By Odhiambo Ocholla
Determining a reasonable goodwill figure for a company’s balance sheet is no easy task.
There is no universal rule on how to figure out goodwill, which adds value to the company. Goodwill is essentially the amount of the asking price for a company over and above its tangible net worth.
Goodwill is an intangible asset on the balance sheet that is used to value a strong brand name, good customer relations, good employee relations, patents, and proprietary technology.
Goodwill arrives on the balance sheet when a firm acquires another for more than the book value of assets acquired.
When a company pays more than the book value for a company, the difference between the price paid and the book value of the assets is classified as goodwill.
Financial Accounting Standards Board defines how to treat goodwill.
The rules require that companies are to assess goodwill for impairment at least annually.
If goodwill is deemed to be impaired, its carrying amount is reduced and an impairment loss is recognised on the income statement.
This means that the amount spent for an acquisition is no longer worth what was paid.
The goodwill is tested at least annually to determine if the recorded value of the goodwill is greater than the fair value.
If the fair value is less than the carrying value, the goodwill is said to be "impaired" and must be charged off.
This reduces the value of the goodwill on the balance sheet to the fair market value.
This is a just like a mark-to-market charge for financial assets only it is for goodwill.