How to calculate goodwill

Goodwill refers to non-physical items that can increase a company’s market value. It can take many forms, including reputation, brand, domain names, intellectual property, trade secrets and other intangible assets.

Assigning a numerical value to goodwill can be challenging because these assets are not quantifiable. However, the need to determine goodwill often arises when one company acquires another firm, a subsidiary of another firm, or some intangible aspect of that firm’s business.

Key Findings

Goodwill is an intangible asset that comes in many forms, including reputation, brand, domain names and intellectual property.
The need to determine goodwill often arises when one company is purchased by another.
Goodwill is calculated as the difference between the consideration transferred from the acquirer to the acquiree and the net identifiable assets acquired.

History of Goodwill

The concept of goodwill in business relationships dates back at least a century. One of its first definitions appeared in Halsbury’s Laws of England. an extensive encyclopedia dating back to 1907. The current Halsbury (4thEdition, Vol. 35), states that:

“Business goodwill is all the advantages of reputation and connection with clients, and of circumstances, habitual or otherwise, which tend to make that connection permanent. In relation to any business or business product, it reflects the customer acquisition value that name and reputation have.”

Today, accountants rely on the more prosaic and limited provisions of International Financial Reporting Standards (IFRS) to include goodwill in financial statements. IAS 38 Intangible Assets does not allow the recognition of internally generated goodwill (own brands, headers, publishing titles, customer lists and similar items). The only acceptable form of goodwill is that acquired externally, through business combinations, purchases or acquisitions.

For example, in 2010 Facebook (META), now Meta, bought the domain name fb.com for $8.5 million from the American Farm Bureau Federation. The only meaning of a domain name is the name or (in this case) the initials. This means that the entire amount paid for it could be considered goodwill, and Facebook would recognize it as such on its balance sheet. However, prior to the acquisition, the American Farm Bureau Federation could not recognize fb.com as a goodwill company. his balance sheet – goodwill must arise from an external source (not internal).

Goodwill calculation

Under IFRS 3 Business Combinations, goodwill is calculated as the difference between the consideration transferred from the acquirer to the acquiree and the net identifiable assets acquired. The general formula for calculating goodwill according to IFRS:

$\begin{aligned} &\text{Goodwill} = \left(C + NCI + FV\right) – NA\\ &\textbf{where:}\\ &C = \text{Consideration transferred}\\ &NCI = \text {Amount of non-controlling interest}\\ &FV = \text{Fair value of previous interests}\\ &NA = \text{Net identifiable assets} \end{aligned}$

Non-controlling interest in goodwill calculation

The method for calculating goodwill is simple, but problems can arise when measuring one of the variables: non-controlling interest (NCI). The amount of NPOs plays an important role in the formula for calculating goodwill. A non-controlling interest is a minority interest in a company, meaning the position is not significant enough to exercise control over the company.

According to IFRS 3, there are two methods for measuring non-controlling interest:

Fair value or total goodwill method
Non-controlling interest’s proportionate share of the acquiree’s net identifiable assets

The two methods may give different results.

For example, suppose company A Inc. acquires B Inc., agreeing to pay US$150 million (transferred consideration) to obtain a 90% interest in B Inc. The fair value of the non-controlling interest is US$16 million. Assume that the fair value of the net identifiable assets acquired is $140 million and that there is no pre-existing equity interest.

Under the first NCI measurement method, the amount of goodwill is $26 million ($150 million + $16 million – $140 million).

In the second method of measuring NCI, we take into account the 10% of shares of B Inc. that A Inc. owns. did not purchase. As a result, the value of goodwill will be $24 million ($150 million + (140 million x 0.1) – $140 million). Therefore, the difference between the amount of goodwill calculated using the two methods is US$2 million.

Special Considerations

Although goodwill represents a premium paid over the fair value of an entity in a transaction, the value of goodwill itself cannot be sold or purchased as an intangible asset.

Determining the price of goodwill can be difficult because it consists of subjective values. Transactions involving goodwill may have a significant risk that the acquiring company may overvalue goodwill in the acquisition and end up paying too much for the acquiree.

However, although goodwill is intangible, it is quantifiable and is a very important part of valuing a company.

What is the formula for calculating goodwill?

In accordance with IFRS 3 Business Combinations, the formula for calculating goodwill is as follows: Goodwill = (Consideration transferred + Non-controlling interest + Fair value of previous interests) – Net identifiable assets.

How is goodwill different from other assets?

Like other assets, goodwill can appear on a company’s balance sheet (but only when two companies complete a merger or acquisition). However, unlike some other assets, goodwill is intangible. It is not a physical asset such as buildings or equipment. Another difference is that it has an indefinite duration (as long as the company is in operation). Other assets have a definite useful life and, as such, are depreciated: a fixed amount is reduced each year, resulting in a simultaneous charge to profit.

What is an intangible asset?

Goodwill refers to the value of certain non-monetary and non-physical resources, such as customer loyalty and brand reputation. While customer loyalty and brand reputation are certainly intangibles, on a company’s balance sheet an intangible asset refers to something else. An intangible asset is not physical, but is identifiable. Examples include a company’s proprietary technology (computer software, etc.), copyrights, patents, licensing agreements, and website domain names.

Bottom line

Goodwill is a non-physical item, such as a trademark or intellectual property, that adds value to a company. It is valued when a firm buys another firm or buys some portion of that firm’s business; it cannot be sold, purchased or transferred separately. The formula for calculating goodwill is: Goodwill = (Consideration transferred + Non-controlling interest + Fair value of previous interests) – Net identifiable assets.