I am quite confused by “Goodwill” in FSA. It may a very simple idea for you so please help. When a company is just started, its goodwill asset = 0 and over the years the goodwill increases to a substantial asset for the company. Normally when an asset increases, there should be either a decrease to an asset account or an increase to a liability account or an increase in the equity. In the case of Goodwill, I cannot think of an increase in any of the accounts in the liability or equity side of the equation. That leads me to believe that when the value of Goodwill which is an intangible asset increases, the value of some other asset decreases. Could somebody throw some ideas here? I may be missing something in this observation. Thanks a lot.
Kochunni, Jes, you are missing the point. Goodwill can’t be internally generated.
That’s true. But my question is more towards the impact of goodwill as an asset on the equation: Asset = liability + equity. Suppose you started a company with $1000; you did nothing that year. So revenue = 0 and expenses = 0. In the balance sheet asset = $1000, liability = 0 and equity = $1000. This fits in the above equation. Year2 You produced something for $1000 and sold it for $1200 and made a net profit of $200. (Ignore Tax and other non operating expenses). In the balance sheet, Asset = $1200 in cash, liability = $0 and Equity = $1200 (sum of original contribution of $1000 and the retained income from year2 of $200) Year3: This year you produced something else for $10000 and sold it for $12000 and made a net profit of $2000. Your company is well recognized in the market place; so your company has goodwill value; say $100. At the end of year 3: Asset = 3200 (ie: 1200 + 2000), liabilities = 0 and equity = 3200 In this basic equation, if I add the goodwill ($100), the equation will be imbalanced. I cannot add goodwill without impacting some other accounts. My question is which account will possibly be affected by adding goodwill?
Read Milos comment again - you can’t, absolutely can’t add goodwill to your balance sheet. Goodwill is a balancing variable that represents nothing real, tangible or otherwise.
Joey, Is Goodwill counted towards the total asset of the company? Thanks K
Read Investopedia: An account that can be found in the assets portion of a company’s balance sheet. Goodwill can often arise when one company is purchased by another company. In an acquisition, the amount paid for the company over book value usually accounts for the target firm’s intangible assets. Goodwill is seen as an intangible asset on the balance sheet because it is not a physical asset such as buildings and equipment. Goodwill typically reflects the value of intangible assets such as a strong brand name, good customer relations, good employee relations and any patents or proprietary technology. And it would be found when someone buys out your company. CP
But I can’t clarify this phrase “Goodwill can often arise …”. I don’t know of any other way but there are some accounting experts here who do.
I just think it says often because it might not be applicable for all companies?case of companies that are bought at value or under?just a thought
Think of it this way. Goodwill is an asset, say…just like land. At day zero you buy a piece of land for $100 and as in your example goodwill is zero. Five years later, even if the land is worth a million dollars you still record it at $100 on your books. The value of your company may have increased (ie the value of its equity), but you don’t recognize that in the books and records. The same is essentially true for goodwill. While the gain on the land can eventually be recognized either by selling it, or by selling the company and revaluing its assets to FMV, you can’t sell goodwill on its own, so it can only be recognized when the company is sold. Joey - investopedia may just be allowing for purchases where there is no excess qualifying as goodwill as florinpop suggested, and also looking at old cases where pooling was allowed.