The term goodwill has a number of definitions in business. For instance, a company may offer a valued customer a discount on future purchases if the customer has had a poor experience with the brand. This is often referred to as a goodwill gesture or discount.
In accounting and investment terms, goodwill has a different meaning. Under international financial reporting standards (IFRS), goodwill is described as an intangible asset that is used to explain the excess purchase price of one company by another.
The value of a company is not only measured in its fixed and current assets or the contents of its current financial statement. It is also measured in more ephemeral terms not reported on a balance sheet. This can include the goodwill a brand has built with its consumer base, the intellectual property or proprietary technology it leverages, or the good relations it has with its employees.
An acquiring company may pay a greater price than the net fair value of all of the acquiring company’s assets and assumed liabilities. This extra portion is referred to as goodwill.
Examples of goodwill
After deducting liabilities from assets, Company X determines that Company Y’s net assets are worth $8 billion. However, Company X purchases Company Y for $10 billion. Why? Because Company Y has developed a product that’s a big hit with consumers and has a strong base of loyal brand advocates. Goodwill accounts for this extra $2 billion being added to the purchase price.
A good example is the acquisition of Time Warner by Discovery which was approved in 2022. When Discovery purchased the moviemaking titan, it also purchased intellectual properties like DC comics and Wizarding World/Harry Potter characters that command goodwill from loyal fanbases. Although the licenses to these franchises (also intangible assets) can be bought and sold, the devotion of their fans falls under the definition of goodwill.
However, goodwill is about more than just intellectual properties. It’s anything that makes up the brand identity to which customers have a personal attachment. There are many factors at play here, from the quality of customer service you offer to how easy and flexible you make it for customers to pay you.
How does goodwill differ from other intangible assets?
Goodwill is not the only asset a company may have that is intangible. Goodwill varies slightly from other intangible assets such as licenses, trademarks, or patents.
Unlike these intangible assets, goodwill does not have a defined useful life. As such, under US Generally Accepted Accounting Principles
(GAAP), it is not subject to compulsory amortization. Instead, it is subjected to an impairment test. Goodwill can be amortized in private companies.
Frequently asked questions about goodwill
What does goodwill tell you about a company?
Goodwill supplements the net value of a company’s assets to provide a more balanced valuation. Once the fair value of all net assets has been deducted, what remains is goodwill. Likewise, when a company acquires a failing company in a distressed sale, it will likely have negative goodwill. In which case, the company will often be asset-stripped.
Can businesses claim tax relief on goodwill?
That depends. If goodwill is created in an acquisition structured as an asset sale, it may be tax-deductible. Goodwill created in an acquisition structured as a stock sale is unlikely to be tax-deductible.
What are goodwill impairments?
Goodwill impairment means anything that decreases the goodwill account on a company’s balance sheet. Increased competition, economic downturns, or decreases in cash flow can cause a company’s intangible assets to be impaired.
Under international financial reporting standards (IFRS), companies must evaluate the value of their goodwill annually on their financial statements and record any impairments.