What is it called when an entire business is purchased the excess of amount paid for the entire business over the fair value of the net identifiable assets acquired?

The Goodwill formula calculates the value of the goodwill by subtracting the fair value of net identifiable assets of the company to be purchased from the total purchase price; the fair value of net identifiable assets is calculated by deducting the fair value of the net liabilities from the sum of the fair value of all the assets.

Table of Contents Show

• Steps / Method to Calculate Goodwill
• Examples of Goodwill Calculation Method (with Excel Template)
• Goodwill Formula Calculator
• Relevance and Uses of Goodwill Formula
• Recommended Articles

The term “goodwill” refers to that intangible asset that comes into play only when a company is planning to acquire another company and is willing to pay a price that is significantly higher than the fair market value of the company’s net assets. In short, goodwill can be seen as the difference between the purchase price and the fair market value of a company’s identifiable assets and liabilities.

The calculation of the goodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price.read moreequation is done by adding the consideration paid, the fair value of non-controlling interests, and the fair value of previous equity interestsEquity Interest is the percentage of ownership rights either individual or a company holds in one company which gives holder voting right in that company. They have residual rights in economic benefits obtained from the business or realization from assets.read more and then deducting the fair value of net assets of the company.

The goodwill calculation method is represented as,

Goodwill Formula = Consideration paid + Fair value of non-controlling interests + Fair value of equity previous interests – Fair value of net assets recognized.

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Steps / Method to Calculate Goodwill

The goodwill can be calculated by using the following five simple steps:

1. Firstly, determine the consideration paid by the acquirer to the seller, and it will be available as part of the deal contract. The consideration may be paid in stocks, cash, or cash-in-kind. The consideration is valued either by an appropriate valuation method or the share-based payment method.
2. Next, determine the fair value of the non-controlling interest in the acquired company. The portion of equity ownership in a subsidiary is not attributable to the parent companyA holding company is a company that owns the majority voting shares of another company (subsidiary company). This company also generally controls the management of that company, as well as directs the subsidiary's directions and policies.read more.
3. Next, determine the fair value of equity in previous interests.
4. Next, figure out the fair value of the net assets recognized in the acquired company. It is the net of the fair value of assets and the fair value of liabilities. It is easily available on the balance sheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more.
5. Finally, the goodwill equation is calculated by adding the consideration paid (step 1), non-controlling interestsIt generally projects curves on the data sets. For example, to forecast population growth, forming a non-linear relationship between time and growth.read more (step 2), and the fair value of previous equity interests (step 3) and then deducting the net assets of the companyThe net asset on the balance sheet is the amount by which your total assets exceed your total liabilities and is calculated by simply adding what you own (assets) and subtract it from whatever you owe (liabilities). It is commonly known as net worth (NW).read more (step 4) as shown below.

   Goodwill Formula = Consideration paid + Fair value of non-controlling interests + Fair value of equity previous interests u2013 Fair value of net assets recognized

   
   

Examples of Goodwill Calculation Method (with Excel Template)

Let us look at some simple to advance examples of the Goodwill Formula and calculate it to understand it better.

Goodwill Calculation – Example#1

Let us take the example of company ABC Ltd which has agreed to acquire company XYZ Ltd. The purchase consideration is $100 million to obtain a 95% stake in XYZ Ltd. As per an esteemed valuation company, the fair value of the non-controlling interest is $12 million. It is also estimated that the fair value of identifiable assets and liabilities to be acquired is $200 million and $90 million, respectively. There are no equity interests. Calculate the goodwill based on the given information.

Given,

• Consideration paid = $100 million
• Fair value of non-controlling interests = $12 million
• The fair value of equity previous interests = $0

Below is given data for calculation of goodwill of company ABC Ltd

First, we need to calculate Net identifiable assets of company ABC Ltd

Therefore, Net identifiable assets = Fair value of identifiable assets – Fair value of identifiable liabilities

= $200 million – $90 million

Net Identifiable Assets = $110 million

Therefore, the method to calculate goodwill will be as follows,

Goodwill Equation = Consideration paid + Fair value of non-controlling interests + Fair value of equity previous interests – Fair value of net assets recognized

Goodwill formula = $100 million + $12 million + $0 – $110 million

= $2 million

Therefore, the goodwill generated in the transaction is $2 million.

Goodwill Calculation – Example#2

Let us take another example of Company A, which plans to acquire Company B. The acquisition consideration is agreed at $90,000. The following information is available concerning the Company.

Given,

• Consideration paid = $90,000
• Fair value of non-controlling interests = $0
• The fair value of equity previous interests = $0

Below given table shows data for calculation of goodwill of Company A

Therefore, Net Identifiable Assets of Company A can be calculated as,

Net Identifiable Assets = Fair value of identifiable assets – Fair value of identifiable liabilities

= $300,000 – $220,000

Net Identifiable Assets = $80,000

Therefore, the calculation of Goodwill will be as follows,

Goodwill = Consideration paid + Fair value of non-controlling interests + Fair value of equity previous interests – Fair value of net assets recognized

Goodwill calculation = $90,000 + $0 + $0 – $80,000

= $10,000

Therefore, the goodwill generated in the transaction is $10,000

Goodwill Formula Calculator

You can use this Goodwill Formula Calculator

Relevance and Uses of Goodwill Formula

It is very important to understand the concept of goodwill because it is the metric that encapsulates the value of a company’s reputation built over a significant period. The different factors aiding the goodwill include (not exhaustive) the company’s brand name, extensive customer base, good customer relations, any proprietary patents or technology, and excellent employee relations.

This brand value ensures that future profits can be expected to be over and above normal profitsThe term "normal profit" is used when the profit is zero after accounting for both the implicit and explicit expenses, as well as the overall opportunity costs. It happens when all of the resources have been used to their full potential and cannot be put to better use.read more. Nevertheless, goodwill is an intangible asset that can neither be seen nor be felt, although it exists in reality and can be purchased and sold. In case of a distress saleDistressed sale refers to the immediate sale of stocks, real estate, or other assets for a price lower than its intrinsic value or at a financial loss because of an economic threat, medical emergency, debt payment, or any other reason.read more i.e., when a company is acquired for less than its tangible net worthTangible Net Worth is a company's total net worth minus the value of its intangible assets such as copyrights, company goodwill, and patents, among other things. Total Assets – Total Liabilities – Intangible Assets = Tangible Net Worthread more, the target company is said to have ‘negative goodwill.’ The appropriate pricing for goodwill is extremely difficult, but it does make a commercial enterprise more valuable.

Under IFRS and US GAAP standards, goodwill is considered as an intangible assetIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more with an indefinite life, and as such, there is no requirement to amortize the value. However, it should be evaluated every year for impairment loss. Most companies prefer to amortize goodwillGoodwill amortization refers to the process in which the cost of the goodwill of the company is expensed over a specific period of the time i.e., there is a reduction in the value of the goodwill of the company by the way of recording of the periodic amortization charge in the books of accounts.read more over 10 years.

Recommended Articles

This article has been a guide to Goodwill Formula. Here we discuss the Goodwill Calculation Method using practical examples and downloadable excel templates. You may learn more about Financial Analysis from the following articles –

• Net Asset FormulaThe net asset formula evaluates the company's total assets surplus or deficit over its total liabilities. It determines the company's net worth or value which is an indicator of its financial health.read more
• Intangible Assets ExamplesSome of the most common intangible assets are logos, self-developed software, customer data, franchise agreements, Newspaper Mastheads, license, royalty, Marketing Rights, Import Quotas, Servicing Rights etc.read more
• Goodwill ValuationGoodwill valuation is the systematic evaluation of the goodwill of the company to be shown in the balance of the company under the head intangible assets and top methods to value include Average Profits Method, Capitalization Method, weighted average profit method and the Super Profits Method.read more
• Negative GoodwillNegative goodwill is a negotiated purchase made by one company for acquiring the other company whose assets value more than the actual amount paid. Here, the selling company faces hardship and is ready to sell off its assets at a meager price.read more