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INVESTMENTS
CALCULATION OF GOODWILL


What is Goodwill?

An intangible asset connected to the acquisition of a business by another is goodwill. It stands for the potential value that might provide a competitive edge to the acquiring business.

The part of the purchase price that exceeds the total of the net fair value of all the assets acquired in the acquisition and the liabilities taken on during the process is specifically referred to as goodwill.

Goodwill

Aspects of goodwill include the worth of a company's name, reputation, and patented technology. It also includes a devoted client base, strong customer service, positive staff relations, and reliable customer service. This value explains why one business would pay more for another.


KEY KNOWLEDGE
  • An intangible asset called goodwill is used to offset the extra amount paid while buying another business.
  • Proprietary or intellectual property and brand awareness are examples of non-quantifiable items that are included in goodwill.
  • The computation of goodwill involves deducting the acquisition price of the business from the fair market value of its obligations and assets.
  • Businesses must at least once a year examine the goodwill value on their financial statements and note any impairments.
  • While most other intangible assets have a limited useful life, goodwill has an endless lifespan.


    • Knowing About Goodwill

    Goodwill usually comes into play when a firm is acquired. The value of the target's goodwill is often represented by the amount that the acquiring firm pays for the target business above and beyond the target's net assets at fair value.

    If the acquiring company pays less than the target’s book value, it gains negative goodwill. This means that it purchased the company at a bargain in a distress sale.

    In theory, quantifying goodwill is a rather simple procedure, but in reality, it may be extremely involved. A straightforward procedure to calculate goodwill is to deduct the net fair market value of identified liabilities and assets from the purchase price of the business.

    Goodwill = P−( A − L )
    Where:

    P = Purchase Prices Of Target Company

    A = Fair Market Value Of Assets

    L = Fair Market Value Of Liabilities



    Types Of GoodWill

  • Purchased Goodwill:

    • The difference between the price paid for a business as a going concern and the total of its assets minus the total of its liabilities—each of which has been identified and appraised separately—is known as purchased goodwill.

  • Inherent Goodwill:

    • It is the amount that the firm is worth more than its separable net asset fair value. It is known as internally produced goodwill and develops gradually as a result of a company's positive reputation. It is also known as non-purchased or self-generated goodwill.

    FAST FACT!
    Whole Foods Market Inc. was acquired by Amazon.com, Inc. (AMZN) in 2017 for a sum of $13.7 billion. In other words, Amazon had to pay a staggering $9 billion more than Whole Foods' net asset worth. On Amazon's books, such sum was noted as goodwill, an intangible asset.


    Accounting for Goodwill(Journal Entries)

    Date Particulars Debit Credit
    xx Asset xxx
    xx Goodwill xxx
    xx Liability xxx
    xx Cash xxx


    Factors Of Affecting Goodwill

  • Location Of the Business:

    • Businesses that are situated in prime locations are more likely to enjoy greater goodwill, than those that are situated in more remote areas.

  • Quality of Goods & Services:

    • A company that offers superior products and services has a greater chance of building more goodwill than its rivals who offer subpar products and services.

  • Efficiency of Managment:

    • Effective management raises the company's earnings, which strengthens the company's reputation.

  • Business Risk:

    • A lower risk firm is more likely to build goodwill than a higher risk one.

  • Nature of Business:

    • It refers to the kinds of goods a business sells, the degree of market rivalry, the demand for those goods, and the laws that have an effect on the company. A company that achieves success in each of these areas will be more well-liked.

  • Possession Of Trademark & Patents:

    • Businesses with trademarks and patents will have a monopoly in the market, which will boost the company's reputation.

  • Capital:

    • Buyers will see a company as more lucrative and with greater goodwill if it has a higher return on investment with less capital expenditure.


    Need for Valuation Of Goodwill

  • The variation in the current partners' profit-sharing ratios
  • Admission Of Partners
  • Retirement Of Partners
  • Death Of Partners
  • Dissolution of a company that includes selling the company as a going concern

    • Methods Of Valuation Of Goodwill:

  • Average Profit Method
  • Super Profit Method
  • Capitalisation Method


    • Related Articles:

  • Accounting
  • Balance Sheet
  • Goods & Service Tax
  • Acquisition
  • Bank Overdraft