What is Goodwill in Accounting?

What is Goodwill in Accounting?

What is goodwill in accounting? In accounting, goodwill is the value of a business in excess of its assets less liabilities. These represent non-physical assets, such as value created by a strong customer base, brand recognition or management excellence.

Goodwill is usually associated with business acquisitions. This is recorded if the purchase price is greater than the combined fair value of the identifiable assets and liabilities.

Definition of Goodwill

When a business is acquired, the buyer typically pays more than the market value of the business’ identifiable assets and liabilities. The amount paid is known as goodwill.

Unlike physical assets such as buildings and equipment, goodwill is an intangible asset that is recorded in long-term assets on the acquirer’s balance sheet. It can’t be sold or transferred separately from the business as a whole.

While contributing significantly to its success, the value of goodwill to a business may be difficult to define because it does not generate cash flow for the business.

Some assets that are categorized as goodwill include:

1. Business reputation
2. Brand name
3. Licenses and permissions
4. Domain name
5. Business secret
6. Copyrights and patents
7. Managerial and executive talent

Examples of Goodwill in Business

There are different types of goodwill based on the type of business and customer.

1. Business goodwill is related to the business, its position in the market, and its customer service.

2. Professional Practice Goodwill relates to practicing professionals such as doctors, engineers, lawyers, and accountants. It can further be classified as practitioner goodwill related to the reputation and professional skills of individuals and practice goodwill arising from the practitioner’s track record, institutional reputation, location and operating procedures.

How to Calculate Goodwill?

One of the simplest methods of calculating goodwill for a small business is to subtract the fair market value of the identifiable net assets from the price paid for the acquired business.

Goodwill is an intangible asset that arises when a business is acquired by someone else. The purchase cost of a business often exceeds its book value.

The gap between the purchase price & the book value of a business is known as goodwill. Calculating goodwill in accounting is important to keep the books of the parent company in balance.

Financial advisors use residual analysis in the assessment of goodwill. In this case, goodwill represents the remainder of the overall business value less the total value of all tangible assets and identifiable intangible assets used in the business entity.

1. Get the book value of all assets on the balance sheet
2. Determine the proper value of the asset
3. Find the fair value adjustment which is the difference between the fair value and the book value of the asset
4. Calculate the excess purchase price by taking the difference between the price paid to acquire the target business and the net book value of assets
5. Goodwill is calculated by taking the excess of the purchase price and reducing the fair value adjustment


You buy another business for $3 million. The purchased company has $2 million in identifiable assets and $600,000 in liabilities.

Identifiable net assets equal $1.4 million ($2 million minus $600,000).

Goodwill = $1.6 million ($3 million – $1.4 million)

Record goodwill as $1.6 million in the non-current assets section of your balance sheet.

Types of Goodwill Calculation Methods

1. Average profit method

In this method, the value of goodwill is equal to the average profit for a certain period of time. It is calculated by multiplying the average gain by the number of years of purchase.

Average Profit = Sustainable Future Profit After Tax x Number of Years Purchased

2. Super profit method

Super profit is the excess of the estimated future profit over the average profit. To use this method, you need to calculate the average profit from previous years.

1. Super profit = Maintainable average profit – Normal profit
2. Goodwill = Super Profit x Number of Years Purchased
3. Profit capitalization

The capitalization method determines how much capital is needed to generate average or super-profits, assuming the business is earning a normal rate of return for a given industry.

This amount of capital is known as the value of capitalized profits. The excess of the amount of capital over the total capital used by the business can be considered as goodwill.

Average Capitalization Value / Super Profit = Average Profit / Super Profit X (100 / Normal Rate of Return)

Goodwill = Average Capitalization Value / Super Profit Capital Used

3. Goodwill Treatment in Accounting

Goodwill is calculated and categorized as fixed assets on the balance sheet of the business. From an accounting and fiscal point of view, goodwill is not subject to amortization. However, accounting rules need businesses to test goodwill for impairment after a specific period of time.

In 2014, the Financial Accounting Standards Board (FASB) issued an update on accounting for goodwill. FASB Accounting Standard Update No. 2014-02, Intangibles — Goodwill and Other (Topic 350): Goodwill accounting, allows private companies to amortize goodwill on a straight-line basis over 10 years.

Is goodwill a current asset?

Goodwill is a non-current asset. These assets refer to long-term business investments such as property, plant & investments, goodwill, & other intangible assets.

Is goodwill a nominal account?

No, goodwill is not a nominal account. This is an intangible real account. This account represents assets that can’t be seen, touched or felt but can be measured in terms of Cash.

Goodwill Assessment

Goodwill needs to be valued when a triggering event causes the fair value of the goodwill to be below its current book value.

This relates to:

1. Damage caused by a breach of contract, breach or interruption of business opportunity
2. Merger or separation of business or professional practices
3. Bankruptcy and reorganization

How to Calculate Goodwill at the Time of Acquisition?

1. Get Asset Book Value

The book value of all assets includes fixed assets, current assets, non-current assets and intangible assets.

2. Determine the Fair Value of Assets

The next step is to determine the fair value of the assets, also representing the value of the company’s assets when the financial statements of the subsidiary are consolidated with the parent company.

3. Make Adjustments

Find the difference between the fair value and the book value of each asset and make adjustments in the books of accounts

4. Calculate Excess Purchase Price

The difference between the actual purchase price paid to acquire the target company and the net book value of assets (assets less liabilities) is the excess purchase price.

5. Calculate Goodwill

Subtract the fair value adjustment from the excess purchase price to calculate goodwill. This will be recorded on the acquirer’s balance sheet after the acquisition.

While businesses can build internal goodwill by training employees, maintaining good relationships with clients, and developing a customer base, they can only record the business goodwill they have earned. Internal goodwill is not classified as an asset.

Goodwill plays a large role in the acquisition price of a business. This has an impact on the value of the business as it reduces the risk of declining profitability once it changes hands.

Generally Accepted Accounting Principles (GAAP) require that goodwill be recorded only when an entire business or business segment is purchased. To record and report it as an intangible asset on the balance sheet, there must be actual numbers.

Although it is an intangible asset, calculating and recording goodwill is an important part of business valuation.

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