Get to Know the Benefits and How to Calculate Goodwill!

The Definition of Goodwill

According to Investopedia, goodwill is an intangible asset that is associated with the purchase of one company by another. Specifically, it is the portion of the purchase price that is higher than the sum of the net fair value of all assets purchased in the acquisition and the liabilities assumed in the process. The value of a company’s brand name, solid customer base, good customer relations, good employee relations, and proprietary technology represents some reasons why it exists.

So, how important is the role of goodwill for company accounting? In fact, It will make it easier for companies to calculate whether the its value gives profits in the future or not. Furthermore, the company can also see revenue that the owner’s company has received with it. 

Also read: 4 Key Benefits of Using an Accounting App

The Benefits of Goodwill

The company will obtain various benefits through their goodwill. What are its benefits? Here are some benefits that the company will get from goodwill:

• • 1. Earn income on goods or services sales
    2. Earn income on rentals that other companies do
    3. Improve the service quality more faster than other companies
    4. Save the company’s expenses in operational activities
    5. Reduce the number of employees in carrying out the company’s work
    6. Give license of other companies that your company has purchased

Types of Goodwill

Goodwill has two types, namely, purchased and inherent. The purchased type is the difference between the company’s value as operational cost and assets amount that the liabilities amount has reduced. Each item has been identified and assessed separately. Meanwhile, the inherent type is the business value that has exceeded the fair value of a net asset that can be separated.

Also read: Fixed Assets & Depreciation | Accounting Principles

Factors That Affect Goodwill

Additionally, various factors can affect goodwill. Here are some factors that will affect it following with the explanation:

• • 1. Product quality: Good product quality will increase sales and profits and increase the value of goodwill. Currently, you can check the quality of the products in the warehouse instantly through the inventory management system.
    2. Management efficiency: The goodwill value will increase along with the company’s management efficiency. In addition, increased company’s management efficiency will make the operational activities run well.
    3. Location: Strategic company location will make it easier for customers to get products or services that the company sells. As a result, this will also increase the goodwill value.
    4. Market conditions: Monopoly market situations facilitate earning more profits. Indeed, this also will leads to increased it value.
    5. Access to raw materials: If the company has easy access to purchasing raw materials, it will certainly guarantee its goods supply.
    6. Special advantages: If the company gets special advantages such as trademarks and brand image, then the company will also get a higher goodwill value.
    7. External resources: In this case the examples are after-sales service, the effectiveness of advertising, electricity supply, and trademarks will certainly get more goodwill value.

Formulas and How to Calculate Goodwill

Finally, after knowing the definition and benefits, of course, you must know the formula and how to calculate goodwill. What is the formula like? And how to calculate it? Check out this explanation:

Formula:

Goodwill = P-(A-L), 

where: P = Purchase price of the target company, A = Fair market value of assets, L = Fair market value of liabilities.

In calculating goodwill, you must take the purchase price of a company and reduce the fair market value of identifiable assets and liabilities.

Also read: What is PPIC (Production Planning & Inventory Control)?

Study Case

Great Machine Pte Ltd. acquired Shine Machine Pte Ltd. for 50,000,000,000, which is based on annual net income from Shine Machine Pte Ltd. The fair value of identified assets of Shine Machine Pte Ltd. is 40,000,000,000. Meanwhile, the obligation is 10,000,000,000. Therefore, Great Machine Pte Ltd. must pay 50,000,000,000 for identified assets and liabilities of 30,000,000,000 (40,000,000,000-10,000,000,000).

To sum up, the calculations flow that Great Machine Pte Ltd. record is:

• • • Debit of various asset accounts amounting to 40,000,000,000
    • Credit of various liability accounts amounting to 10,000,000,000
    • Cash credit of 50,000,000,000
    • Debit of 20,000,000,000 (50,000,000,000 – 30,000,000,000)

Conclusion

In short, Goodwill is an intangible asset that is associated with the purchase of one company by another. The company will obtain various benefits from it, ranging from earning revenue on goods or services sales to saving the company’s expenses in operational activities. In calculating these, you must take the purchase price of a company and reduce the fair market value of identifiable assets and liabilities.

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