Goodwill is an intangible asset that is associated with the purchase of one company by another. It is the good name of any business, which arises from the reputation, connection, or other advantages possessed by the company. This intangible asset enables an organization to earn profits greater than the-return normally expected on the capital invested intangible assets. The value of a company’s brand name, solid customer base, good customer relations, good employee relations, and any patents or proprietary technology represent some examples of goodwill. This value can be created from the excellence of management, customer loyalty, brand recognition, favorable location, or even the quality of employees.
The value of a company’s brand name, solid customer base, good customer relations, good employee relations, and proprietary technology represents some reasons why goodwill exists. It arises when a company acquires another entire business. The amount of goodwill is the cost to purchase the business minus the fair market value of the tangible assets, the intangible assets that can be identified, and the liabilities obtained in the purchase. Anything that adds value to the company beyond its excess assets over liabilities is considered goodwill.
To calculate goodwill, we should take the purchase price of a company and subtract the fair market value of identifiable assets and liabilities.
Goodwill Formula: P−(A+L)
- P = Purchase price of the target company
- A = Fair market value of assets
- L = Fair market value of liabilities
The account for goodwill is located in the assets section of a company’s balance sheet. It is an intangible asset, as opposed to physical assets like buildings and equipment.
Types of Goodwill
There are two distinct types:
- Purchased: Purchased goodwill is the difference between the value paid for an enterprise as a going concern and the sum of its assets less the sum of its liabilities, each item of which has been separately identified and valued.
- Inherent: It is the value of the business in excess of the fair value of its separable net assets.
For example, if you are selling an outstanding product or providing excellent service consistently, there is a lot of chance that goodwill raises quicker.