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In
accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to compare with other ob ...
, Goodwill is an
intangible asset An intangible asset is an asset In financial accountancy, financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive econom ...
that arises when a buyer acquires an existing business. Goodwill represents assets that are not separately identifiable. Goodwill does not include identifiable assets that are capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability regardless of whether the entity intends to do so. Goodwill also does not include contractual or other legal rights regardless of whether those are transferable or separable from the entity or other rights and obligations. Goodwill is also only acquired through an acquisition; it cannot be self-created. Examples of identifiable assets that are goodwill include a company's brand name, customer relationships, artistic intangible assets, and any patents or proprietary technology. The goodwill amounts to the excess of the "purchase consideration" (the money paid to purchase the asset or business) over the net value of the assets minus liabilities. It is classified as an intangible asset on the balance sheet, since it can neither be seen nor touched. Under
US GAAP Generally Accepted Accounting Principles (GAAP or U.S. GAAP, pronounced like "gap") is the accounting standard adopted by the U.S. Securities and Exchange Commission (SEC). While the SEC previously stated that it intends to move from U.S. GAAP ...
and
IFRS International Financial Reporting Standards, commonly called IFRS, are accounting standard Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus a ...
, goodwill is never
amortized In computer science, amortized analysis is a method for Analysis of algorithms, analyzing a given algorithm's Computational complexity theory, complexity, or how much of a resource, especially time or memory, it takes to Execution (computing), execu ...
, because it is considered to have an indefinite useful life. Instead, management is responsible for valuing goodwill every year and to determine if an impairment is required. If the fair market value goes below historical cost (what goodwill was purchased for), an impairment must be recorded to bring it down to its fair market value. However, an increase in the fair market value would not be accounted for in the financial statements. Private companies in the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., ...

United States
, however, may elect to amortize goodwill over a period of ten years or less under an accounting alternative from the Private Company Council of the
FASB The Financial Accounting Standards Board (FASB) is a private standard-setting body whose primary purpose is to establish and improve Generally Accepted Accounting Principles Publicly traded companies typically are subject to the most rigorous ...
.


Calculating goodwill

In order to calculate goodwill, the fair market value of identifiable assets and liabilities of the company acquired is deducted from the purchase price. For instance, if company A acquired 100% of company B, but paid more than the net market value of company B, a goodwill occurs. In order to calculate goodwill, it is necessary to have a list of all of company B's assets and liabilities at fair market value. Fair market value Accounts Receivable $10 Inventory $5 Accounts payable $6 ------------------------- Total Net assets = $10 + $5 - $6 = $9 In order to acquire company B, company A paid $20. Hence, goodwill would be $11 ($20 − $9). The journal entry in the books of company A to record the acquisition of company B would be: DR Goodwill $11 DR Accounts Receivable $10 DR Inventory $5 CR Accounts Payable $6 CR Cash $20


Modern meaning

Goodwill is a special type of intangible asset that represents that portion of the entire business value that cannot be attributed to other income producing business assets, tangible or intangible. For example, a
privately held A privately held company or private company is a company which does not offer or trade its company stock In finance, stock (also capital stock) consists of all of the shares In financial markets A financial market is a market in whic ...
software company may have
net assets Net worth is the value of all the non-financial and financial asset In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and no ...
(consisting primarily of miscellaneous equipment and/or property, and assuming no debt) valued at $1 million, but the company's overall value (including customers and
intellectual capitalIntellectual capital is the result of mental processes that form a set of intangible objects that can be used in economic activity and bring income to its owner (organization), covering the competencies of its people (human capital), the value relati ...
) is valued at $10 million. Anybody buying that company would book $10 million in total assets acquired, comprising $1 million physical assets and $9 million in other intangible assets. And any consideration paid in excess of $10 million shall be considered as goodwill. In a private company, goodwill has no predetermined value prior to the acquisition; its magnitude depends on the two other variables ''by definition''. A
publicly traded company A public company, publicly traded company, publicly held company, publicly listed company, or public limited company A public limited company (legally abbreviated to PLC or plc) is a type of public company under United Kingdom company law, som ...
, by contrast, is subject to a constant process of market valuation, so goodwill will always be apparent. While a business can invest to increase its reputation, by advertising or assuring that its products are of high quality, such expenses cannot be capitalized and added to goodwill, which is technically an
intangible asset An intangible asset is an asset In financial accountancy, financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive econom ...
. Goodwill and intangible assets are usually listed as separate items on a company's
balance sheet In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such a ...

balance sheet
.


Types of goodwill

There are two types of goodwill, Institutional (Enterprise) or Professional (Personal). Institutional goodwill may be described as the intangible value that would continue to inure to the business without the presence of specific owner.  Professional goodwill may be described as the intangible value attributable solely to the efforts of or reputation of an owner of the business. The key difference between the two types of goodwill is whether the goodwill is transferable upon a sale to a third party without a non-competition agreement.


US practice


History and purchase vs. pooling-of-interests

Previously, companies could structure many acquisition transactions to determine the choice between two accounting methods to record a business combination: purchase accounting or pooling-of-interests accounting. Pooling-of-interests method combined the book value of assets and liabilities of the two companies to create the new balance sheet of the combined companies. It therefore did not distinguish between who is buying whom. It also did not record the price the acquiring company had to pay for the acquisition. Since 2001, U.S.
Generally Accepted Accounting Principles Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus any specific disclosures required by their specific lenders and shareholders. Some firms opera ...
(FAS 141) no longer allows the pooling-of-interests method.


Amortization and adjustments to carrying value

Goodwill is no longer
amortized In computer science, amortized analysis is a method for Analysis of algorithms, analyzing a given algorithm's Computational complexity theory, complexity, or how much of a resource, especially time or memory, it takes to Execution (computing), execu ...
under U.S. GAAP (FAS 142). FAS 142 was issued in June 2001. Companies objected to the removal of the option to use pooling-of-interests, so amortization was removed by
Financial Accounting Standards Board The Financial Accounting Standards Board (FASB) is a private standard-setting body whose primary purpose is to establish and improve Generally Accepted Accounting Principles (GAAP) within the United States in the public's interest. The Securi ...
as a concession. As of 2005-01-01, it is also forbidden under
International Financial Reporting Standards International Financial Reporting Standards, commonly called IFRS, are accounting standard Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus ...
. Goodwill can now only be
impaired A disability is a societal imposition on people who have impairments, making it more difficult for people to do certain activities or interact with the world around them. Due to Cognitive disability, cognitive, Developmental disability, devel ...
under these GAAP standards. Instead of deducting the value of goodwill annually over a period of maximal 40 years, companies are now required to determine the fair value of the reporting units, using present value of future cash flow, and compare it to their carrying value (book value of assets plus goodwill minus liabilities.) If the fair value is less than
carrying value In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Trad ...
(impaired), the goodwill value needs to be reduced so the carrying value is equal to the fair 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.Focus on Goodwill, Intangible Assets
/ref>


Controversy

When the business is threatened with
insolvency In accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporations. Accounting, which has been call ...
, investors will deduct the goodwill from any calculation of residual equity because it has no resale value. The accounting treatment for goodwill remains controversial, within both the accounting and financial industries, because it is, fundamentally, a workaround employed by accountants to compensate for the fact that businesses, when purchased, are valued based on estimates of future cash flows and prices negotiated by the buyer and seller, and not on the fair value of assets and liabilities to be transferred by the seller. This creates a mismatch between the reported assets and net incomes of companies that have grown without purchasing other companies, and those that have. While companies will follow the rules prescribed by the Accounting Standards Boards, there is not a fundamentally correct way to deal with this mismatch under the current financial reporting framework. Therefore, the accounting for goodwill will be rules based, and those rules have changed, and can be expected to continue to change, periodically along with the changes in the members of the Accounting Standards Boards. The current rules governing the accounting treatment of goodwill are highly subjective and can result in very high costs, but have limited value to investors.


See also

*
Business valuation Business valuation is a process and a set of procedures used to estimate the economic value In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), product ...

Business valuation
*
Consolidation (business) In business Business is the activity of making one's living or making money by producing or buying and selling products (such as goods and services). Simply put, it is "any activity or enterprise entered into for profit." Having a busin ...
*
Control premium A control premium is an amount that a buyer is sometimes willing to pay over the current market price of a publicly traded company in order to acquire a controlling share in that company. If the market perceives that a public company's profit and c ...
*
Divestment In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money availabl ...
*
Enterprise valueEnterprise value (EV), total enterprise value (TEV), or firm value (FV) is an economic measure reflecting the market value Market may refer to: *Market (economics) A market is a composition of system A system is a group of Interaction, intera ...
*
Mergers and acquisitions In , mergers and acquisitions (M&A) are transactions in which the ownership of , other business organizations, or their operating units are transferred or with other entities. As an aspect of , M&A can allow enterprises to grow or , and change ...
*
Subsidiary A subsidiary, subsidiary company or daughter company is a company (law), company owned or controlled by another company, which is called the parent company or holding company. Two subsidiaries that belong to the same parent company are called sis ...


References

{{DEFAULTSORT:Goodwill (Accounting) Intangible assets Mergers and acquisitions