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Goodwill

By
Lia Kopin-Green
/
December 18, 2022

What is Goodwill?

The term “goodwill” refers to intangible assets that represent the value of a business by examining its reputation, customer relationships and other factors beyond its physical assets. Goodwill value plays an important role in a company’s overall worth. In accounting, goodwill is recorded on a company’s balance sheet.

The principle of goodwill is typically associated with mergers and acquisitions. When one company is in the process of acquiring another company, they may pay more than the fair market value of the company’s overall assets. In these cases, the difference between the fair market value and the purchase price is referred to as goodwill. Simply put, goodwill brings additional value to a company as a result of positive reputations and strong customer relationships. 

Key Takeaways

  • Goodwill refers to the intangible assets that represent the value of a business beyond its physical assets.
  • In most cases, goodwill is associated with mergers and acquisitions.
  • Goodwill is calculated by taking the purchase price of a company and subtracting the net fair market value.

Understanding and Calculating Goodwill

As one might expect, a company's intangible assets are often just as significant as its physical assets. Therefore, it is essential for businesses to manage their goodwill effectively in order to maximize its value. Understanding goodwill can also provide deep insight into a company’s identity and worth when it comes to mergers and acquisitions. 

In order to calculate goodwill, one must first determine the value of a company’s tangible assets and liabilities. This number is used to determine the fair market value of a business. Tangible assets include things like property, equipment and inventory. Certain liabilities, such as short-term and long-term debt, deferred tax liabilities and lease liabilities are typically deducted from these assets. Next, one must estimate the value of a company’s intangible assets. A few common examples of intangible assets include intellectual property such as patents, copyrights, and trademarks, as well as customer relationships, brand value and reputation, licenses and permits. Lastly, the value of the company's intangible assets are subtracted from the total purchase price to determine goodwill. 

For instance, assume that Company A acquired Company B for $50 million. If Company B’s tangible assets are set at $30 million, the value of the goodwill in this case would be $20 million.

Goodwill Impairment

Goodwill impairment occurs when the value of a company’s goodwill has declined and is no longer reflected accurately on a company’s balance sheet. In other words, a company’s intangible assets, such as its reputation and intellectual property, are no longer worth as much as they were when they were initially acquired. When goodwill is impaired, the company must decrease the value of the goodwill on its balance sheet to reflect the change in value. Moreover, the impairment loss is listed on a company’s income statement.

Bottom Line

In closing, goodwill is a key principle in corporate law, business law and accounting. It must be reviewed on a regular basis to make sure it presents an accurate picture of a company’s true worth. If you are looking for additional guidance when it comes to optimizing your business’s value, contact a professional business attorney today.

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