Nature affecting Goodwill

What is Goodwill?

Goodwill is an indefinable asset that helps a firm earn a higher profit than the average profit. In short, to purchase one company by another is known as Goodwill. It is a portion of the purchase price which is higher than the total of all assets’ fair value purchased in liabilities and acquisition. Goodwill is based on the value of the brand name, the solid customer base, good relations between the customers, employees, and the company, and the proprietary technology.

Nature affecting Goodwill

There are a few factors affecting Goodwill in accounting. These factors are the following:

• Product Quality:

A company that produces qualitative products can easily establish a name in the market. If the product quality is good, it will increase sales and profit, increasing the value of Goodwill.

• Management Efficiency:

The value of Goodwill will increase if the management is efficient. Well-handled management usually enjoys the merit of more productivity and cost-efficiency. Increasing profits also help increase the value of Goodwill through properly planned distribution, production, and services.

• Nature of the Business:

Business nature or the nature of business is another factor that can affect the value of Goodwill. When the company enjoys a favourable situation, a secured monopoly, and assured earnings, the value of Goodwill will increase. The company having constant sales has a good chance of earning profit and Goodwill.

• Location:

If the company is located in a popular place, it can easily attract more customers and eventually increase turnover. A better location will attract more customers, increasing sales and profit. It results in increasing the value of Goodwill too.

• Market Condition:

Limited competition or the monopoly facilitates the concern to earn more profits and leads to more value for Goodwill. 

• Supply Access:

When the supply access of the company is better, or it has an assured supply of inputs, then the company easily enjoys a better reputation than the other companies. And thus can earn higher Goodwill.

• More capital more chances of Goodwill:

More business capital means more chances for Goodwill. More buyers may come to purchase a business that requires a comparatively small amount of capital. At the same time, the rate of earning profit is high. And this, in turn, consequently raises the value of Goodwill.

Value of Goodwill

Goodwill value will arise when the acquirer purchases a target company. The acquiring company’s amount to the target company is based on net assets. The value of the target’s Goodwill is the target at fair value. If the acquiring company is paying less than in that case, the target’s book value has negative Goodwill. And it means that it has purchased the company at a bargain in a distress sale.

The record of Goodwill is put together in the balance sheet as an indefinable asset of the acquiring company under the long-term assets account. The IFRS and GAAP companies need to investigate their Goodwill value every year on their financial statements and record any impairments. Goodwill is not a physical asset like equipment or the building; instead, it is considered an indefinable and non-current asset.

Methods to Treat Goodwill

During the time of admission of a partner, by following the below two methods, Goodwill can be treated:

1. Premium Method: In this method of Goodwill, as the incoming partner brings his Goodwill share in cash in a sacrificing ratio, the existing partner shares it. Moreover, if the Goodwill amount is paid privately by the new partner to the old partner in cash, then entries will not pass in the firm’s books.
2. Revaluation Method: This method is used when the new partner decides not to bring his share of Goodwill in cash. In this case, the Goodwill account in the books can be raised by debiting the Goodwill account. And also by crediting the capital account of the old partners in the old profit-sharing ratio.

Goodwill in Diverse Scenarios

The accounting treatment of Goodwill in various scenarios is different:

• If the deceased or the retiring partner is authorised to his part of Goodwill during the retirement or death, goodwill is earned by the company with all the existing partners’ perseverance and hard work
• Therefore, during the retirement or death of a partner, the evaluation of Goodwill is based on the agreement among the partners of the retiring or deceased
• It also recompensed for his portion of Goodwill with the continuing partners

In these two scenarios, the accounting treatment of Goodwill will depend on whether Goodwill exists in the book of the company.

Conclusion

In this article, we have learned about Goodwill and how the factors affect Goodwill in accounting.It is an indefinable asset that helps a firm earn a higher profit than the average profit. There are a few factors affecting Goodwill in accounting, for instance, product quality, management efficiency, business nature, location, supply access, market condition etc. More capital means more chances of goodwill. The value of goodwill arises when the acquirer purchases a target company. The acquiring company’s amount to the target company is based on net assets. The value of the target’s Goodwill is the target at fair value. Goodwill can be treated using the two methods, such as the Premium method and the Revaluation method.