What do You Understand by Goodwill?

Goodwill is the value of the company that surpasses its assets over its liabilities. In other words, goodwill describes that the business has value outside its actual physical assets and liabilities. The value of goodwill can be generated from the good work performance of management, customer loyalty, brand recognition, favorable location, or even the excellence of employees. Anything that brings an addition in value to the company outside its excess assets over liabilities is considered goodwill.

The existence of goodwill in the books is not a definite indication of success. A potential purchaser would agree to make any compensation for the goodwill only when he agrees that the profit probable to be received to him from the purchased business would be higher than the normal return expected in a similar business.

Meaning of Goodwill

Goodwill is a long-term or noncurrent asset identified as an intangible asset in the balance sheet of the company. Goodwill occurs when a company takes over another entire business. The amount of goodwill is the cost to purchase the business deducting the fair market value of the tangible assets, the identified intangible assets, and the liabilities attained in the purchase.

Goodwill may be defined as the total of those intangible characteristics of a business that provides its higher earning capacity over the normal return on investment. It may come from such characteristics as the favorable locations, the capability, and skill of its employees and management, quality of its products and services, customer satisfaction, etc.

Features of Goodwill

• Goodwill is an intangible asset that cannot be seen but it is not a fictitious asset.
• It cannot be detached from the business and thereby cannot be sold like other tangible and detachable assets, without selling off the business as a whole.
• The value of goodwill has no relation to the amount of capital invested or the cost suffered to build the business.
• Valuation of goodwill is subjective and is highly dependent on the ruling of the valuer.
• Goodwill is subject to variations. The value of goodwill may change broadly according to internal and external factors of the business.

Types of Goodwill

Purchased goodwill

It originates when a business concern is purchased for an amount over the fair value of the net assets taken over. As an outcome, it is disclosed as an asset on the balance sheet. It is the only type of goodwill that can be disclosed on the books of accounts of the company.

Inherent goodwill

It is the reverse of purchased goodwill and denotes the value of a business higher than the fair value of its net assets taken over. This type of goodwill is internally created and increases over time because of a good reputation, which can be either positive or negative.

Importance of Goodwill

Boosts Brand Loyalty

When the business is fulfilling, different business organizations transact with them often. When the business builds goodwill with the customers, it becomes more confident about doing business with the firm and is more expected to be faithful to the brand of the company. As an outcome, the customers are more probable to transact with the business the next time they require a product or service offered by the business. This may also increase the brand as the other businesses may recommend our business to others. This helps the business to grow consistently.

Helps to Stand Out

The goodwill can help us to stand out from competitors who offer identical products and similar prices. This enhances the position of the business in the market, helping the business to discriminate itself from the competition. Goodwill can be an outcome of the hard work to resolve stuff or complex data. If goodwill is created, the brand will stand out among its competitors and fascinate more customers.

Improves Your Value of Business

As an outcome of goodwill, a company grows in value with a positive name. Customers identify the value of goodwill of a company. This also helps us to attract more investors. It can also help us to accept recognition more simply if we want to enlarge our business. In case the business plans to sell off, it will allow us to make a more margin of profit as goodwill building simply means building value.

Need for Valuation of Goodwill

The valuation of the goodwill of a business often occurs when there is any major variation in the business. The main reasons for the valuation of goodwill are:

Economic Damage Analyses: If the business enterprise suffers a breach of contract or tort, then goodwill is measured to know the decrease in the value of the goodwill of the firm due to such breach.

Amalgamation: In case of merger of two business entities or one business of the company is acquired by another company, then also the goodwill is measured.

Business Separation: During the separation of assets of the business, from individual business owners such as partners of a firm, goodwill is valued. Therefore, it is a common way to apportion the assets to the individual partners in the ratio of the relative value of the assets created by each partner along with goodwill.

Change in Partnership: In the case of admission, retirement, or death of a partner in a partnership firm, goodwill is valued, as the variation in a partnership may affect the profitability of the partners.

Business Enterprise Valuation: In an asset-based approach, the goodwill of the company is recognized and computed, for taxation, ownership transition, litigation, financing, corporate governance, bankruptcy, etc.

Accounting Treatment of Goodwill

It is important to know that goodwill should be maintained and recorded in business only when some sum of money or worth of money has been spent on it. However, goodwill can be treated as the following cases:

• Transfer it as an asset and write it off over periods through the profit and loss account.
• Write off goodwill instantly against profits or accumulated reserves.
• Hold it as an asset with no write-off till a permanent reduction in value becomes certain.
• Show it as a reduction from shareholder’s funds which may be legally carried forward indefinitely.

Conclusion

Goodwill is a long-term or noncurrent asset identified as an intangible asset in the balance sheet of the company. Goodwill occurs when a company takes over another entire business. The value of goodwill can be generated from the good work performance of management, customer loyalty, brand recognition, favorable location, or even the excellence of employees. Goodwill is an intangible asset that cannot be seen but it is not a fictitious asset. It cannot be detached from the business and thereby cannot be sold like other tangible and detachable assets, without selling off the business as a whole. In the case of admission, retirement, or death of a partner in a partnership firm, goodwill is valued, as the variation in a partnership may affect the profitability of the partners.