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When can a business book goodwill?

Mark asks:

On the balance sheet of a Media Production Company, total assets are reported at $4,048,395 and consist primarily of goodwill of $3,312,324. When asked, the management team of the company stated “goodwill was established at the time when investor dollars were sought to enhance the company”. This company has one 60% ‘partner’ and 51 other partners. Can they just ‘book’ goodwill?

Linda answers:

It sounds similar to real estate development companies where there is the developer owner and the other 51 are the investors. So I can see why the 60% owner would need to show the value to entice the investor partners. But booking goodwill is not the way to do it.

More from the borrower

The borrower’s management team went on to say: “In essence, we created the company to show investor capital and business activities moving forward. The goodwill dollars are based on existing company contracts, sales, and net income figures from the prior years.”

Okay, that’s their story. Here are some variations on the GAAP (Generally Accepted Accounting Principles) definition. Without more information, it does not look right to me, but maybe I am missing a critical piece of information.

Three definitions of goodwill

Here is the Investopedia definition:

An intangible asset that arises as a result of the acquisition of one company by another for a premium value. The value of a company’s brand name, solid customer base, good customer relations, good employee relations and any patents or proprietary technology represent goodwill. Goodwill is considered an intangible asset because it is not a physical asset like buildings or equipment. The goodwill account can be found in the assets portion of a company’s balance sheet.

And one of my favorite resources, Wikipedia!

Goodwill in accounting is an intangible asset that arises when one company acquires another, but pays more than the fair market value of the net assets (total assets – total liabilities). The goodwill amounts to the excess of the “purchase consideration” (the money paid to purchase the asset or business) over the total value of the assets and liabilities.

And from InvestorWords.com

An intangible asset which provides a competitive advantage, such as a strong brand, reputation, or high employee morale. In an acquisition, goodwill appears on the balance sheet of the acquirer in the amount by which the purchase price exceeds the net tangible assets of the acquired company.

This company must have acquired another company

Notice all three reference the acquisition of the company. So if there is substantial goodwill on the media production company’s balance sheet, that should indicate an acquisition of another company. One does not simply get to ‘book’ goodwill to try to indicate value in the absence of an arms-length transaction. Otherwise, we all could simply add goodwill to the books.

Heck, I have a good reputation with you, Mark, and that is worth something! I think I’ll book another $10,000 goodwill. See the problem?

Who established the goodwill?

So, Mark, I do not understand the comment that goodwill was established. By whom? I do not disagree that they enticed the investors with the ‘value’ of the business opportunity when encouraging them to invest. But that would be a ‘market value’ balance sheet, not a GAAP Balance Sheet.

As you get more info on this, Mark, I would love to hear more about this explanation. Did this media production company acquire another company? Maybe. If so, that is where the goodwill is coming from.

Tell me what you learn

Remember, Mark, your payment for this great advice is to keep me in the loop should you find out something that clears it up. I am curious!

Featured Online Module

Goodwill is a Balance Sheet item. For more on the other aspects of the Balance Sheet that help you understand the resources the company has and how they are leveraged, take our self-study online module:

Balance Sheet Basics

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Linda Keith, CPA

Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis.
She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans.
Creator of the Tax Return Analysis Virtual Classroom at www.LendersOnlineTraining.com, she speaks at banking associations on risk management, lending and director finance topics.