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Goodwill

The excess of the purchase price over the fair market value of an asset. Accountants record this as a 'write off' in the financial report.

Notes:

The market sets the price of what a business is worth. In mergers and acquisitions, goodwill arises when more was paid for the business than you'd expect from just looking at the value of its assets and liabilities. This difference can have a number of reasons, including a happy workforce, customer loyalty, a good location, and so on.

See also: Amortization, Depreciation, Fair Market Value, Negative Goodwill

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Goodwill

Excess of purchase price over fair market value of net assets acquired under the purchase method of accounting.

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goodwill

1. The amount above the fair net book value (adjusted for assumed debt) paid for an acquisition. Goodwill appears as an asset on the balance sheet of the acquiring firm and must be reduced in the event the value is impaired.

2. The discounted value of a larger-than-normal return on tangible assets. A business may build goodwill over time as loyalty builds among its customer base.

Case Study The Financial Accounting Standards Board (FASB), the body charged with establishing generally accepted accounting standards, in 2001 changed the method by which companies account for goodwill. Goodwill is posted as an asset to a firm's balance sheet when the firm makes an acquisition for above net asset value. In other words, goodwill is created when a firm pays more than the accounting value of a firm's assets adjusted for its debts. Huge amounts of goodwill were created in the late 1990s and early 2000s when the merger and acquisition business was progressing at full steam. Prior to 2002 companies were required to write down, or deduct, a prescribed amount of goodwill each accounting period. Thus, firms that engaged in major acquisitions at high prices posted large amounts of goodwill that had to be written off over a period of years. Goodwill writeoffs increase expenses and reduce reported earnings to shareholders. Prior to the change in accounting standards, companies were required to amortize goodwill regardless of how much the acquired assets were actually worth. Under the new standard imposed by the FASB in 2001 goodwill does not have to be reduced in value until it is determined the acquisition that created goodwill is no longer worth the purchase price. This change was expected to result in substantially higher reported earnings for companies with large amounts of goodwill on their balance sheets. For example, AOL Time Warner had $127 billion in goodwill on its balance sheet at the time of the change and was expecting to report substantially higher earnings because of the change in standards. On the downside, the firm announced in March 2001 it would incur record charges of $54 billion in goodwill impairment in the first quarter.