# Understanding Goodwill in Accounting: Definition, Calculation, and Impairment

## What Is Goodwill?

When a company purchases another, it often pays more than the net fair value of the target's assets and liabilities. This excess is recorded as goodwill, an [intangible asset](https://www.investopedia.com/terms/i/intangibleasset.asp) reflecting brand strength, customer loyalty, and proprietary technology, among other factors. It signifies a competitive edge and justifies premiums paid during acquisitions.  

### Key Takeaways

*   Goodwill is an intangible asset recorded when a company is acquired for more than the fair value of its net assets.
*   Goodwill reflects premium aspects of a business, such as brand reputation and customer loyalty, which are not easily quantifiable.
*   Companies must perform annual impairment tests to assess goodwill's value, addressing any necessary write-downs on the balance sheet.
*   The formula for calculating goodwill involves subtracting the fair market value of assets and liabilities from the acquisition price.
*   Negative goodwill, or badwill, occurs when a company is bought for less than its market value, typically in a distress sale.

![Goodwill](https://www.investopedia.com/thmb/936B8L1ci4nAAStxDH9fU_eWL7I=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Goodwill-Definition-6b68b9485c394cb185b3097a8558a25e.jpg)

*— Investopedia / Lara Antal*

## How Goodwill is Valued in Company Acquisitions

Goodwill is important when one company buys another. Even if a company's net assets have a fair value, the buyer might pay more for that company. This difference is usually due to the value of the target’s goodwill.

> **Fast Fact**
>
> A company gains negative goodwill, also known as badwill, if the acquiring company pays less than the target’s book value. It purchased the company at a bargain in a distress sale.

Goodwill is recorded as an intangible asset on the acquiring company's balance sheet under the long-term [assets account](https://www.investopedia.com/ask/answers/062215/goodwill-considered-form-capital-asset.asp). It's considered to be an intangible or non-current asset because it's not a physical asset such as buildings or equipment.

Companies are required under [generally accepted accounting principles](https://www.investopedia.com/terms/g/gaap.asp) (GAAP) and the International Financial Reporting Standards (IFRS) to evaluate the value of goodwill on their financial statements at least once a year and record any impairments.  

> **Important**
>
> Goodwill isn't the same as other intangible assets. It's the premium paid over fair value during a transaction and it can't be bought or sold independently. Other intangible assets such as licenses or patents can be. Goodwill has an indefinite life. Other intangibles have a finite useful life.

## Identifying and Addressing Goodwill Impairments 

Accounting goodwill involves the [impairment](https://www.investopedia.com/terms/i/impairment.asp) of assets that occurs when the market value of an asset drops below [historical cost](https://www.investopedia.com/terms/h/historical-cost.asp). This happens due to events like reduced cash flow, more competition, or an economic downturn.

The company must impair or do a [write-down](https://www.investopedia.com/financial-edge/0113/writing-down-goodwill.aspx) on the value of the asset on the balance sheet if a company assesses that acquired net assets fall below the book value or if the amount of goodwill was overstated. The impairment expense is calculated as the difference between the current market value and the purchase price of the intangible asset.

Impairment reduces goodwill on the balance sheet and is recorded as a loss on the income statement, lowering the year's net income. [Earnings per share](https://www.investopedia.com/terms/e/eps.asp) (EPS) and the company's stock price are also negatively affected.  

### Methods for Conducting Goodwill Impairment Tests 

Companies perform tests on intangible assets to check for impairment. The two commonly used methods for testing impairments are the income approach and the market approach.

*   **Income approach**: Estimated future cash flows are discounted to the present value.
*   **Market approach**: Assets and liabilities of similar companies operating in the same industry are analyzed.  
    

## How to Accurately Calculate Goodwill 

Calculating goodwill is simple in theory, but can be complex in real-world situations. You can determine goodwill with a simple formula by taking the purchase price of a company and subtracting the net [fair market value](https://www.investopedia.com/terms/f/fairmarketvalue.asp) of identifiable assets and liabilities.

$\begin{aligned}&\text{Goodwill} = \text{P} - ( \text{ A } - \text { L } ) \\&\textbf{where:} \\&\text{P} = \text{Purchase price of the target company} \\&\text{A} = \text{Fair market value of assets} \\&\text{L} = \text{Fair market value of liabilities} \\\end{aligned}$  

[Accountants](https://www.investopedia.com/terms/a/accountant.asp) use competing approaches in calculating goodwill.

Goodwill includes estimating future cash flows and other unknown factors during acquisition. This may not normally be a major issue but it can become significant when accountants look for ways to compare reported assets or net income between companies. Some of them may have acquired other firms and some may not have.  

The Financial Accounting Standards Board (FASB), which sets standards for GAAP rules, was considering a change to how goodwill impairment is calculated. FASB was considering reverting to an older method called "goodwill [amortization](https://www.investopedia.com/terms/a/amortization.asp)" due to the subjectivity of goodwill impairment and the cost of testing it. This method would have reduced the value of goodwill annually over several years but the project was set aside in 2022 and the older method was retained.

## Challenges and Limitations of Goodwill Valuation 

Pricing goodwill is challenging. Negative goodwill happens when a company is bought for less than fair market value, often due to negotiation issues.

Negative goodwill is usually seen in [distressed sales](https://www.investopedia.com/terms/d/distressale.asp) and is recorded as income on the acquirer's income statement.

There's also the risk that a previously successful company could face [insolvency](https://www.investopedia.com/terms/i/insolvency.asp). The goodwill the company previously enjoyed has no resale value at the point of insolvency. Investors deduct goodwill from their determinations of residual equity when this happens.

## Real-World Examples of Goodwill in Business Acquisitions

If a company buys Company ABC for $15 billion and its assets minus liabilities are worth $12 billion, the $3 billion difference is the acquisition premium. This $3 billion will be included on the acquirer's balance sheet as goodwill.

Consider the T-Mobile and Sprint merger announced in early 2018 for a real-life example. The deal was valued at $35.85 billion as of March 31, 2018, per an S-4 filing. The fair value of the assets was $78.34 billion and the fair value of the liabilities was $45.56 billion.

The difference between the assets and liabilities is $32.78 billion so goodwill for the deal would be recognized as $3.07 billion ($35.85 billion - $32.78 billion), the amount over the difference between the fair value of the assets and liabilities.

## How Is Goodwill Different From Other Assets?

Goodwill is an intangible asset that's created when one company acquires another company for a price greater than its net asset value. It's shown on the company's [balance sheet](https://www.investopedia.com/terms/b/balancesheet.asp) like other assets.

But goodwill isn't amortized or depreciated, unlike other assets that have a discernible useful life. It's periodically tested for goodwill impairment instead. The value of goodwill must be written off, reducing the company’s earnings, if the goodwill is thought to be impaired.

## How Is Goodwill Used in Investing?

Evaluating goodwill is a challenging but critical skill for many investors. It can be difficult to tell whether the goodwill claimed on a balance sheet is justified.

Investors should scrutinize what's behind its stated goodwill when they're analyzing a company’s balance sheet. The answer should determine whether that goodwill may have to be written off in the future.

The opposite can also occur in some cases with investors believing that the true value of a company’s goodwill is greater than what's stated on its balance sheet.

## What Is an Example of Goodwill in an Acquisition?

Amazon.com, Inc. ([AMZN](https://www.investopedia.com/markets/quote?tvwidgetsymbol=AMZN)) bought Whole Foods Market Inc. for $13.7 billion in 2017. The current share price of Whole Foods was $35 at that time. Amazon ended up paying $42 per share. Amazon paid $9 billion more in total than the value of Whole Foods' net assets. That amount was recorded as the intangible asset goodwill on Amazon's books.

## The Bottom Line

Goodwill is an intangible asset recorded during acquisitions, reflecting the premium paid above the fair market value of a company’s net assets. It accounts for elements like brand reputation, customer loyalty, and proprietary technology, offering the acquiring company a competitive edge. Unlike other intangible assets, goodwill has an indefinite life, but it requires annual impairment testing to ensure its value has not diminished. Impairments, caused by declining cash flows or adverse events, directly decrease goodwill on the balance sheet and result in a loss on the income statement, affecting the company’s net income and potentially its stock price.

> **Article Sources**
>
> 1.  International Financial Reporting Standards Foundation. "[IAS 36 Impairment of Assets](https://www.ifrs.org/issued-standards/list-of-standards/ias-36-impairment-of-assets/)."
>     
> 2.  Deloitte. "[FASB Removes Goodwill Project From Its Technical Agenda](https://www.iasplus.com/en/news/2022/06/fasb-goodwill)."
>     
> 3.  T-Mobile. "[T‑Mobile and Sprint to Combine, Accelerating 5G Innovation & Increasing Competition](https://www.t-mobile.com/news/press/5gforall)."
>     
> 4.  U.S. Securities and Exchange Commission. "[Form S-4, T-Mobile US, Inc.](https://www.sec.gov/Archives/edgar/data/1283699/000119312518231621/d589303ds4.htm)" Page 242.
>     
> 5.  U.S. Securities and Exchange Commission. "[Form S-4, T-Mobile US, Inc.](https://www.sec.gov/Archives/edgar/data/1283699/000119312518231621/d589303ds4.htm)" Page 243.
>     
> 6.  Goldman Sachs. "[Firm Advises, Helps Fund Amazon's Stunning US$13.7 Billion Acquisition of Whole Foods](https://www.goldmansachs.com/our-firm/history/moments/2017-amazon-acquires-whole-foods.html)."