Goodwill definition
/What is Goodwill?
Goodwill is the excess of the purchase price paid for an acquired entity and the amount of the price not assigned to acquired assets and liabilities. It arises when an acquirer pays a high price to acquire another business. This asset only arises from an acquisition; it cannot be generated internally.
Example of Goodwill
As an example of goodwill, Acorn Corporation acquires Brittle Corporation for $10 million. The fair market value of Brittle’s identifiable net assets (assets minus liabilities) is $7 million, which are comprised of the following:
Tangible assets: $6 million
Intangible assets: $1 million
Liabilities: $0
Goodwill is the excess of the purchase price over the fair value of identifiable net assets, or $3 million. Accordingly, Acorn Corporation records a $3 million goodwill asset on its balance sheet as part of its acquisition accounting.
Goodwill Impairment
The value of goodwill is highly subjective, especially since it does not independently generate cash flows. Consequently, the accounting standards require that an acquirer regularly test its goodwill asset for impairment, and to write down the asset if impairment can be proven. When a write-down occurs, it tends to be for a significant amount, and perhaps for the entire amount of a goodwill asset.
Presentation of Goodwill
Goodwill is an intangible asset, and so is listed within the long-term assets section of the acquirer's balance sheet. This classification is used because goodwill is assumed to give value for an extended period of time to the business on whose books it is recorded.
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FAQs
What Happens to Goodwill When a Subsidiary is Sold?
When a subsidiary is sold, any goodwill that was originally allocated to that subsidiary is included in the calculation of the gain or loss on the sale. The amount of goodwill is determined based on the relative fair value of the subsidiary compared to the entire reporting unit. This ensures that only the portion of goodwill related to the sold business is removed from the consolidated balance sheet.
What is Negative Goodwill?
Negative goodwill arises when an acquirer pays less for an acquiree than the fair value of its assets and liabilities. This situation usually only arises as part of a distressed sale of a business.