Goodwill, explained

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, paying 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.

Q

Are the dividends in my Roth IRA taxable?

— E.M., Wilkes-Barre, Pennsylvania

A

Nope. Whatever you invest in a Roth IRA grows free of taxes on capital gains and dividends. Your ultimate withdrawals will not be taxed, either, if you follow the rules.

Traditional IRAs work differently. The qualified contributions you make to them reduce your taxable income, giving you an upfront tax break. When you withdraw them and their dividends and gains in retirement, that becomes taxable income. Learn more at www.fool.com/ retirement.