Goodwill (initial calculations)

Lesson:

When a company buys another business, it has make updates to its financial ledger.

Often it has to add value of goodwill, the amount paid over the fair market value of the acquired firm's net identifiable assets.

Goodwill can never be generated internally, and it can never be lower than zero.

These are the steps to calculate goodwill:

  1. Calculate the value of assets of the purchased business
  2. Calculate the value of liabilities of the purchased business
  3. Calculate the fair value of net identifiable assets (assets - liabilities)
  4. Compare purchase price to fair value of net identifiable assets
  5. If the purchase price > the fair value of net identifiable assets, the difference is the goodwill
You're a tax accountant, trying to figure out the goodwill resulting from a recent acquisition.

You've been briefed with the following facts:

  • There's a $50 balance in notes payable
  • There's a $41 balance in PP&E
  • The firm was purchased for $1
  • There's a $58 balance in unearned revenue
  • There's a $49 balance in long-term investments
What is the goodwill for the purchased company?

Answer:

  • There is goodwill of $19.

Explanation:

  1. First, we need to figure out the net assets of the purchased firm.
    NET ASSETS = ASSETS - LIABILITIES
  2. Next, Let's plug in the assets.
    NET ASSETS = $41 + $49 - LIABILITIES
  3. Next, Let's plug in the liabilities.
    NET ASSETS = $41 + $49 - $58 - $50
  4. Next, Let's do the math.
    NET ASSETS = $-18
  5. Now let's compare the purchase price to net assets
    PURCHASE PRICE = $1
  6. Since the purchase price is greater than the net assets, we do have goodwill.
    GOODWILL = PURCHASE PRICE - NET ASSETS
  7. Let's plug in the numbers.
    GOODWILL = $1 - $-18
  8. Let's do the math.
    GOODWILL = $19
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