What does goodwill on your company’s balance sheet mean?
Goodwill is the value gained by your company after acquiring another company. When an acquiring company pays an amount that is higher than the target company’s book value, the excess quantity would be the company’s goodwill. Conversely, there will be negative goodwill when the amount paid by the acquiring company is lesser than the target company’s book value.
Some examples of goodwill are the value of your company’s brand, great employee relations, good client relations, patents, strong customer base and proprietary technology. Hence, goodwill is an intangible asset as it could not be touched like equipment or buildings. Goodwill account should be listed in the fixed assets section on the balance sheet (Also see Difference Between Balance Sheet & Consolidate Balance Sheet).
How to Determine A Company’s Goodwill?
It is hard to figure out the specific value of a company’s goodwill. Nonetheless, it makes the company more valuable, as an intangible asset of the company. To illustrate, a business that has run for many years and always offers top quality products to its customers will have higher goodwill than a small business that has involved in numerous scams cases and provides low-quality products.
There is a huge risk where a business might overestimate their goodwill in the acquisition since the elements of goodwill consist of subjective values (Also see Type of Common Accounting Errors). This over-estimation is bad news to every shareholder of the acquiring company because as the company would be writing off their goodwill, their share value will be reduced.
How to Calculate Goodwill?
To compute goodwill, take the price paid to the target company subtract the fair market price net identifiable assets
Goodwill = Purchase Price of the Target Company – Fair Market Price Net Identifiable Assets
To determine the value of net identifiable assets (NA), deduct the total amount of the acquired company’s liabilities from its total value of identifiable assets. Identifiable assets are stocks and other business assets.
NA = Total Assets – Total Liability
If you need to think about any other asset that is not recorded in the company’s balance sheet, then, it should be from legal right, or you can sell it independently from the business. For example, contracts or patents are such assets.
According to the Financial Reporting Standard 38 (FRS 38), business owners are required to acknowledge positive, purchased goodwill as an asset in the balance sheet. In your company receive negative goodwill after the acquisition, the acquired assets are required to be checked for impairment and the liabilities value need to be examined for completeness.
If the goodwill remains negative, this value must be acknowledged and revealed on the balance sheet under goodwill heading. You need to disclose the net quantity of positive goodwill and negative goodwill
The evaluation of goodwill is a complicated procedure. It is suggested to engage an accounting firm in Johor Bahru if you are not sure about the concept of goodwill on the balance sheet.