Goodwill

Reviewed by Bhavana | Updated on Aug 27, 2020

Introduction

An intangible asset correlated with one company being bought by another. In particular, goodwill is the component of the purchase price which is greater than the amount of the net fair value of all the properties acquired during the sale and the expected liabilities in the transaction. Many sources of goodwill are the importance of a company's brand identity, a stable client base, good customer relationships, good employee relationships and advanced technologies.

Let Us Understand What a Goodwill Is in Detail

The goodwill calculation method in theory is relatively straightforward but can be very complicated in practice. To calculate goodwill in a simplified manner, take a company's purchase price and subtract the net fair market value of known assets and liabilities.

Importance of Goodwill

Usually the importance of goodwill emerges in an acquisition — when an acquirer purchases a target company. The sum that the purchasing firm charges to the target business over the book value of the target typically accounts for the goodwill of the client. When the purchasing firm spends less than the book value of the target, it receives negative goodwill, meaning it acquired the company in a panic sale at a discount.

Competitive approaches exist among accountants on how to measure goodwill. One explanation for this is that sympathy for accountants provides some form of solution. This appears to be important because acquisitions usually have a factor in forecasting potential cash flows and other factors not understood at the time of the acquisition. Although this may not be a big concern, it becomes one as accountants search for ways to equate recorded assets or net profits between different companies; some have already purchased other companies and others have not.

Goodwill is not equivalent to other intangible properties. Goodwill is a premium charged above market value during a sale, which can not be individually bought or sold. Certain intangible assets meanwhile include the likes of licenses that can be individually purchased or sold. Goodwill has an indefinite life, while other intangibles have a life of definite use.