What Is Goodwill?: Key Takeaways

What Is Goodwill?
Goodwill is an intangible asset that is associated with the purchase of one company by
another. Specifically, goodwill is the portion of the purchase price that is higher than
the sum of the net fair value of all of the assets purchased in the acquisition and the
liabilities assumed in the process. The value of a company’s brand name, solid
customer base, good customer relations, good employee relations,
and proprietary technology represent some reasons why goodwill exists.
KEY TAKEAWAYS
 Goodwill is an intangible asset that accounts for the excess purchase

price of another company.
 Items included in goodwill are proprietary or intellectual property and
brand recognition, which are not easily quantifiable.
 Goodwill is calculated by taking the purchase price of a company and
subtracting the difference between the fair market value of the assets and
liabilities.
 Companies are required to review the value of goodwill on their financial
statements at least once a year and record any impairments. Goodwill is
different from most other intangible assets, having an indefinite life, while
most other intangible assets have a finite useful life.
Goodwill
Understanding Goodwill
The process for calculating goodwill is fairly straightforward in principle but can be quite
complex in practice. To determine goodwill in a simplistic formula, take the purchase
price of a company and subtract the net fair market value of identifiable assets and
liabilities.
Goodwill = P-(A-L), where: P = Purchase price of the target company, A = Fair market

value of assets, L = Fair market value of liabilities.
What Goodwill Tells You

The value of goodwill typically arises in an acquisition—when an acquirer purchases a
target company. The amount the acquiring company pays for the target company over
the target’s net assets at fair value usually accounts for the value of the target’s
goodwill. If the acquiring company pays less than the target’s book value, it
gains negative goodwill, meaning that it purchased the company at a bargain in a
distress sale.
Goodwill is recorded as an intangible asset on the acquiring company's balance sheet
under the long-term assets account. Under the generally accepted accounting
principles (GAAP) and the International Financial Reporting Standards (IFRS),
companies are required to evaluate the value of goodwill on their financial statements
at least once a year and record any impairments. 1 Goodwill is considered an intangible
(or non-current) asset because it is not a physical asset like buildings or equipment.
Goodwill Calculation Controversies

There are competing approaches among accountants as to how to calculate goodwill.
One reason for this is that goodwill represents a sort of workaround for accountants.
This tends to be necessary because acquisitions typically factor in estimates of future
cash flows and other considerations that are not known at the time of the acquisition.
While this is perhaps not a significant issue, it becomes one when accountants look for
ways of comparing reported assets or net income between different companies; some
that have previously acquired other firms and some that have not.
Goodwill Impairments
Impairment of an asset occurs when the market value of the asset drops
below historical cost. This can occur as the result of an adverse event such as
declining cash flows, increased competitive environment, or economic depression,
among many others. Companies assess whether an impairment is needed by
performing an impairment test on the intangible asset.
The two commonly used methods for testing impairments are the income approach and
the market approach. Using the income approach, estimated future cash flows are
discounted to the present value. With the market approach, the assets and liabilities of
similar companies operating in the same industry are analyzed.
If a company's acquired net assets fall below the book value or if the company
overstated the amount of goodwill, then it must impair or do a write-down on the value
of the asset on the balance sheet after it has assessed that the goodwill is impaired.
The impairment expense is calculated as the difference between the current market
value and the purchase price of the intangible asset.
The impairment results in a decrease in the goodwill account on the balance sheet.
The expense is also recognized as a loss on the income statement, which directly
reduces net income for the year. In turn, earnings per share (EPS) and the company's
stock price are also negatively affected.
The Financial Accounting Standards Board (FASB), which sets standards for GAAP
rules, is considering a change to how goodwill impairment is calculated. 2 Because of
the subjectivity of goodwill impairment and the cost of testing impairment, FASB is
considering reverting to an older method called "goodwill amortization" in which the
value of goodwill is slowly reduced annually over a number of years.
Goodwill vs. Other Intangibles

Goodwill is not the same as other intangible assets. Goodwill is a premium paid over
fair value during a transaction and cannot be bought or sold independently. Meanwhile,
other intangible assets include the likes of licenses and can be bought or sold
independently. Goodwill has an indefinite life, while other intangibles have a
definite useful life.
Limitations of Using Goodwill

Goodwill is difficult to price, and negative goodwill can occur when an acquirer
purchases a company for less than its fair market value. This usually occurs when the
target company cannot or will not negotiate a fair price for its acquisition. Negative
goodwill is usually seen in distressed sales and is recorded as income on the acquirer's
income statement.
There is also the risk that a previously successful company could face insolvency.
When this happens, investors deduct goodwill from their determinations of residual
equity. The reason for this is that, at the point of insolvency, the goodwill the company
previously enjoyed has no resale value.
Example of Goodwill
If the fair value of Company ABC's assets minus liabilities is $12 billion, and a company
purchases Company ABC for $15 billion, the premium value following the acquisition is
$3 billion. This $3 billion will be included on the acquirer's balance sheet as goodwill.
As a real-life example, consider the T-Mobile and Sprint merger announced in early
2018.3 The deal was valued at $35.85 billion as of March 31, 2018, per an S-4
filing.4 The fair value of the assets was $78.34 billion and the fair value of the liabilities
was $45.56 billion. The difference between the assets and liabilities is $32.78 billion.
Thus, goodwill for the deal would be recognized as $3.07 billion ($35.85 - $32.78), the
amount over the difference between the fair value of the assets and liabilities. 5
How Is Goodwill Different from Other Assets?

Shown on the balance sheet, goodwill is an intangible asset that is created when
one company acquires another company for a price greater than its net asset
value. Unlike other assets that have a discernible useful life, goodwill is not
amortized or depreciated but is instead periodically tested for goodwill
impairment. If the goodwill is thought to be impaired, the value of goodwill must
be written off, reducing the company’s earnings.
How Is Goodwill Used in Investing?

Evaluating goodwill is a challenging but critical skill for many investors. After all,
when reading a company’s balance sheet, it can be very difficult to tell whether
the goodwill it claims to hold is in fact justified. For example, a company might
claim that its goodwill is based on the brand recognition and customer loyalty of
the company it acquired. When analyzing a company’s balance sheet, investors
will therefore scrutinize what is behind its stated goodwill in order to determine
whether that goodwill may need to be written off in the future. In some cases, the
opposite can also occur, with investors believing that the true value of a
company’s goodwill is greater than that stated on its balance sheet.

What Is Goodwill?: Key Takeaways

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What Is Goodwill?: Key Takeaways

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What Is Goodwill?

 Goodwill is an intangible asset that accounts for the excess purchase

Goodwill = P-(A-L), where: P = Purchase price of the target company, A = Fair market

What Goodwill Tells You

Goodwill Calculation Controversies

Goodwill vs. Other Intangibles

Limitations of Using Goodwill

How Is Goodwill Different from Other Assets?

How Is Goodwill Used in Investing?

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