Last modified on July 26, 2022, at 15:43

Difference between revisions of "Goodwill"

(Goodwill (as a Business Asset))
 
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Goodwill can have a number of meanings but this brief article contemplates it's meaning as a financial asset.
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''For the charitable organization known for its chain of thrift stores, see [[Goodwill Industries]].''
  
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Goodwill that appears on a balance sheet is always 'purchased' Goodwill.  That is, it is not generated by some mechanism internal to the company and then created as an asset.
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In accounting, '''goodwill''' represents the purchase price of a business over the underlying fair value of its acquired assets.
  
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Goodwill normally arises from the purchase of a business where the price paid exceeds the fair value of the net assets acquired.  Consider the purchase of an extremely profitable business that had a very low asset base.  If the buyer paid, say, $2 million for a company whose net assets where only worth $1.3 million, the $700 thousand difference would be treated as goodwill.
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For example, a buyer paid $2 million for a company whose net assets where only worth $1.3 million; the $700 thousand difference is treated as goodwill.
  
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On a strictly theoretical basis, Goodwill is the present value of the superior earnings stream of a business, capitalized in perpetuity.  Put another way, you would only pay $2 million for a business with assets of $1.3 million if you thought you would make a lot more money than that sort of investment would normally generate.
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Management must review the asset value of goodwill every year to determine if it has been "impaired".  If it is determined that the goodwill has been impaired, it must be reduced or, in some cases, completely written off.  An impairment may occur for any reason; for example, a company purchases another company which has several government contracts, but later the purchased company fails to win the contract renewals and has difficulty winning new business.
  
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Managment must review the asset value of Goodwill every year to determine if it is still a legitimate asset.  If it is not, the asset must either be reduced or written of completely.  Reverting to the previous example, suppose the business purchased had a competitor that opened a location just across the street, and that ongoing profits would be reduced.  Management would be required to reduce, if not write off completely, the value of Goodwill.
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[[Category:Accounting Terms]]

Latest revision as of 15:43, July 26, 2022

For the charitable organization known for its chain of thrift stores, see Goodwill Industries.

In accounting, goodwill represents the purchase price of a business over the underlying fair value of its acquired assets.

For example, a buyer paid $2 million for a company whose net assets where only worth $1.3 million; the $700 thousand difference is treated as goodwill.

Management must review the asset value of goodwill every year to determine if it has been "impaired". If it is determined that the goodwill has been impaired, it must be reduced or, in some cases, completely written off. An impairment may occur for any reason; for example, a company purchases another company which has several government contracts, but later the purchased company fails to win the contract renewals and has difficulty winning new business.