Goodwill is an intangible asset representing the established reputation and additional value of a business over and above the fair value of its distinctly identifiable net assets. Goodwill is of following two types:
- Purchased or acquired goodwill
- Internally generated goodwill
In our previous chapter “Intangible assets”, we have discussed that internally generated goodwill does not meet the recognition criteria of intangible assets as its cost cannot be measured reliably. Therefore, internally generated goodwill cannot be recognized in accounting. However, cost of purchased or acquired goodwill can be measured reliably and is recognized as an intangible asset.
Purchased or acquired goodwill
Whenever a company acquires a subsidiary, quite often it pays more than the fair value of the subsidiary’s distinctly identifiable net assets. Why is it so? As a matter of fact, the company is not just acquiring the subsidiary’s net assets, it is also acquiring the inherent benefits associated with that subsidiary. These may include the benefits associated with its established reputation in the market, its excellent technical expertise in the relevant field or any other such factor. This excess payment while acquiring the subsidiary is for these inherent benefits which are collectively called as goodwill of the business. Let’s sum up the definition of purchased or acquired goodwill.
In a business acquisition, goodwill is that portion of the purchase consideration which is more that the fair values of acquired net assets (assets minus liabilities).
Negative goodwill or gain on bargain purchase
Sometimes when a business is acquired by another business, purchase consideration paid for acquisition is even lesser than the fair value of net assets acquired. There can be several reasons for this such as the business being acquired was forced to sell due to adverse financial position and lack of suitable purchasers etc. As it is exactly the opposite of purchased or acquired goodwill, so it is often called negative goodwill. It is basically a gain for the acquiring company as it is paying less and acquiring more net assets and therefore it is also called gain on bargain purchase.
This negative goodwill or gain on bargain purchase is recorded as income in the income statement at the time of acquisition of the business.