Goodwill Accounting: What It Is and How to Calculate It (2025)

Goodwill accounting is the process of valuing and recording intangibles such as company reputation, customer base, and brand identity. Learn how it’s calculated and how to record its value properly.

Goodwill accounting involves the process of calculating and accounting for the value of an intangible asset that is part of a company’s value. Because many existing businesses are purchased at least partly because of the value of intangible assets such as customer base, brand recognition, or copyrights and patents, the purchase price frequently exceeds book value.

Roughly speaking, the difference between the purchase price of a business and its book value is considered goodwill.

Calculating goodwill, while not difficult, can be confusing and is usually completed by an experienced accounting professional rather than a bookkeeper or accounting clerk.

Overview: What is goodwill accounting?

Before we can talk about goodwill accounting, we’ll need to explain exactly what goodwill is and why it’s so important.

Goodwill is considered an intangible asset -- something that you cannot touch. A variety of asset types can be considered goodwill, including the following intangible assets:

  • Business brand
  • Business reputation
  • Licensing and permits
  • Copyrights
  • Patents
  • Domain names
  • Talent

Goodwill accounting is most frequently used in the business valuation process when acquiring another business. Goodwill is an intangible asset, meaning that it has no physical presence, but it adds value to the company.

Goodwill is not always part of acquiring a business but needs to be recorded in your company’s general ledger any time that the cost of purchasing a business exceeds the fair value of its assets and liabilities.

Goodwill Accounting: What It Is and How to Calculate It (1)

Goodwill is an intangible asset that usually occurs when a company buys another company. Image source: Author

Goodwill accounting involves a series of simple calculations to determine exactly how much goodwill will need to be recorded. Entering this information into your accounting software promptly after purchasing another business will help to ensure that your financial statements are accurate while reflecting the correct amount of goodwill.

Types of goodwill

The type of goodwill used in a business transaction can vary depending on the type of business purchased and what factors have been taken into consideration. In most cases, one of the following two types of goodwill will be used.

Business goodwill

Business goodwill considers the entire business and looks at factors such as customer base, marketplace standing, and brand considerations.

Professional practice goodwill

When a professional practice such as an accounting firm, law firm, or medical practice is purchased, things such as the current firm/practitioner’s reputation, clientele, location, and brand are all taken into consideration.

How to calculate goodwill

Calculating goodwill for a company that you have recently purchased is easy if you follow the goodwill formula.

(Consideration Paid + Fair Value) – (Assets Acquired – Liabilities Assumed) = Goodwill

To calculate goodwill, just follow the steps below.

1. Calculate the book value of assets

The book value of assets is the assets that are currently recorded on the balance sheet of the business that has recently been purchased. Total assets would include the following:

  • Cash
  • Accounts receivable
  • Inventory
  • Property, plant, & equipment (PP&E)

Once you determine the book value of the assets, you can move on to the next step.

2. Determine the fair market value of the assets

Fair market value can be a bit tricky to calculate and is not an Accounting 101 task, so be sure to have a CPA involved in the process, even if it’s just to look over your calculations. While the results will only be an estimate, fair market value should be arrived at by examining similar assets and their value on the open market.

3. Find the difference and adjust totals

The next step is calculating the difference between the book value of assets and the fair market value. For example, if a company’s assets were valued at $600,000 on the books but had a fair value of $700,000, you’ll need to subtract the book value from the fair market value, leaving you with a net value adjustment of $100,000.

4. Determine the excess purchase price

Before you can complete the goodwill calculation, you will first need to determine the excess purchase price. The excess purchase price is the amount paid minus the net book value of the company’s assets. This is a two-step calculation, with the first step to subtract liabilities from assets.

For example, if the company’s assets were $450,000 and liabilities were $175,000, the total net book value would be $275,000. The second step of the calculation is to subtract the $275,000 from the actual purchase price to arrive at the excess purchase price.

5. Complete goodwill calculation

With all of your calculations completed, you can now calculate goodwill. This is done by subtracting the fair market value adjustment in Step 3 from the excess purchase price. For example, if your excess purchase price is $400,000 and your fair value adjustment is $100,000, your goodwill amount would be $300,000.

Example of goodwill in accounting

Farm Fresh Restaurant is a household name in the southwestern part of the U.S, but with its recent purchase of Leticia’s, a small chain of restaurants found throughout the U.S., the company’s name recognition is going to get a lot better.

On Sept. 30, 2020, Farm Fresh purchased Leticia’s for $3 million. The book value of Leticia’s was $1.25 million, with a fair market value of $1.5 million, for a difference of $250,000. Leticia’s also had $500,000 in liabilities. To determine the excess purchase price, you would first need to subtract net liabilities from net assets. This gives you your net identifiable asset total.

$1,250,000 – $500,000 = $750,000

You would then subtract your net identifiable assets from your purchase price to determine the excess purchase price.

$3,000,000 – $750,000 = $2,250,000

Your final step would be to subtract the fair market adjustment, which is $250,000, from the excess purchase price.

$2,250,000 – $250,000 = $2,000,000

This result means that the goodwill valuation of Leticia’s totals $2 million. The transaction would be recorded on Farm Fresh’s books as follows:

Remember to record goodwill as a non-current asset since it is considered a long-term investment. Though not required by generally accepted accounting principles, or GAAP, rules, goodwill can be amortized for up to 10 years.

Why is goodwill important to small businesses?

As your business reaches more people, the value of your business increases as well. It’s difficult to put a price on the value of brand recognition or intellectual property, but both of those things are reflected in goodwill.

If this year has taught us nothing else, it’s certainly taught us that while we can plan for the future, we never really know what it holds. So, although your business may be small today, next year you could be buying up the competition.

Understanding what goodwill is and how it can impact your business is just one more part of being a business owner. And if you do start buying up the competition, you’ll know exactly what to look for.

Goodwill Accounting: What It Is and How to Calculate It (2025)

FAQs

Goodwill Accounting: What It Is and How to Calculate It? ›

It's calculated by taking the purchase price of a company and subtracting the difference between the fair market value of the assets and liabilities. Companies are required to review the value of goodwill on their financial statements at least once a year and record any impairments

impairments
In accounting, impairment is a permanent reduction in the value of a company asset. It may be a fixed asset or an intangible asset. When testing an asset for impairment, the total profit, cash flow, or other benefits that can be generated by the asset is periodically compared with its current book value.
https://www.investopedia.com › terms › impairment
.

What is goodwill and how is it calculated? ›

The excess of the amount of capital over the total capital employed by the business can be considered goodwill. Capitalized Value of Average/Super Profits = Average/Super Profits X (100 / Normal Rate of Return) Goodwill = Capitalized Value of Average/Super Profits – Capital Employed.

How to calculate the value of goodwill? ›

Simple Average – In this process, goodwill evaluation is done by calculating the average profit by the number of years it is called years purchase. It can be calculated by using the formula. Goodwill = Average Profit x No. of years' of purchase.

What is the accounting of goodwill? ›

In accounting, goodwill is the value of the business that exceeds its assets minus the liabilities. It represents the non-physical assets, such as the value created by a solid customer base, brand recognition or excellence of management.

What is the formula for goodwill to assets? ›

The goodwill to assets ratio is calculated by dividing goodwill, which is usually found in the no-current assets section of a company's balance sheet, by total assets.

Why is goodwill hard to calculate? ›

Although goodwill is the premium paid over the fair value of an entity during a transaction, goodwill's value cannot be sold or bought as an intangible asset in of itself. Goodwill can be challenging to determine its price because it is composed of subjective values.

What are the three methods of calculating goodwill? ›

There are several methods which can be implemented for valuation of goodwill which is as follows:
  • Average Profit Method. Goodwill's value in this method is considered by multiplying the Average Future profit by a certain number of year's purchase. ...
  • Super Profit Method: ...
  • Capitalization Method: ...
  • Annuity Method:

What is the accounting standard for goodwill? ›

Under IFRS 3, Business Combinations, goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised. Goodwill is not amortised but must be tested annually for impairment.

How to write off goodwill in balance sheet? ›

The goodwill account is debited with the proportionate amount and credited only to the retired/deceased partner's capital account. Thereafter, in the gaining ratio, the remaining partner's capital accounts are debited and the goodwill account is credited to write it off.

What is the double entry for goodwill? ›

The double entry for this is therefore to debit the full market value to the goodwill calculation, credit the share capital figure in the consolidated statement of financial position with the nominal amount and to take the excess to share premium/other components of equity, also in the consolidated statement of ...

What is goodwill in accounting for dummies? ›

Goodwill is an intangible asset that accounts for the excess purchase price of another company. Goodwill includes proprietary or intellectual property, brand recognition, and other aspects of a company that are valuable but not easily quantifiable.

What is an example of goodwill? ›

The value of a company's brand name, solid customer base, good customer relations, good employee relations, and any patents or proprietary technology represent some examples of goodwill.

What are the three types of goodwill? ›

There are two distinct types of goodwill, namely the purchased goodwill and inherent goodwill. There are three methods used for the valuation of goodwill: Super Profits, Average Profits, and Capitalization Method.

How do I calculate goodwill? ›

One of the simplest methods of calculating goodwill is by subtracting the fair market value of a company's net identifiable assets from the price paid for the acquired business.

What is goodwill in simple words? ›

Goodwill is an intangible asset (an asset that's non-physical but offers long-term value) which arises when another company acquires a new business. Goodwill refers to the purchase cost, minus the fair market value of the tangible assets, the liabilities, and the intangible assets that you're able to identify.

What is the entry of goodwill? ›

As per the AS 10, we shall record Goodwill in the books only when some consideration in money or money's worth has been paid for it. It also says that in case of admission of partner, retirement or death of a partner, goodwill should not be raised in the books of the firm.

What is the formula for full goodwill? ›

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.

How does goodwill come on a balance sheet? ›

Goodwill only shows up on a balance sheet when two companies complete a merger or acquisition. When a company buys another firm, anything it pays above and beyond the net value of the target's identifiable assets becomes goodwill on the balance sheet.

How do I write off goodwill? ›

The goodwill account is debited with the proportionate amount and credited only to the retired/deceased partner's capital account. Thereafter, in the gaining ratio, the remaining partner's capital accounts are debited and the goodwill account is credited to write it off.

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