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Goodwill

Goodwill is an accounting concept meaning the value of an asset owned that is intangible but has a quantifiable "prudent value" in a business. For example, a software company may have net assets (consisting primarily of miscellaneous equipment, and assuming no debt) valued at $1 million, but the company's overall value (including brand, customers, and intellectual capital) is valued at $10 million. Anybody buying that company would book $10 million in total assets acquired, comprising $1 million physical assets, and $9 million in goodwill. In a private company, goodwill has no predetermined value prior to the acquisition; its magnitude depends on the two other variables by definition. A publicly traded company, by contrast, is subject to a constant process of market valuation, so goodwill will always be apparent.

While a business can invest to increase its reputation, by advertising or assuring that its products are of high quality, such expenses cannot be booked as contributing to goodwill. There is hence a disconnect: goodwill from acquisitions can be booked, since it is derived from a market or purchase valuation, but similar internal spending cannot be booked, although it will be recognized by investors who compare a company's market value with its book value.

It should also be noted that while goodwill is technically an intangible asset, goodwill and intangible assets are usually listed as separate items on a company's balance sheet.

Goodwill is no longer amortized under U.S. GAAP (FAS 142). FAS 142 was issued in June 2001. Companies objected to the removal of the option to use pooling-of-interests, so amortization was removed by Financial Accounting Standards Board as a concession. As of 2005-01-01, it is also forbidden under International Financial Reporting Standards. Goodwill can now only be impaired under these GAAP standards.

Instead of deducting the value of goodwill annually over a period of maximal 40 years, companies are now required to determine the fair value of the reporting units, using present value of future cash flow, and compare it to their carrying value (book value of assets plus goodwill minus liabilities.) If the fair value is less than carrying value (impaired), the goodwill value needs to be reduced so the fair value is equal to carrying value. The impairment loss is reported as a separate line item on the income statement, and new adjusted value of goodwill is reported in the balance sheet.

When the business is threatened with insolvency, investors will often deduct the goodwill from any calculation of residual equity because it will likely have no resale value.

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