Questions:
What is the difference between inherent goodwill and purchased goodwill?

If XYZ Inc is acquired for a purchase price of $500 million with a fair value of assets of $400 million and no liabilities, what is the purchased goodwill? How will this be recorded on the balance sheet of the company that acquired XYZ Inc?

Reference answers:
# Inherent Goodwill
Inherent Goodwill is the value of the business more than the fair value of its separable net assets and cannot be purchased directly. It increases with time due to certain factors such as good reputation of the business, customer loyalty, and brand recognition.
Inherent Goodwill cannot be calculated directly, as it arises from certain factors with the passage of time. Analysts usually use various methods and techniques to estimate the overall value of a business. These techniques include income approach, market approach, discounted cash flow method, cost approach, market capitalization, and so on.
Therefore, the inherent goodwill of XYZ will include the talented R&D team, and a reputation for cutting-edge technology etc. This will not impact the financial statements because they will not be valued.

# Purchased Goodwill
Purchased Goodwill arises when a company acquires another company or business. The extra amount paid to acquire the company is considered as purchased goodwill. It is calculated as the value paid to acquire the target company, less the sum of its assets and liabilities that is stated in the target company’s balance sheet.

# Calculation of Purchased Goodwill
Purchased Goodwill is calculated as follows:
Goodwill = Purchase price of the target company – (Fair value of Assets + Fair value of Liabilities)

# Goodwill in case of acquiring XYZ
Purchase price  = $500 million
Fair value of assets = $400 million
Purchased goodwill = $500 million - $400 million = $100 million

The excess of $100 million that ABC will pay over the fair value of the net assets of XYZ will be the purchased goodwill. It will be recorded as a long-term asset in the balance sheet and will be tested for impairment annually.