How to Record a Goodwill Journal Entry
Understand how to accurately record and account for goodwill, a unique intangible asset from business acquisitions, throughout its lifecycle on financial statements.
Goodwill is an intangible asset recorded when one company acquires another. It arises when the purchase price paid for the acquired entity exceeds the fair value of its identifiable net assets. This article explains how to accurately record goodwill in financial records.
When Goodwill Arises
Goodwill arises from a business combination when one company purchases or merges with another. It is recognized when the acquiring company pays a price for the target company that exceeds the fair value of its identifiable assets minus its liabilities. This excess payment is attributed to factors that provide future economic benefits but cannot be individually identified as separate assets.
Identifiable net assets are the sum of all recognized assets, both tangible and intangible, reduced by all recognized liabilities of the acquired entity. Tangible assets include cash, accounts receivable, inventory, and property, plant, and equipment. Identifiable intangible assets might include patents, trademarks, customer lists, or proprietary technology. Goodwill, by contrast, is an unidentifiable intangible asset.
Goodwill reflects elements like the acquired company’s strong brand reputation, customer loyalty, skilled workforce, or unique business processes. These contribute to its overall value but are not separate, measurable assets. Accounting standards mandate that goodwill is only recognized upon the acquisition of a business, not when internally generated.
Calculating Goodwill for Recording
Calculating goodwill is a necessary step before making a journal entry. The first step is determining the total purchase price paid for the acquired entity. This price can include cash, equity shares issued, or liabilities assumed by the acquirer.
Next, all identifiable assets acquired (tangible and intangible) and all liabilities assumed must be identified and valued at their fair values on the acquisition date. Fair value refers to the price received to sell an asset or paid to transfer a liability in an orderly market transaction.
The fair value of net identifiable assets is calculated by subtracting total liabilities from total identifiable assets. For example, if identifiable assets are valued at $900,000 and liabilities at $150,000, net identifiable assets are $750,000. Goodwill is then determined by subtracting the fair value of net identifiable assets from the total purchase price. If the purchase price was $1,000,000 and net identifiable assets were $750,000, goodwill would be $250,000.
The Initial Goodwill Journal Entry
Once the goodwill amount is calculated, the initial journal entry records the acquisition and associated goodwill. This entry reflects the acquisition of individual assets and the assumption of liabilities at their determined fair values. All assets acquired are debited, increasing their balances on the company’s books.
Individual asset accounts, such as Cash, Accounts Receivable, Inventory, Property Plant and Equipment, and identifiable intangible assets like Patents, will each receive a debit for their fair values. The goodwill amount, calculated as the residual from the acquisition, is also debited as an asset. For instance, if the calculated goodwill is $250,000, the Goodwill account will be debited for that amount.
Conversely, all liabilities assumed by the acquiring company are credited, increasing their balances. These might include accounts like Accounts Payable or Notes Payable. Finally, the cash paid or other consideration given for the acquisition is credited. Applying the double-entry accounting principle, the sum of all debits, including the debited goodwill, must exactly equal the sum of all credits, ensuring the accounting equation remains balanced.
Subsequent Accounting for Goodwill
After the initial recording, the accounting treatment for goodwill differs significantly from other assets. Unlike most tangible or even some intangible assets, goodwill is not systematically amortized over a useful life. This means its value does not decline gradually through regular expense recognition over time.
Instead, companies are required to test goodwill for impairment at least annually. An impairment occurs when the carrying value of goodwill on the balance sheet exceeds its implied fair value. This assessment ensures that the recorded goodwill does not overstate the company’s actual economic value.
Should an impairment be identified, a loss must be recognized. This loss is recorded with a debit to an Impairment Loss account and a corresponding credit to the Goodwill account. This adjustment reduces the carrying amount of goodwill on the balance sheet to its recoverable amount, reflecting the diminished value of the acquired attributes it represents.