What is goodwill in accounting?

2. Definition of goodwill and goodwill calculation formula

Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.

When goodwill is recognized in a business combination, it is recorded as an asset on the balance sheet and is shown separately from other assets.

According to the generally accepted accounting principles, goodwill is not amortized. So, there is no accumulated goodwill amortization on the balance sheet. At the same time goodwill is tested for impairment annually or when factors indicate impairment may exist. If impairment is determined to exist, the goodwill amount is written down by increasing a goodwill valuation account (i.e., contra-asset account similar to accumulated amortization).

As was mentioned earlier, the amount of goodwill is calculated as the difference between the net assets acquired (i.e., assets acquired less liabilities assumed) and the purchase price:

(+) Tangible Assets Acquired

(+) Intangible Assets Acquired

() Liabilities Assumed

(=) Net Assets Acquired

(+) Purchase Price

() Net Assets Acquired

(=) Goodwill

In many instances the fair value of net assets acquired is less than the purchase price. So, the difference is recorded as goodwill. However, in some situations the fair value of net assets acquired is more than the purchase price. In this case the difference is recognized as a gain in the income statement at the time of the business combination, and no goodwill is recorded on the balance sheet. This situation is called a bargain purchase.

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