Goodwill Explained
In accounting, goodwill is considered an intangible asset. It occurs when a company seeking to acquire another company is willing to pay more than the fair market value of the company’s net assets.
The purchaser will pay over-and-above the net asset value of a company for elements and factors such as a good reputation, a loyal customer base, brand recognition, talented employees and proprietary technology. These, in fact, are some of the company’s most valuable assets. However, their value cannot be precisely measured since they are not tangible assets and have an indefinite lifespan.
Goodwill in Practice
If the fair value of Company XYZ’s assets minus liabilities is R12 million, and a company purchases Company XYZ for R15 million, the premium paid for the acquisition is R3 million (R15 million – R12 million). This R3 million will be included as goodwill on the acquirer’s balance sheet.
Assets categorized as goodwill include:
- Business Reputation
- Brand Name
- Licenses and Permits
- Domain Names
- Trade Secrets
- Copyrights and Patents
- Managerial and Executive Talent
The Bottom Line
The goodwill of a company represents its potential value (and competitive advantage) when it acquires another. In other words, it is the difference between the purchase price and the fair market value of the target company’s assets, less its liabilities. Despite goodwill’s indefinite life, impairment tests can be run to determine if its value has changed due to adverse financial events.
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