What is Goodwill and How Does a Company Create it?

By Stock Research Pro • June 10th, 2009

Goodwill is an accounting term used to reflect the portion of the value of a company over and above its book value. Goodwill is most often evaluated in the case of a company acquisition as it reflects an intangible asset; the premium the buyer is willing to pay for the company beyond its tangible assets. The acquiring company recognizes goodwill as an asset on its balance sheet. Goodwill can also be negative. This happens when the fairly valued net assets exceed the cost of acquisition. In this case, goodwill would be recognized as a liability.

How to Calculate Goodwill

The formula for goodwill can be written as:

Goodwill = Purchase Price – Fair Market Value of Net Assets

Because goodwill does not reflect a physical asset such as a building or piece of machinery, it is reflected as an intangible asset on the balance sheet. There are two primary forms of intangible assets, legal and competitive. Goodwill falls into the legal category.

What is Negative Goodwill?

The term negative goodwill refers to a gain that occurs when the acquisition price is less than the fair value of the company’s net assets. Negative goodwill is most often attributed to two possible causes:

• The purchasing company made the acquisition at a “bargain” price

• The purchase price was reduced to account for expected future costs or losses

How is Goodwill Created?

Another way to look at goodwill is as a reflection of the synergy among the various assets of the business and their ability to generate revenue. The key factors that contribute to the creation of goodwill include:

Value as a Going Concern: Refers to the availability of business assets that can be utilized to produce income.

Expectation of Future Financial Benefit: The belief that part of the value the business offers is its potential to attract new customers through the creation of new products or services.

Excess business income: Reflects the idea of the company’s ability to generate earnings beyond a fair return on its combined business assets.


The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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