A thread on Goodwill:
Today, I will talk about the basics of Goodwill. Grab a cone of Cornetto ice cream , sit back, and relax.
Today, I will talk about the basics of Goodwill. Grab a cone of Cornetto ice cream , sit back, and relax.
Imagine, you are a Chartered Accountant Aspirant.
You completed the entrance and inter exams. You worked a lot in your internship. Finally passed your final exam to become a CA.
You completed the entrance and inter exams. You worked a lot in your internship. Finally passed your final exam to become a CA.
Rather than joining some MNC firms, you decided to start your firm and grow it.
You rented out a small flat, bought books, computers, and other stuff, and set up your office. The firm name is *Abhinay Ltd*
You rented out a small flat, bought books, computers, and other stuff, and set up your office. The firm name is *Abhinay Ltd*
It is the first day of your office. You are pretty excited. But no client has approached. After all, it is only the beginning.
You used your network of friends, got some clients from them, and started providing services.
You used your network of friends, got some clients from them, and started providing services.
The existing clients have been satisfied with your services. They referred to others and this brought new clients.
Soon, the firm started to make decent profits and is growing.
Soon, the firm started to make decent profits and is growing.
You decided to expand it. You opened up a new office. You bought new computers, hired staff, completed client requirements on-time.
This continued for a long time, and you opened branches of your firm in various locations.
This continued for a long time, and you opened branches of your firm in various locations.
The name *Abhinay Ltd* has been widespread across the nation for its quality on-time services at a minimal cost.
Looking at the efficiency of your firm, a big audit firm named *Deloitte* thought of merging it with them. They contacted you regarding this.
Looking at the efficiency of your firm, a big audit firm named *Deloitte* thought of merging it with them. They contacted you regarding this.
You agreed to the deal. Now you have to find out the fair value of your business. You took out the balance sheet and it looked like this.
Here are the key points:
Assets:
•Out of 55,000 worth of receivables, you know 5,000 will be irrecoverable. So you reduced the same.
•Half of inventory has no resale value.
•Property has more resale value than shown in the books.
Assets:
•Out of 55,000 worth of receivables, you know 5,000 will be irrecoverable. So you reduced the same.
•Half of inventory has no resale value.
•Property has more resale value than shown in the books.
Liabilities:
•You know that you don't need to pay 5,000 worth of payables and reduced the same.
•You need to pay accrued expenses and long-term debt fully.
•The book value of the firm is 25,000 whereas the fair value as per the calculation is 32,500.
•You know that you don't need to pay 5,000 worth of payables and reduced the same.
•You need to pay accrued expenses and long-term debt fully.
•The book value of the firm is 25,000 whereas the fair value as per the calculation is 32,500.
Ok, since now you have calculated fair value, Deloitte has to pay that amount right?
Nope. Think about it for a moment.
You have developed a good customer base, good efficiency, good employee relations all these years. After all, you created a brand name *Abhinay Ltd*
Nope. Think about it for a moment.
You have developed a good customer base, good efficiency, good employee relations all these years. After all, you created a brand name *Abhinay Ltd*
All of these are not reflected in fair value.
So you demand an additional 17,500 from Deloitte for your firm's *Goodwill*
Deloitte has paid a total amount of 50,000 to you and the merger is successful.
So you demand an additional 17,500 from Deloitte for your firm's *Goodwill*
Deloitte has paid a total amount of 50,000 to you and the merger is successful.
So yes there you go,
Goodwill is an intangible (can't be touched or seen) asset that is associated with the purchase of one company by another.
It is the portion of the purchase price that is higher than the fair value of a business.
Goodwill is an intangible (can't be touched or seen) asset that is associated with the purchase of one company by another.
It is the portion of the purchase price that is higher than the fair value of a business.
The formula is simple.
G = P - F
Whereas
G = Goodwill
P = Purchase consideration
F = Fair value of a business (Fair value of assets - Fair value of liabilities)
G = P - F
Whereas
G = Goodwill
P = Purchase consideration
F = Fair value of a business (Fair value of assets - Fair value of liabilities)
Here is a real-life example of an acquisition done by Motherson Sumi systems Ltd during the year 19-20.
As you can see, it has paid INR 291 mn over fair value and recorded it as Goodwill in the books.
As you can see, it has paid INR 291 mn over fair value and recorded it as Goodwill in the books.
Goodwill has an indefinite useful life. It doesn't get amortized like other intangibles.
However, it is tested for impairment yearly. The acquirer ascertains future cash flows, competitive landscape, etc., and reduces goodwill if needed.
However, it is tested for impairment yearly. The acquirer ascertains future cash flows, competitive landscape, etc., and reduces goodwill if needed.
For instance, say after one year, Deloitte has computed the fair value of Abhinay Ltd and came up with an amount of 30,000 only.
Then it has paid excess of 2,500, it impairs goodwill by reducing the same in the books.
Then it has paid excess of 2,500, it impairs goodwill by reducing the same in the books.
Nothing can be complete without flaws. The biggest flaw of goodwill is its *calculation*
They may say employee relations, brands, synergy, etc., demand goodwill.
But as an investor, we never know the trueness of those elements in business.
They may say employee relations, brands, synergy, etc., demand goodwill.
But as an investor, we never know the trueness of those elements in business.
Also, a company may pay high amounts over fair value *irresponsibly* and show it as goodwill.
If it turns out to be true one day, the entire goodwill will be impaired and the assets decline all of a sudden.
If it turns out to be true one day, the entire goodwill will be impaired and the assets decline all of a sudden.
All in all, that's goodwill for you. Hope you enjoyed reading. Like and share the thread if u find it value-added. Have a great day.
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