Goodwill is an accounting concept that refers to the value of a business that is not directly attributable to its physical assets or tangible intangible assets. For example, the value of a company’s reputation, customer base, or relationships with suppliers may be considered goodwill. Goodwill also often reflects the company’s ability to generate profits and cash flow in excess of the normal returns expected for its industry. When a company acquires another business, the purchase price typically includes a premium over the fair market value of the target’s net assets to reflect this goodwill. The accounting for goodwill can be complex and sometimes controversial.
One accounting method for allocating goodwill to specific acquired assets and liabilities is the “cost allocation” method. In this approach, all costs associated with the acquisition are capitalized and then allocated to the specific assets and liabilities acquired based on their relative fair market values. This method is often criticized because it can result in large goodwill amounts being assigned to intangible assets with little or no actual value, such as customer relationships or a brand name.
Accounting principles generally require that goodwill be amortized (written off) over time. The rate at which this amortization occurs may be accelerated if the asset is determined to be impairment (i.e., its value has declined). Goodwill impairments are typically recorded as one-time charges against earnings in the period they are identified.