Acquisition can lead to ‘goodwill’ on balance sheet

Motley Fool

Q: What’s “goodwill” on a balance sheet? — L.B., Abilene, Texas

A: Goodwill is an intangible asset listed on a company’s balance sheet if it has acquired another company at a premium over the intrinsic value.

On the books, a company might be worth, say, $50 billion, but it might have other assets not represented on its financial statements, such as valuable brands, proprietary technology and/or patents. If those total $10 billion, the acquiring company might pay $60 billion, adding $10 billion of goodwill onto its own books. Some companies pay a premium price when acquiring others simply because there’s a bidding war or other possible acquirers.

Imagine that Carrier Pigeon Communications (ticker: SQUAWK), valued at $100 million, acquires Smoke Signal Communications (ticker: PUFFS), with a book value of $20 million, paying $25 million in cash. Carrier Pigeon’s value won’t change. It will still be worth $100 million, but it won’t have that $25 million in cash on its balance sheet anymore. That sum would be replaced by the $20 million value of Smoke Signal along with $5 million of “goodwill.”

Just as capital assets such as factory equipment depreciate over time, with their value decreased eventually to zero, goodwill is also incrementally reduced to zero.

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