Definition
Goodwill is the excess of the price paid in a business combination over the fair value of the identifiable net assets acquired. It represents future benefits that cannot be recognised separately, such as an assembled workforce, market position and expected synergies. Under IFRS 3 and IAS 36 goodwill is not amortized but tested for impairment at least annually.
How it works
Goodwill arises only from an acquisition. Reputation built internally is never recorded as an asset, however valuable, because its cost cannot be measured reliably. Under US GAAP public companies also test goodwill for impairment, while private companies may elect to amortize it over up to ten years.
In group accounts goodwill appears on consolidation when the parent's investment is eliminated against the subsidiary's equity. The multi-entity accounting guide explains how groups keep each company's books and combine them.
Formula
Goodwill = Consideration paid + Non-controlling interest - Fair value of identifiable net assets
Example: buying a competitor
A company pays 900,000 for 100% of a competitor. The fair value of the competitor's identifiable assets is 1,100,000, including a customer list valued at 150,000, and its liabilities are 400,000. Net assets are 700,000, so goodwill is 900,000 - 700,000 = 200,000.