Goodwill?

ɡʊdˈwɪl/ – goodwill

“Old English: godes willan “virtuous, pious, upright,” also “state of wishing well to another.”

What is goodwill?

Goodwill is an elusive concept. According to the Hon. Justice G T Pagone, goodwill is as difficult to hunt for (and value) as Lewis Carroll’s mythical Snarks1.

The definition is certainly slippery and interpretations differ between accountants and lawyers.

According to the accountants:

“Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised.”,  International Financial Reporting Standards2:

According to the lawyers (and the ATO):

“Goodwill is inseparable from the conduct of a business. It may derive from identifiable assets of a business, but it is an indivisible item of property, and it is an asset that is legally distinct from the sources – including other assets of the business – that have created the goodwill.”, High Court of Australia in FCT v Murry3

Simply put: goodwill can’t be divided and separated.  Goodwill  is attached to the business. Goodwill is distinctive from the sources that created the goodwill.

Valuing goodwill

Goodwill is commonly referred to and calculated as the value of the business (or price in a transaction) over and above the value of the tangible assets of the company.  Where the tangible assets are items that have a value on the balance sheet, such as work in progress and stock.

Watch out! This inferred residual value, the “rump” end of the valuation, might not just be goodwill.  This residual value is the value of all intangible assets.  Goodwill is just one example of an intangible asset.

To muddy matters, there exist identifiable and unidentifiable intangible assets. Those intangible assets that can be individually identified and separately recognised aren’t included in goodwill. Identifiable intangible assets include intellectual property such as copyrights, patents, trademarks and brand names.

Goodwill is the residual balance after all identifiable intangible assets have been deducted.  Valuing goodwill therefore first requires that the identifiable intangible assets be valued.

Sources of Goodwill

Often from an accounting perspective, goodwill is classified into three key areas4:

  • Personal goodwill. The skills, abilities, reputation, character and personality possessed by the business owners and key people working in the business.  If the owners and the key people no longer operate in the business then the value of the goodwill in the business must diminish.  Which is why in a transaction owners and key individuals are encouraged (and employment contracts signed) to stay on in the business.
  • Site goodwill. The goodwill attached to the location. Site goodwill may exist if the premises are in a favourable location and or because customers have been going to that same location over several years. The site goodwill cannot be transferred to another property. Site goodwill is commonly attached to the property value – avoid double counting!
  • Name goodwill. This relates to the name or reputation attached to a business.  The name which attracts customers.

Lonergan considers the following business qualities and characteristics as goodwill: the quality of the management team, know how, marketing & management expertise, distribution network, economies of scale, technical skills, location qualities, carry-over of any advertising affect, and synergies related to the combination of the purchased business and the existing business and consumer loyalty.5

If goodwill can be separated into components then by definition it can’t be goodwill! The above must then be sources, not components, of goodwill.

Goodwill is a slippery fellow and clear as mud.

For other valuation articles click here:

Is value the same as price?   Fair value v market value    Valuation experience

1. G.T.Pagone (2011) Goodwill and its relationship to land

2. International Financial Reporting Standards (IFRS) 3 – business combinations

3. Commissioner of Taxation v Murry [1998] HCA 42

4. FCT v Krakos Investments Pty Ltd (1995) 61 FCR 498; 32 ATR 7

5. Lonergan, W (1995) Goodwill and bad ideas

Further reading

Bloom, M (2008) Double accounting for goodwill: A problem redefined, Routledge, United Kingdom

Tregoning, I (2010) The meaning and nature of goodwill in the tax context

 

Simon Cook, Valuations, Forensic Accounting, Virtual CFO. CA Accredited Business Valuation expert, Chartered Accountant and Certified Fraud ExaminerSimon is a CA Accredited Business Valuation expert, Chartered Accountant and a Certified Fraud Examiner. Simon specialises in providing forensic accounting and valuation services. Prior to founding Lotus Amity, he was a Forensic Accounting partner with BDO Australia and led their National Forensics practice. He has worked as a forensic director for a major offshore forensic accounting practice which included assisting in multi-billion-dollar litigation in relation to giant Bernie Madoff Ponzi scheme. Simon provides valuation services in disputes, for raising finance, for restructuring, transactions and for tax purposes.

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