Purchased Goodwill: Understanding Acquired Goodwill

A comprehensive guide to understanding purchased goodwill, its historical context, categories, importance, applicability, and examples in finance and accounting.

Historical Context

The concept of purchased goodwill has been around for centuries, emerging as a critical component in the valuation of businesses. Purchased goodwill typically arises during mergers and acquisitions when a company is bought for more than the fair value of its identifiable net assets. This difference often reflects non-tangible elements such as brand reputation, customer relationships, and intellectual property.

Categories

Purchased goodwill falls under intangible assets, which are critical in understanding a company’s valuation. These intangible assets can be divided into:

• Acquired Goodwill: Goodwill that is purchased during the acquisition of another company.
• Internally Generated Goodwill: Goodwill developed internally through business operations and not explicitly purchasable.

Key Events

• Accounting Standards Codification (ASC) 805: Provides guidelines on how purchased goodwill is recognized and measured in business combinations.
• International Financial Reporting Standard (IFRS) 3: Similarly, this standard deals with accounting for goodwill in the context of international finance.

Detailed Explanations

Purchased goodwill is recognized as an intangible asset on the balance sheet and typically subject to annual impairment tests rather than amortization. This process involves comparing the carrying value of the goodwill to its fair value. If the carrying value exceeds the fair value, an impairment loss is recognized.

Mathematical Formulas/Models

The calculation of purchased goodwill can be simplified with the following formula:

$$ \text{Purchased Goodwill} = \text{Purchase Price} - \left( \text{Fair Value of Net Identifiable Assets} \right) $$

Importance and Applicability

Goodwill plays a significant role in:

• Valuation: Reflects the premium paid for anticipated future economic benefits.
• Business Combinations: Helps in evaluating the fair price for mergers and acquisitions.
• Investor Insight: Offers investors insights into the premium a company is willing to pay over its net asset value.

Examples

• Acquisition of Instagram by Facebook: Purchased for $1 billion, the valuation exceeded the tangible assets, primarily constituting goodwill.
• Google’s acquisition of YouTube: Similar high-value transactions where purchased goodwill formed a significant part of the total price.

Considerations

• Impairment Risks: Goodwill impairment can impact financial statements and stock prices.
• Regulatory Requirements: Adherence to both local and international accounting standards is essential.

Related Terms

• Amortization: The process of spreading the cost of an intangible asset over its useful life.
• Impairment: When an asset’s carrying amount exceeds its recoverable amount.

Comparisons

• Purchased Goodwill vs. Internally Generated Goodwill: Purchased goodwill arises during acquisitions, while internally generated goodwill develops through regular business operations.

Interesting Facts

• A company with significant goodwill might be perceived as having a strong brand presence and customer loyalty.
• Goodwill impairment can sometimes lead to major financial restatements, affecting investor trust and market valuation.

Inspirational Stories

When Warren Buffett purchased See’s Candies, a significant part of the purchase price was goodwill, highlighting his belief in the intangible value of the brand’s reputation and customer loyalty.

Famous Quotes

“Goodwill is the one and only asset that competition cannot undersell or destroy.” - Marshall Field

Proverbs and Clichés

• “Goodwill is the glue that holds business relationships together.”
• “A business’s goodwill is as good as gold.”

Expressions

• “Buying into the brand” often implies paying for goodwill during an acquisition.
• “Paying a premium” relates to the excess amount over tangible asset value, often indicating goodwill.

Jargon and Slang

• “Blue Sky Value”: Another term for goodwill in real estate or business acquisitions.
• “Above book”: Refers to the purchase price exceeding the book value of assets, indicating goodwill.

FAQs

Can goodwill be negative?

No, if the fair value of net identifiable assets exceeds the purchase price, it results in a bargain purchase, not negative goodwill.

How is goodwill impairment tested?

Goodwill impairment testing involves comparing the carrying amount to the recoverable amount, with any excess indicating impairment.

Is goodwill amortized?

No, purchased goodwill is not amortized but tested annually for impairment.

References

• ASC 805: Business Combinations (Financial Accounting Standards Board).
• IFRS 3: Business Combinations (International Financial Reporting Standards).
• “Valuation of Goodwill and Intangible Assets” by Gordon V. Smith and Russell L. Parr.

Summary

Purchased goodwill, also known as acquired goodwill, is a pivotal concept in the valuation of businesses, particularly during mergers and acquisitions. Recognized as an intangible asset, it represents the premium paid over the fair value of net identifiable assets, capturing the value of a company’s brand, customer relations, and other non-tangible elements. Its correct valuation, recognition, and impairment testing are essential under various accounting standards like ASC 805 and IFRS 3. Understanding purchased goodwill is crucial for investors, analysts, and business strategists to assess the true value of business acquisitions and mergers accurately.