How to calculate goodwill
/What is Goodwill?
Goodwill is an intangible asset generated from the acquisition of one entity by another. It cannot be generated internally; it can only be recognized through the acquisition of another business. Goodwill is the excess of the price paid for a business over the sum of the fair values of the assets acquired and liabilities assumed as part of an acquisition transaction. This can be quite a substantial sum, especially when the acquired business has significant competitive advantages that the acquirer is willing to pay a high price to acquire. These advantages may include a strong brand, a loyal customer base, and patented technologies that no one else can use.
How to Calculate Goodwill
Goodwill is the difference between the price paid by the acquirer for a business and the amount of that price that cannot be assigned to any of the individually-identified assets and liabilities acquired in the transaction. The acquirer must recognize goodwill as an asset as of the acquisition date. The goodwill calculation is as follows:
Goodwill = (Consideration paid + Fair value of noncontrolling interest)
– (Assets acquired – Liabilities assumed)
When calculating the total amount of consideration paid as part of the derivation of goodwill, consider the additional factors noted below.
Fair Value of Assets Paid
When the acquirer transfers its assets to the owners of the acquiree as payment for the acquiree, measure this consideration at its fair value. If there is a difference between the fair value and carrying amount of these assets as of the acquisition date, record a gain or loss in earnings to reflect the difference. However, if these assets are simply being transferred to the acquiree entity (which the acquirer now controls), do not restate these assets to their fair value; this means there is no recognition of a gain or loss.
Share-Based Payment Awards
The acquirer may agree to swap the share-based payment awards granted to employees of the acquiree for payment awards based on the shares of the acquirer. If the acquirer must replace awards made by the acquiree, include the fair value of these awards in the consideration paid by the acquirer, where the portion attributable to pre-acquisition employee service is classified as consideration paid for the acquiree. If the acquirer is not obligated to replace these awards but does so anyways, record the cost of the replacement awards as compensation expense.
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Goodwill Impairment
Once goodwill has been recorded by the acquirer, there may be subsequent analyses that conclude that the value of this asset has been impaired. If so, the amount of the impairment is recognized as a loss, which reduces the carrying amount of the goodwill asset.
Problems with Goodwill
There are several problems with the goodwill concept, which have led some theoreticians in the direction of advising that all goodwill be written off as of the acquisition date. The first issue is that it is quite difficult to derive a hard estimate of goodwill impairment. A decline in the value of an acquired business might lead one to suspect that the goodwill asset is indeed impaired - but by how much? The outcome tends to be a range of possible impairment values, which could be quite broad. Another concern is that the amount of goodwill recorded on the acquirer’s balance sheet may be so high that it distorts the total amount of assets stated on this report. The distortion may be so high that investors automatically deduct the goodwill from their analyses of the company’s financial position, essentially ignoring it.
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