What Is Goodwill in Accounting? Everything You Need to Know

Who it’s for:

• Small business owners

• New acquirers and investors

• Anyone trying to understand goodwill on financial statements

Key Takeaways:

• Goodwill is an intangible asset created when a buyer pays more than the fair market value of a company’s net assets.

• It reflects brand reputation, customer loyalty, and other elements that create long-term value.

• Goodwill appears on the balance sheet and is tested for impairment rather than amortized.

• Calculating goodwill requires determining the purchase price and subtracting the fair value of identifiable assets and liabilities.

• Impairment reduces goodwill and creates a loss on the income statement, which can affect financial performance.

When one company buys another, the numbers do not always fit neatly. The purchase price may be higher than the fair value of the target’s identifiable assets. That difference does not disappear. It becomes goodwill, an intangible asset that represents the value of a business that cannot be touched or counted in a warehouse. It shows up on the balance sheet, but it reflects things like customer loyalty, brand reputation, strong leadership, and the systems that make the company run well.

Goodwill in accounting can feel abstract if you do not work with acquisitions regularly. Yet understanding it helps owners and investors make better decisions. It shapes business valuation and financial statements. It also affects how outsiders view a company’s financial health. This guide breaks goodwill into simple parts so you can see what it is and how to calculate it.

What Is Goodwill in Accounting?

Goodwill is the intangible asset created when a company purchases another for more than the fair market value of its identifiable assets minus its liabilities. In short, it is the premium paid above net assets because the buyer believes the business is worth more than the numbers on paper.

Goodwill might include the value of:

• Strong brand recognition

• Customer loyalty

• Trained employees and leadership

• Effective processes or proprietary know-how

• Favorable relationships with vendors or the community

Goodwill is listed as a long-term intangible asset on the acquiring company’s balance sheet. It exists only after a purchase. You cannot create goodwill without a transaction.

How Goodwill Fits on the Balance Sheet

Once the deal closes, goodwill is recorded on the acquiring company’s balance sheet within long-term assets. It is not a current asset, nor is it a tangible asset like equipment or buildings. It is also not grouped with other intangible assets, such as patents or licenses. Goodwill stands alone.

You will see it listed after fixed assets and other intangible assets. Its purpose is to bridge the gap between fair value and the total purchase price. In financial statements, goodwill helps explain why a buyer was willing to pay a premium for the target company.

Because it is tied to the business's success, goodwill does not depreciate. Instead, companies must regularly evaluate it to determine whether its value still holds.

Why Companies Pay More Than Fair Value in Business Acquisitions

During a business acquisition, the buyer is not only buying equipment, real estate, or inventory. They are also buying the market position and competitive strength of the target company. That often means paying more than the fair market value of its net assets.

Companies pay a premium because they believe the target offers:

• A loyal customer base

• A strong brand that can be scaled

• Reliable future cash flows

• A competitive advantage that the buyer cannot build quickly on its own

In these cases, paying above net tangible assets is reasonable. Goodwill captures that belief in future value.

How to Calculate Goodwill

The calculation itself is simple. The interpretation requires careful financial judgment.

Goodwill equals the purchase price minus the fair market value of identifiable net assets.

In other words:

• Determine the fair market value of all identifiable assets

• Subtract the fair market value of all liabilities

• Subtract the result from the total purchase price

The remainder is goodwill.

Example

Company A buys Company B for 20 million dollars.

Company B’s identifiable assets have a fair value of 15 million dollars.

Its liabilities total 4 million dollars.

Net identifiable assets equal 11 million dollars.

The excess purchase price is 9 million dollars.

That 9 million dollars is goodwill.

This amount then appears on the acquiring company’s balance sheet as an intangible asset.

What Counts as Identifiable Assets and Liabilities?

To calculate goodwill accurately, you must review the fair market value of identifiable assets and liabilities. These are assets that can be valued and sold separately from the business.

Identifiable assets include:

• Tangible assets, such as equipment, inventory, and buildings

• Other intangible assets, such as patents, licenses, or trademarks

• Accounts receivable

• Current assets

• Fixed assets

• Inventory at fair market value

Liabilities include:

• Debt

• Accounts payable

• Accrued expenses

• Contract obligations

Only the difference between total assets and total liabilities becomes the foundation for calculating goodwill.

Goodwill Accounting: Amortization and Impairment

Goodwill has an indefinite life under GAAP, so it is not amortized. Instead, companies must test it for impairment at least once each year or when events suggest its value may have declined.

Private companies may amortize goodwill over a ten-year period or less. This election can simplify financial reporting, though it reduces flexibility when assessing value over time.

When goodwill is reviewed, accountants look at whether the fair value of the reporting unit has decreased. If the carrying value is greater than the fair value, an impairment loss is recorded.

What Causes Goodwill Impairment?

Impairment happens when goodwill is no longer worth what the company originally recorded. Several events can trigger a review:

• Declining profitability or cash flows

• Increased competition

• Economic downturn

• Loss of major customers

• Management changes that affect performance

If the fair market value of the business has fallen, goodwill must be written down. This loss appears on the income statement and reduces net income. The balance sheet will show goodwill at its new carrying value.

Impairment can also affect how investors view the company since it signals potential weakness in future performance.

Where Goodwill Appears in Financial Reporting

Goodwill influences both the balance sheet and income statement, and is essential to how stakeholders interpret financial health.

On the balance sheet, goodwill sits within long-term assets at its carrying value. If impairment occurs, the carrying value drops.

On the income statement, impairment creates a loss in the period it is recognized. This affects net income and may lower earnings per share.

In financial statements as a whole, goodwill affects how lenders and investors judge the company’s stability, especially if the business has grown through acquisitions.

Why Goodwill Matters in Business Valuation

Business valuation involves more than counting assets. Analysts consider the value of customer relationships, brand strength, and the company’s ability to generate future cash flows. Goodwill influences these calculations because it represents value that exists above book value.

During an acquisition or investment decision, goodwill affects:

• The price buyers will pay

• How the company’s reputation factors into valuation

• The present value of expected future cash flows

• Perceived competitive strength

A high level of goodwill is not always negative. It can indicate a company with a strong market presence and loyal customers. The key is whether the goodwill aligns with real financial performance.

Example of How Goodwill Works in Practice

Imagine a growing software firm acquiring a smaller competitor with a strong user base and recognizable brand. The smaller company’s net assets, including equipment, cash, and other identifiable assets, total $ 6 million. Its liabilities total $2 million. Net identifiable assets equal $4 million.

The acquiring company pays $10 million because the target has a loyal customer base and proprietary technology that the buyer values. The $6 million difference is goodwill. This goodwill appears on the buyer’s balance sheet and stays there unless impairment is needed later.

Conclusion: Why Understanding Goodwill Matters

Goodwill in accounting represents the value of a business beyond what you can measure with equipment lists or property records. It captures the strength of a brand and the systems that make the company successful. When one company buys another, goodwill explains why the price often exceeds the fair market value of net assets.

Knowing how goodwill works helps owners understand acquisition pricing, business valuation, financial statements, and how investors interpret long-term value. It sits quietly on the balance sheet, but it reflects some of the most important parts of a business.

At Steady Co, we help companies understand their financial statements and organize their bookkeeping. If you're looking for an integrated tax solution and experts who can help you understand everything from goodwill to deductions, schedule an appointment today!