Like many of you, I have heard of Goodwill but not really had a firm idea of what it is.
Basically, Goodwill is an intangible asset that is recorded on the acquiring company’s balance sheet under the long-term assets account. Goodwill is considered an intangible (or non-current) asset because it is not a physical asset like buildings or equipment.
Under generally accepted accounting principles (GAAP) and the International Financial Reporting Standards (IFRS), companies are required to evaluate the value of Goodwill on their financial statements at least once a year and record any changes in its value.
The process for calculating Goodwill is fairly straightforward in principle but can actually be quite complex in practice. To determine Goodwill with a simple formula, you take the purchase price of a company and subtract the net fair market value of identifiable assets and liabilities.
Goodwill = P − ( A − L ) where:
P = Purchase price of the target company
A = Fair market value of assets
L = Fair market value of liabilities
For example, if the fair value of Company ABC’s assets minus liabilities is $12 billion, and a company purchases Company ABC for $15 billion, the premium paid for the acquisition is $3 billion ($15 billion – $12 billion). This $3 billion will be included on the acquirer’s balance sheet as Goodwill.
While Goodwill officially has an indefinite life, its value can easily change due to an adverse financial event. If there is a change in value, that amount decreases the Goodwill account on the balance sheet and is recognized as a loss on the income statement. From a credit perspective, depending on the materiality of the loss, a highly rated company could find its Goodwill account completely wiped away and in fact, devolve into negative Goodwill which could hugely impact its credit rating.
Nancy Seiverd, President, CMI Credit Mediators, Inc. (firstname.lastname@example.org