Table of Contents

Almost all aspects of your life

require building goodwill among
people. It is gratifying to spread
goodwill, and the same is true in
business as well. Business success is
largely determined by the
relationships that you build, so
creating goodwill is important.

In this post, we shall come across

the following talking points:

Goodwill in Accounting
What is Goodwill?
What is goodwill in accounting?
Essential features of goodwill
Types of goodwill
How to calculate goodwill?
Valuation and Types of Valuation
Techniques
Example of goodwill
Importance of goodwill in business
Factors affecting goodwill
What is Goodwill?
An intangible asset that is acquired
when one company purchases
another is known as goodwill. In
other words, goodwill refers to the
portion of the purchase price that
surpasses the aggregate net fair
value of all the assets acquired in
the acquisition and all the liabilities
assumed.

Among the factors that define

goodwill are brand recognition, a
solid customer base, good customer
relations, good employee relations,
and proprietary technology. The
items that makeup goodwill are
intellectual property and brand
recognition, which cannot be easily
measured.

What is Goodwill in Accounting?

In accounting, goodwill is an
increase in value over the company's
assets minus its liabilities. Assets
that are non-physical, such as solid
customer relationships, brand
recognition, or excellence in
management, are considered
tangible.

The goodwill must be evaluated for

impairment each year. The
amortization period for goodwill
may only be ten years for private
companies.

According to US GAAP and IFRS

standards, the goodwill of a
company has an indefinite life span,
so it does not have to be amortized.

Essential Features of Goodwill

Goodwill can be defined through its
features as described here:

Goodwill comes under the category

of intangible assets. It does not have
a physical form but it is not
hypothetical or fictional.
Since it can't be separated from the
business, it can't be sold separately
like other identifiable assets.
Goodwill is a unique asset that is not
based on investments or costs.
Types of Goodwill
There are two main types of
goodwill:

Purchased
Inherent
Purchased Goodwill

Purchased goodwill is a result when

purchasing a business is done for a
higher price than the fair value of
the separated acquired assets. Due
to this, goodwill is shown as an
asset on the balance sheet, whereas
other types cannot be recognized.

Non-Purchased or Inherent Goodwill

In contrast to purchased goodwill,
inherent goodwill represents the
business's value in excess of its
separable net assets. Developing
inherent goodwill is an internal
process that occurs over time as a
result of reputation. It could go
either ways, positive or negative.

Goodwill takes time to build but it

can bring you a lot of benefits. There
are certain factors that can greatly
impact it.

How to Calculate Goodwill?

For calculating Goodwill, we need
the values of the Purchase price of
the company, Fair market value of
assets, and Fair market value of
liabilities.

With these three values, here is how

the Goodwill is calculated:

Goodwill Formula:

Goodwill = Purchase Price of target

Company- (A+L)

Where

A= Fair Market Value of Assets

L= Fair Market Value of Liabilities

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Valuation of Goodwill
We have seen the various aspects
related to Goodwill but in this
section, we highlight the importance
and need for the valuation of
Goodwill. Let’s explore this along
with the methods of valuation of
goodwill.

We need to carry out the valuation

of goodwill for the following
reasons:
When there is more number of
partners, valuation of goodwill
becomes important for the purpose
of Profit-sharing and for deriving
the Profit Sharing Ratio (PSR).
The inclusion of a new member or a
partner demands the valuation of
goodwill.
It is also carried out in the times
when the enterprise dissolves and
the sale of the business need to be
accomplished.
Valuation is also done in case of the
death of one of the partners.
Goodwill valuation needs to be done
in the case of the retirement of a
partner.
Methods of Valuation
There are three methods used for
the valuation of goodwill:

Super Profits Method

Average Profits Method
Capitalization Method
Example of Goodwill
All the factors pertaining to goodwill
that we have learned so far can be
better understood by a simple
example here.

Let us assume a company ABC ltd.

has (Assets-Liabilities) worth
$100,000.

(Assets-Liabilities) = $100,000
Another company purchases ABC
Ltd. for $150,000. The premium
value comes out to be $50,000.

Purchase Price = $150,000

Going by the formula of Goodwill:

Goodwill = 150,000 - 100,000

= 50,000

The acquirer's balance sheet will list

the $50,000 as goodwill.

Additionally, it is recorded when the

purchase price of the target
company exceeds the assumed
liabilities of the company.

Importance of Goodwill in Business

Creating goodwill can take a number
of forms, from implementing
customer appreciation programs to
providing extra services. Business
owners will reap several benefits in
return. Some examples of how
goodwill with customers can benefit
your business follow.

Boosts Brand Loyalty

When you are satisfied with a

company, you do business with them
frequently. When you build goodwill
with your customers, they'll be more
confident about doing business with
you and are more likely to be loyal
to your brand. As a result, your
customers are more likely to contact
you the next time they need a
product or service you offer.
Moreover, they may also recommend
your business. This consequently
enables you to grow your business.

It Can Help You Stand Out

Your goodwill can enable you to

stand out from competitors who
offer similar products and prices.
This boosts your position in the
market, helping you differentiate
yourself from your competition.
Goodwill can be a result of your
hard work to resolve matters or
complicated information. If you
create this goodwill, your brand will
stand out among your competitors
and attract more customers.

Inspires forgiveness

Imagine what it is like to receive a

gift from your neighbor who has
upset you in the past. This same
neighbor may be less likely to upset
you the next time when they park
their car incorrectly. Your business
is subject to the same principles.
Making your customers feel
appreciated - by going the extra
mile, exceeding their expectations,
or providing personal attention - can
make the customers overlook your
mistakes.
Improves Your Business' Value

Because of its goodwill, a company

with a positive reputation grows in
value. Customers recognize the
value of goodwill of a company. This
way you will be able to attract more
investors. It can also help you to
receive credit more easily if you
desire to expand your business. In
case you choose to sell your
business, it will enable you to make
a bigger profit. Building goodwill
builds value.

Factors Affecting Goodwill

Let’s cover this topic in the table
here:
Factors Affecting Goodwill

Quality of Products/ Services

Businesses with a commitment to

good quality are likely to earn more
goodwill than those providing
inferior products and services.

Location of the Business

A location that is convenient for the

business is likely to enjoy higher
goodwill than a location that is more
remote.

Business Risk
A business that has a low level of
risk has an advantage over a
business that has a high level of
risk.

Efficiency

A business with effective

management increases its profits,
improving its reputation and
goodwill.

Nature of the Business

In essence, it refers to the products

that the company deals with, the
competition it faces in the market.
The nature also refers to the density
of customer demand and the laws
and regulations that affect the
business.

Capital

Buyers will consider a firm with low

capital investment and a high return
on investment as being profitable
and having a good reputation and
goodwill.

Trademark and Patents

The possession of trademarks and

patents will enhance the goodwill of
the firm because patents and
trademarks will give it monopoly
rights in the market.
Favorable Contracts

Goodwill increases if a company is

able to obtain favorable contracts
for selling products.

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