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Goodwill

Definition:

Goodwill comes into play when one company acquires another company. It is the difference between the net assets acquired (that is, the fair market value of the assets less the assumed liabilities) and the amount of money the acquiring company pays for them.

Example:

If a company’s net assets are valued at $1 million and the acquirer pays $3 million, then goodwill of $2 million goes onto the acquirer’s balance sheet. That $2 million reflects all the value that is not reflected in the company’s tangible assets – for example, its name, reputation, client list, patents, proprietary technology, key employees, business location(s), future revenue stream, and so on.

Book Excerpt:

(Excerpts from Financial Intelligence, Chapter 11 – Assets)

In years past, goodwill was amortized. Assets were typically depreciated over two to five years, but goodwill was amortized over thirty years. That was the rule.

Then the rule changed. The people who write those generally accepted accounting principles decided that if goodwill consists of the reputation, the customer base, and so on of the company you are buying, then all those assets don’t lose value over time. They actually may become more valuable over time. In short, goodwill is more like land than it is like equipment. So not amortizing it helps accountants portray that accurate reflection of reality that they are always seeking.

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