Goodwill in Financial Statements

Goodwill in financial statements arises when a company is purchased for more than the fair value of the identifiable net assets of the company. The difference between the purchase price and the sum of the fair value of the net assets is by definition the value of the "goodwill" of the purchased company. The acquiring company must recognize goodwill as an asset in its financial statements and present it as a separate line item on the balance sheet, according to the current purchase accounting method. In this sense, goodwill serves as the balancing sum that allows one firm to provide accounting information regarding its purchase of another firm for a price substantially different from its book value. Goodwill can be negative, arising where the net assets at the date of acquisition, fairly valued, exceed the cost of acquisition.[1] Negative goodwill is recognized as a gain to the extent that it exceeds allocations to certain assets. Under current accounting standards, it is no longer recognized as an extraordinary item. For example, a software company may have net assets (consisting primarily of miscellaneous equipment, and assuming no debt) valued at $1 million, but the company's overall value (including brand, customers, intellectual capital) is valued at $10 million. Anybody buying that company would book $10 million in total assets acquired, comprising $1 million physical assets, and $9 million in goodwill. In a private company, goodwill has no predetermined value prior to the acquisition; its magnitude depends on the two other variables by definition. A publicly traded company, by contrast, is subject to a constant process of market valuation, so goodwill will always be apparent.

There is a distinction between two types of goodwill depending upon the type of business enterprise: institutional goodwill and professional practice goodwill. Furthermore, goodwill in a professional practice entity may be attributed to the practice itself and to the professional practitioner.[2]

It should also be noted that while goodwill is technically an intangible asset, goodwill and intangible assets are usually listed as separate items on a company's balance sheet.[3][4]

[edit] US practice

[edit] History and purchase vs. pooling-of-interests

Previously, companies could structure many acquisition transactions to determine the choice between two accounting methods to record a business combination: purchase accounting or pooling-of-interests accounting. Pooling-of-interests method combined the book value of assets and liabilities of the two companies to create the new balance sheet of the combined companies. It therefore did not distinguish between who is buying whom. It also did not record the price the acquiring company had to pay for the acquisition. U.S. Generally Accepted Accounting Principles (FAS 141) no longer allows