In an acquisition, more often than not, goodwill is booked on the acquiring company’s balance sheet. As part of the opening balance sheet calculation, goodwill is calculated as the excess purchase price that was paid by the acquirer over and above the value of the identifiable tangible and intangible assets acquired. Goodwill is usually paid for by a buyer, and it represents future expected intangible assets that are not yet identifiable as of the date of acquisition.
For example, let’s say a company is acquired for $100 million , and it owns $10 million in accounts receivable, $10 million in property plant and equipment, and $20 million of identifiable intangible assets such as patents and customer relationships. The remaining $60 million ($100M-$10M-$10M-$20M=$60M) is implied future value that is expected to be developed down the road . This $60 million value would be the goodwill that would be booked by the acquirer as part of the purchase.
Because goodwill goes on the acquirer’s balance sheet as an asset, it must be tested for impairment anytime there is a triggering event. This is any event that may lead to the value of the goodwill being less than its current value on the company’s balance sheet. Under the conservatism principle of accounting, if an asset’s fair value is worth less today in an exit scenario than it is currently listed for on a company’s balance sheet, the company must calculate an impairment of that asset, including goodwill.