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Goodwill Accounting: What You Need to Know

by Medha Patel, on Apr 25, 2019

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When selling or merging a business, goodwill is referred to the intangible assets that represent the excess purchase price over the fair market value acquired during the purchase of an organization.

Why is goodwill accounting important?

From the seller’s perspective, a large goodwill value means the buyer saw a lot of excess intangible value in the business. From the buyer’s standpoint though, a large goodwill value could be a warning sign to investors.

However, where goodwill really starts to matters is when you have an impairment—the difference between the fair value and carrying value of your company. An impairment is an indication that a company has significantly, and permanently, reduced its projections for an acquisition—which is not something investors should take lightly. A goodwill impairment is a key indicator that a significant negative event for the future of a company’s business has taken place.

How is goodwill accounting different from other intangibles?

While goodwill and intangible assets are sometimes used interchangeably, there are significant differences between the two in the accounting world.

Intangible assets are those that are non-physical, but identifiable. Investors can think of a company’s proprietary technology (such as computer software), copyrights, patents, licensing agreements and website domain names. These aren’t things that one can touch, exactly, but it is possible to estimate their value to the enterprise. Intangible assets can be bought and sold independently of the business itself.

Goodwill, on the other hand, is more of a miscellaneous category for intangible assets that are harder to determine individually or measured directly. Customer loyalty, brand equity, name and brand recognition, and company reputation are all examples of things that make a company worth more than its book value, or quantifiable assets, and count as goodwill.

Often, a company’s record of research and development, innovation, and the experience of its management team are often included too. Goodwill cannot exist independently of the business, nor can it be sold, purchased or transferred separately. It is tied to the business indefinitely, unlike most of the other intangible assets like licenses, patents, etc. which can be sold and purchased separately.

What is the concept of negative goodwill?

Most of the time, a company will be purchased for more than the value of its net tangible assets, and the difference is attributed to goodwill. When the price paid is less than the actual value of the company's net tangible assets, negative goodwill results. This rarely occurs, and it is typically a sign of a distressed sale in an environment of economic upheaval or sudden industry disruption.

One example is the takeover of the holding company of Bank of Scotland by Lloyds TSB in 2009 for far less than the value of net assets. It produced negative goodwill in the amount of approximately GBP 11 billion that was added to Lloyd's capital base and to its net income that year. On paper, this made Lloyd's look much stronger than the reality at the time.

What is the benefit of having a goodwill accounting expert?

Goodwill only shows up on a balance sheet when two companies complete a merger or acquisition. With an emphasis on the calculation of goodwill, the amortization of intangibles, and the measurement associated with impairments—experts in goodwill accounting offer a unique perspective to these situations. They are also critical to the preparation of company financial statement presentations.

Now, as per the alternative FASB rule for private companies, which was expanded in 2017 for public companies, goodwill can be amortized on a straight-line basis over a period not to exceed 10 years. The IRS also allows for a 15-year write-off period for intangibles that have been purchased.

How can a Paro freelance accountant help your business?

Our exclusive network of finance experts is the best in America, with only the top 2% accepted by us. Paro freelancers have degrees from Wharton, Booth, Notre Dame, and Stern, just to name a few. We also match you with experts that have experience with your software, whether you use QuickBooks Online, Xero, Netsuite, ADP, or myriad other platforms and apps. And to make your process quick and easy, they are available on-demand, at hourly rates.

Topics:Accounting