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Line 1: − Goodwill can have a number of meanings but this brief article contemplates it's meaning as a financial asset. − Goodwill that appears on a balance sheet is always 'purchased' Goodwill. That is, it is not generated by some mechanism internal to the company and then created as an asset. − − Goodwill normally arises from the purchase of a business where the price paid exceeds the fair value of the net assets acquired. Consider the purchase of an extremely profitable business that had a very low asset base. If the buyer paid, say, $2 million for a company whose net assets where only worth $1.3 million, the $700 thousand difference would be treated as goodwill. − − On a strictly theoretical basis, Goodwill is the present value of the superior earnings stream of a business, capitalized in perpetuity. Put another way, you would only pay $2 million for a business with assets of $1.3 million if you thought you would make a lot more money than that sort of investment would normally generate. − − Management must review the asset value of Goodwill every year to determine if it is still a legitimate asset. If it is not, the asset must either be reduced or written off completely. Reverting to the previous example, suppose the business purchased had a competitor that opened a location just across the street, and that ongoing profits would be reduced. Management would be required to reduce, if not write off completely, the value of Goodwill.
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