-2: SKD Limited Case Study SKD Limited is a biotechnology company that uses an internally developed accounting policy, SKD GAAP, to prepare financial statements. Countries A and B prepared reconciliations of SKD's net income and stockholders' equity for the current year to compare financial statements with companies within their country, using accounting practices and policies of biotechnology companies in Country A and Country B to recognize adjustments. Table 1 shows the adjustments to income and stockholders' equity made by Country A and B's analysts: Goodwill Adjustments. Why does the adjustment for goodwill amortization increase net income under Country A GAAP but decrease net income under Country B GAAP? There is no goodwill amortization expense to recognize in Country A. The goodwill amortization expense SKD recognized should be added back to determine income under Country A GAAP. Country B goodwill amortizes over a five-year period, and SKD Limited amortizes for longer. Goodwill amortization in SKD Limited is over twenty years. The additional goodwill amortization expense has to be recognized to determine income under Country B GAAP. Therefore, goodwill amortization under GAAP subtracts from net income under Country B. Why does the goodwill adjustment increase stockholders' equity in Country A but decrease stockholders' equity in Country B? In Case 2-2 SKD Limited, the goodwill adjustments affect retained earnings in stockholders' equity. The increased goodwill will increase Country A stockholders' equity, and the decrease in goodwill will decrease Country B stockholders' equity. Why are the adjustments to stockholders' equity larger than the adjustments to income? The adjustments to stockholders' equity are more than the adjustments to income. The adjustment to income stated is for the current year. The adjustment to stockholders' equity is cumulative. The stockholders' equity adjustment is three times the income adjustment, which implies the goodwill purchase occurred three years ago.