Goodwill

Goodwill is an intangible asset that arises at the time of business acquisition when the price paid for the business exceeds the fair value of the net identifiable assets.

In most cases a business is worth more than the replacement cost of its net identifiable assets and that is why the acquiring company pays more than the fair value of the acquired company's net identifiable assets. At the time of acquisition, the fair value of the acquired company's assets and liabilities are added to the fair value of acquiring company's assets and liabilities. The excess of price over the fair value of net identifiable assets (assets minus liabilities) is recorded as a separate asset called goodwill.

It is an asset because it represents the economic value which is not captured by other assets for example the reputation of the business, the value of its human capital, its future growth potential, its professional management, etc.

Example

Company A purchases Company B for $15 Million. The statements of financial positions of Company A and Company B with their book values and fair values are given below (all amounts are in $ '000').

 Book ValueFair Value
 Company ACompany BCompany ACompany B
Assets    
PPE30,00015,00035,00017,000
Trade Receivables5,0004,5004,9004,000
Cash18,0002,00018,0002,000
Total53,00021,50057,90023,000
Liabilities and Equity    
Long-term Liabilities19,0008,00018,0007,500
Current Liabilities8,0004,0007,5004,500
Equity26,0009,50032,40011,000
Total53,00021,50057,90023,000

The goodwill on acquisition of Company B is calculated below:

Price paid for Company B 15,000
Fair Value of Company B's Net Assets:  
PPE17,000 
Trade Receivables4,000 
Cash2,000 
Long-term liabilities− 7,500 
Current liabilities− 4,500 
  − 11,000
Goodwill 4,000

The statement of financial position of Company A after acquisition would show the goodwill $4 million as an asset

Assets: 
Goodwill4,000
PPE47,000
Trade Receivables9,000
Cash5,000
Total65,000
Liabilities and Equity: 
Long-term Liabilities26,500
Current Liabilities12,500
Equity26,000
Total65,000

Written by Obaidullah Jan, ACA, CFA <--- Hire me on Upwork