All About the Types

Goodwill is an intangible asset that is related to the acquisition of one company by another. Specifically, goodwill is the part of the acquisition price that is more than the aggregate of the net fair value of all of the assets purchased in the acquisition and the liabilities estimated in the process. The value of the brand name of the company, strong customer base, good customer relations, good relations with employees, and proprietary technology show some reasons for the existence of goodwill.

Features of Goodwill

• Intangible Assets: Goodwill goes to the group of intangible assets such as patents, trademarks, copyrights, etc. Intangible assets are those assets that cannot be touched and seen but can only be felt. It does not wear and tear so, the question of depreciation does not rise as is the case of other assets.
• Its value is liable to constant fluctuations: While goodwill is a non-depreciate asset, its value is accountable to constant variations. Goodwill is always present as an invisible asset in a business where there are excess profits but reduces in value with the reduction in the earnings.
• Valuable only when the entire business is sold: Goodwill cannot be sold in shares. It can only be sold when the entire business is sold except at the time of the admission and retirement of a partner.
• Determine the exact amount of goodwill: This is because the value of goodwill may vary from time to time due to varying situations that are internal and external to the business environment.
• Helps in earning excess revenues: Goodwill is the brand name or reputation earned by the business. It benefits in earnings extra revenues by taking more share in the market. This results in excess profits to the firms.
• A valuable asset: Goodwill is a valuable asset but its value changes with the various methods measuring it. The various methods for the calculation of goodwill are the Average Profits Method, Weighted Average Method, Super Profits Method, Capitalization of Average profits method, and Capitalization of Super Profits method.

Types of Goodwill

There are two types of goodwill namely the purchased goodwill and inherent goodwill.

Purchased Goodwill

When a company plans to purchase another company or enterprise, the consideration paid exceeds the total of the individual valuation of each of the assets and liabilities of the company or enterprise being purchased. The excess amount paid as a premium is the amount of purchased goodwill. The level of the premium paid is sometimes a requirement of the growth capacity of the company. In other cases, the premium is connected to the options of cutting the cost when interactions between the existing and new companies are broken. Sometimes, the element that a company has a recognized reputation or a well-known customer base will result in a significant premium being paid by the purchaser. The premium paid is referred to as goodwill and the accounting treatment of purchased goodwill is disclosed in the balance sheet of the company.

Self-Generated Goodwill

Self-generated goodwill or inherent goodwill is the value of the business over the fair value of its net assets. It is referred to as internally generated goodwill and it occurs over some time due to the good status of a business. The value of goodwill may be positive or adverse. Positive goodwill occurs when the value of the business as a total is higher than the fair value of its net assets taken over. It is adverse when the value of the business is lower than the value of its net assets taken over.

Factors affecting Goodwill

• The favorable location of the business: If the business is located at a suitable or easily reachable place, it will appeal to more customers and therefore will increase the value of goodwill.
• The efficiency of management: If the business is operated by skilled and effective management, the profit margins will go on increasing, which raises the value of goodwill.
• Longevity of the business: An older business is better recognized by the customers and therefore, it is expected to have an increase in goodwill. When a business enterprise has constructed up a good status over some time, the number of customers will be more in contrast to the customers of new entrants. The number of customers is an indication of the profit-generating capacity of the business.
• Nature of goods: If business transactions are in goods of daily utility, it will have stable profits as the demand for these goods will be regular and constant. Such business will lead to more goodwill. But if the business transactions are fancy items, its profits will be undefined and therefore, the value of the goodwill will be less.
• Possession of license: If a firm possesses an import license, the goodwill of the firm will be increased as it will be very tough for other firms to enter into the business in the absence of a license.
• Monopolistic and other rights: If a business has a monopoly market, it will have guaranteed profits. Similarly, if it has some specific privileges such as patents, trademarks, copyrights or concessions, etc., it will lead to an increase in goodwill.
• The risk involved: If there is a high risk engaged in the business, a low value of goodwill will be impacted.
• The trend of profits: If the profits of a business are continuously increasing, the value of its goodwill will be increased. If the profits are reduced or if the profits are undefined, the value of its goodwill will be less.
• Future competition: The likelihood or possibility of increased competition in the future would decrease the value of goodwill.
• Capital required: The amount of capital required for a business will also affect the value of goodwill. If two business enterprises make the same rate of profit, the business with lesser capital requirement shall have more goodwill.
• Trade name: If the goods the business deals in have a worldwide name by a trade name or trademark, it will positively affect the value of goodwill.
• Government support: Where the business has the support of the Government, people are willing to purchase the product of such a company which increases the goodwill.
• Money market conditions: Where conditions of the money market are easy, more buyers will be offered in the market and the value of goodwill may increase. On the other hand, if money is unusual the value of the goodwill may reduce.

Conclusion

Goodwill is an intangible asset that is related to the acquisition of one company by another. Specifically, goodwill is the part of the acquisition price that is more than the aggregate of the net fair value of all of the assets purchased in the acquisition and the liabilities estimated in the process. When a company plans to purchase another company or enterprise, the consideration paid exceeds the total of the individual valuation of each of the assets and liabilities of the company or enterprise being purchased. The excess amount paid as a premium is the amount of purchased goodwill. Self-generated goodwill or inherent goodwill is the value of the business over the fair value of its net assets taken over. It is referred to as internally generated goodwill and it occurs over some time due to the good status of a business.