Profitable Accounting

Goodwill

What Is Goodwill?

Goodwill is an intangible asset that is associated with the purchase of one company by another. Specifically, goodwill is the portion of the purchase price that is higher than the sum of the net fair value of all of the assets purchased in the acquisition and the liabilities assumed in the process. The value of a company’s brand name, solid customer base, good customer relations, good employee relations, and proprietary technology represent some examples of goodwill.

KEY TAKEAWAYS

  • Goodwill is an intangible asset that accounts for the excess purchase price of another company.
  • Items included in goodwill are proprietary or intellectual property and brand recognition, which are not easily quantifiable.
  • Goodwill is calculated by taking the purchase price of a company and subtracting the difference between the fair market value of the assets and liabilities.
  • Companies are required to identify the value of goodwill on their financial statements at least once a year and record any impairments.
  • Goodwill is very different from other intangible assets, having an indefinite life, while other intangible assets have a definite useful life.

Understanding Goodwill

The process for calculating goodwill is fairly straightforward in principle but can be quite complex in practice. To determine goodwill in a simplistic formula, take the purchase price of a company and subtract the net fair market value of identifiable assets and liabilities.

Goodwill = P-(A-L), where: P = Purchase price of the target company, A = Fair market value of assets, L = Fair market value of liabilities.

What Goodwill Tells You

The value of goodwill typically arises in an acquisition—when an acquirer purchases a target company. The amount the acquiring company pays for the target company over the target’s book value usually accounts for the value of the target’s goodwill. If the acquiring company pays less than the target’s book value, it gains negative goodwill, meaning that it purchased the company at a bargain in a distress sale.

Goodwill is recorded as an intangible asset on the acquiring company’s balance sheet under the long-term assets account. Under generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS), companies are required to evaluate the value of goodwill on their financial statements at least once a year and record any impairments. Goodwill is considered an intangible (or non-current) asset because it is not a physical asset like buildings or equipment.

 

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