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Goodwill
Goodwill is an accounting concept that describes the value of a business entity not directly attributable to its tangible assets and liabilities.
Overview
For example, a software company may have physical assets of some desktop PCs, servers, office equipment etc valued at $1 million, but the company's overall value (including brand, customer, intellectual capital) is valued at $10 million. Anybody buying that company would show $10 million total assets comprising $1 million physical assets, and $9 million in goodwill.
However the value of Goodwill is very difficult to assess especially in cases where personal contact is important. An accountant who sells his practice would not be able to guarantee that all of his clients would transfer to the buyer. When purchasing a business of this nature it is very important to be sure that provisions are made for an adjustment in the sales price after an initial trial period to see if the client base has eroded.
Goodwill is often included on a balance sheet as an asset, but its valuation may be suspect if supporting evidence like an independent survey is missing. Goodwill is forced onto the balance sheet when a company is purchased for more than the sum of the value of the assets of the company. The difference between the purchase price and the sum of the assets is by definition the value of the "goodwill" of the company.
Goodwilll is no longer amortized under U.S. generally accepted accounting principles (GAAP). As of January 1st, 2005, it is also forbidden under International Accounting Standards. Goodwill can now only be impaired (impairment-only approach).
Since, in general, intellectual property (IP) is part of Goodwill, one of the most important assets of knowledge-based companies does not appear at all on formal balance sheets. As for these companies it is the IP that generates profit, not the buildings or the cash they hold, this may lead to a misleading valuation, discouraging investors who do not understand the company's true value.
See also
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