Goodwill

Goodwill is any surplus money paid to acquire a company that exceeds its net tangible assets value.

Goodwill is used to reflect the portion of the book value of a business entity not directly attributable to its assets and liabilities. It normally arises only in case of an acquisition. It reflects the ability of the entity to make a higher profit than would be derived from selling the tangible assets. Goodwill is considered an intangible asset.

Goodwill in financial statements arises when a company is purchased for more than the fair value of the identifiable assets of the company. The difference between the purchase price and the sum of the fair value of the net assets is by definition the value of the "goodwill" of the purchased company. The acquiring company must recognise goodwill as an asset in its financial statements and present it as a separate line item on the balance sheet, according to the current purchase accounting method. In this sense, goodwill serves as the balancing sum that allows one firm to provide accounting information regarding its purchase of another firm for a price substantially different from its book value.

For example: An innovative technology company may have net assets (consisting primarily of equipment and stocks) valued at $1 million, but the company's overall value (including brand, customers, intellectual capital) is valued at $10 million. The buyer of that company would book $10 million in total assets acquired, comprising $1 million physical assets, and $9 million in goodwill.

The basic goodwill formula:
Goodwill = Purchase Price – Fair Market Value of Net Assets
Fair Market Value of Net Assets = Net Tangible Assets + Write-up of Net Assets
Net Tangible Assets = Assets – Target's Existing Goodwill – Liabilities

The Book Value of an asset with associated goodwill may subsequently be adjusted by management, either by amortization or by means of occasional adjustments of the estimated value of the associated assets which is primarily based upon their ability to generate cash flow and profits.  If the fair value is less than Book Value (impaired), the goodwill value needs to be reduced so the fair value is equal to carrying value. The impairment loss is reported as a separate line item on the income statement, and new adjusted value of goodwill is reported in the balance sheet.

If the business is in trouble with the threat of insolvency, investors will deduct the goodwill from any calculation of residual equity because it will likely have no resale value.

Below is the snapshot of Google Inc.'s Balance Sheet.  Show here the Goodwill as of 30 June 2009 is at US$ 4.8Billion.

Updated On: 15.02.14