Dangling Debit

What is a Dangling Debit?

A dangling debit refers to an accounting practice that has been discontinued under the newer financial reporting standards. Historically, companies would write off goodwill to reserves, creating a goodwill account that was deducted from the total shareholders’ funds. Goodwill is an intangible asset that reflects the excess amount paid during an acquisition over the fair value of the acquired net assets. The treatment of goodwill has evolved over the years, and accounting standards like Financial Reporting Standard (FRS) 10 no longer allow the practice of creating dangling debits.

Examples of Dangling Debits

1. Mergers and Acquisitions: In the past, if Company A acquired Company B and paid more than the fair market value for the net assets, the excess amount would be recorded as goodwill. This goodwill could be written off to a reserve and appear as a deduction in the shareholders’ funds section of the balance sheet.
2. Restructuring: When a company underwent restructuring and needed to adjust the value of its intangible assets, the creation of a dangling debit could be part of the accounting adjustments, though this is no longer allowable under FRS 10.

Frequently Asked Questions (FAQ)

Q1: What is goodwill in accounting?

• A: Goodwill is an intangible asset that represents the excess amount paid during the acquisition of one company by another over the fair value of the acquired company’s net identifiable assets.

Q2: Why is the practice of creating dangling debits no longer permitted?

• A: The practice is no longer permitted under Financial Reporting Standard 10 because it can obscure the true financial position of a company by unduly influencing the disclosed value of shareholders’ funds.

Q3: How is goodwill treated under Financial Reporting Standard (FRS) 10?

• A: Goodwill must be capitalized on the balance sheet and subsequently amortized over its useful economic life, which generally does not exceed 20 years.

Q4: What are shareholders’ funds?

• A: Shareholders’ funds, also known as shareholders’ equity, represents the total value of a company’s assets that are financed by equity-shareholders. It includes share capital, retained earnings, and reserves.

Q5: Can intangibles other than goodwill create a dangling debit?

• A: No, under modern financial reporting standards, dangling debits are not permissible for any intangible assets.

Related Terms with Definitions

• Goodwill: An intangible asset that occurs when a buyer acquires an existing business.
• Reserves: Portions of profits set aside to strengthen a company’s balance sheet against future liabilities.
• Amortization: The spreading of the cost of an intangible asset over its useful life.
• Shareholders’ Funds: The equity stake of shareholders in a company, calculated as total assets minus total liabilities.
• Financial Reporting Standard (FRS): These are standards set for financial accounting used to govern accounting practices and ensure consistency and transparency.

Online References

• Investopedia Article on Financial Reporting Standards
• IFRS on Goodwill and Impairment
• Accountancy Articles from The Institute of Chartered Accountants

Suggested Books for Further Studies

• “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield: A comprehensive guide on accounting principles, including intangibles and goodwill.
• “Financial Accounting and Reporting” by Barry Elliott and Jamie Elliott: Covers various aspects of financial reporting, highlighting the changes under modern standards.
• “International GAAP 2021” by Ernst & Young: Good for understanding global accounting standards and how they pertain to goodwill and intangibles.

Accounting Basics: “Dangling Debit” Fundamentals Quiz

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