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Goodwill

Goodwill is an intangible asset which occurs when a business is being acquired. Goodwill is payment to acquire a business in excess of its net assets. ‘Net assets’ is the total assets minus total liabilities. There are various reasons for the payment of goodwill such as the company is an established one whose assets which comprised the business will generate greater profits in the future than a new entrant or it will earn higher profits than those earned by rivals in the same business. The company’s ideal location is also an important factor and the years of painstaking effort in developing a relationship of trust with the customers and suppliers.

For example:

D Dry is in the process of selling his business to W Wet. They consider all the assets and liabilities of the business and mutually agreed on the valuation of the assets less liabilities of $80,000.  Dry however wants $100,000 for the business. Wet agrees to the price as he can see the potential for the business. Goodwill is calculated as follow:

$
The value of the business 100,000
Less: Net assets 80,000

Goodwill 20,000

The purchaser of the business, Wet believes the goodwill has a useful life of five years. He calculates the amortization rate of the goodwill to be $4,000 per year using the straight-line method. At the end of each financial year, his journal entry will be:

Date Accounts Folio Debit Credit
$ $
20XX
Dec 31 Amortization expense 4,000
Goodwill 4,000
(Yearly amortization of goodwill)

Last Updated (Tuesday, 14 September 2010 15:49)