What is Goodwill? What is the Role in the Company?

What is goodwill – Goodwill is a part of the assets in a company’s balance sheet, which falls into the category of intangible assets.

For some people who are in the accounting world, of course some already understand what goodwill is.

However, not everyone knows what goodwill is even though it is a fairly important thing in a company’s balance sheet.

Given that goodwill is an intangible asset, it is difficult to measure with certainty.

However, in terms of benefits, it will be felt later such as a big name, the strategic level of a product or company and others.

When the purchase company exceeds the market price of net assets, the difference is called goodwill.

In conclusion, goodwill is a representation of a number that is greater than the book value paid by an entity to obtain another entity.

Definition of Goodwill Is

In the world of accounting, goodwill is included in the type of intangible assets.

Technically, goodwill begins to appear in the balance sheet or statement of financial position when a company wants to acquire another company by paying above the nominal fair market value ( Fair Value Market ) which consists of the company’s net assets to be purchased.

The factors that shape goodwill itself are things like a good company reputation, a strong brand identity, competent employees in their fields, technology that is considered up-to-date, and the like.

These are clearly not physically measurable or difficult to qualify precisely.

This does not mean that goodwill is a tangible form of assets owned by the company, but rather a form of recognition or recognition of assets owned by the company.

According to the standards of US GAAP ( United States Generally Accepted Accounting Principles ) and IFRS ( International Financial Reporting Standard ), the value of goodwill has an indefinite life so it does not need to be amortized.

However, it is necessary to conduct an evaluation when there is an impairment or increase in goodwill each year. Typically, many companies conduct goodwill evaluations over a 10-year period.

Warren Buffet, a well-known investor, uses the example of a company called See’s Candies in California.

See’s Company consistently earns a net profit of $2,000,000 with total tangible assets of $8,000,000.

The implication is that See’s company generates a ROA (Return on Assets) of 25%. The amount of ROA and net income can be said to be the result of the contribution of the value of goodwill.

This is also based on the services provided by See’s company and various other advantages that are not measurable in nominal terms.

Acquisition of Goodwill Is

Goodwill will arise if there is an activity from a business entity when buying another entity, where the price paid is relatively greater than the price/net worth of the company purchased.

However, if the purchase price is below the net worth, negative goodwill will appear.

For example, there is a company that wants to buy another company to expand its business. The company has total assets of $ 1 million with total liabilities of $ 250K and total equity of $ 750K.

Because the company has a strategic location, the company is selling high. Then, finally there was an agreement between the two companies at a price of $ 850K.

The total net assets of the purchased company is $  750K, but the company is sold for $ 850K, there is a difference of $ 100K.

This difference is known as goodwill. In nominal terms and numbers it looks like a loss and expensive, but the benefits in the future will be better for the company that buys it considering that there is a strategic location aspect. In accounting, the recording of the occurrence of goodwill is done like this.

Goodwill Amortization Is

Amortization is another term for depreciation, while for fixed assets there is a term for depreciation in intangible assets called amortization.

In the Statement of Financial Accounting Standards (PSAK) amortization is the systematic allocation of depreciable amounts to intangible assets.

Now, the amortization of goodwill in accounting is still a matter of debate in either IFRS or IAS. Neither IFRS nor IAS allow the application of amortization of goodwill and replacing it with impairment (revaluation of goodwill).

Generally, this goodwill is partially charged to the company.

Then, the expense is depreciated over a number of years, to be allocated in each period so as not to interfere with the income statement when goodwill is obtained, because the value is quite good and is predicted to bring benefits in the future.

However, one problem is how to measure goodwill. It is different with the company buying a building whose age can technically be estimated.

However, now the amortization of goodwill is no longer permitted, starting in 1970. In the 2000s the FASB issued concessions in which the amortization of goodwill was no longer allowed.

Goodwill amortization is also prohibited by the International Accounting Standard (IAS), goodwill is only permitted under the Impairment approach.

Steps You Can Take To Assess Company Goodwill

The following are steps you can take to assess the goodwill of a company.

1. Find the Book Value of All Assets Owned by the Company

That is, this book value includes the total of current assets, non-current assets, fixed assets and intangible assets.

The nominal of these components can be used as a statement of financial position or a balance sheet in the company.

2. Find & Determine the Fair Value of a Company’s Assets

You can hire a consultant in the accounting field to help find and determine the Fair Value of a company’s assets. Sometimes, the assessment of the consultant is usually subjective.

However, if the consultant has a good reputation, then the possible value of each asset owned can be well justified.

3. Make Asset Adjustments

In addition to the two things above, the next thing is to make adjustments by comparing the book value and the fair value of the assets owned.

4. Calculate Total Net Assets

Next, try to calculate the total net assets of each book value, specifically the fair value of your assets.

This is done by calculating total assets with total liabilities/liabilities or:

Net Asset Value = Total Assets – Total Liabilities/Liabilities

5. Calculate the value of goodwill

Finally, the value of goodwill can be obtained by subtracting the actual total price paid by the company that bought your company from the net asset value of the company’s fair value.

Finally, you can get the value of goodwill by subtracting the actual total price paid by the company that bought your company by the Net Asset Value of your company’s Fair Value.

Goodwill = Actual Selling Price – Net Value of Assets based on Fair Value

The following is an example of calculating the value of the JKLMNOPQ company’s goodwill purchased by the ABCDFGHI company

Forward JKLMNOPQ CompanyBook valueFair Value
Cash7,000,0007,000,000
Accounts receivable79,000,00068,000,000
Stock38,000,00035,000,000
Fixed assets230,000,000249,000,000
Intangible Assets25,000,00025,000,000
Total Assets379,000,000384,000,000
Total Liability(180.000.000)(180.000.000)
Net Asset Value199,000,000204,000,000

The explanation why Fair Value is different from Book Value is:

  • The Fair Value of Accounts Receivable is less than the Book Value because there are uncollectible receivables.
  • Fair Value of Inventory is less than Book Value because some of the inventory is obsolete.
  • The Fair Value of Fixed Assets is higher than Book Value because it turns out that the depreciation value of Fixed Assets at Book Value is greater than its fair valuation.

If the ABCDFGHI company buys the JKLMNOPQ company for $ 230,000,000, then the value of goodwill obtained is:

$ 230,000,000 – $ 204,000,000 (Net Asset Value of Company’s Fair Value) = $ 26,000,000.

The journals recorded by the buying company, namely the JKLMNOPQ company, are:

debitCredit
Asset384,000,000
goodwill26,000,000
Liability180,000,000
Cash230,000,000

Manage Company Finance and Assets with Accounting Software

With the help of the Accounting Software, you can easily do asset management.

In addition, the Accounting Software is also able to record every asset you own, calculate depreciation on fixed assets easily, and provide reports regarding the condition of the assets you have until the closing period.

Accounting Software has complete features regarding financial reporting, including bookkeeping software features and cash inflow and outflow application features.

Those are some steps that can be taken to assess the goodwill of a company. Hopefully the information above is useful.


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