Goodwill - what is it? Determining the value of goodwill

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

How often do we apply for certain services or services to various companies that our friends advised us? Why do we buy products that are most actively advertised? It's not just that manufacturers spend a lot of money to improve their own reputation, bother with its assessment, and resell it to other owners, deliberately overestimating its value? We will talk about goodwill and the features of its accounting in the article below.

Goodwill as an integral part of a successful business

Goodwill - what is it? Literally, "goodwill". But we are not talking about that now. What does an entrepreneur need to run their own business? What is needed for it to be in demand and make a profit? Undoubtedly, a positive assessment from third-party organizations. Nowadays, this aspect of business is increasingly influencing the minds and behavior of the population. Since, as statistics in recent years show, this is exactly what they are trying toexonerate our corporate entities.

Therefore, if any information discrediting the good name of a business entity has become public, then it has the full civil right to challenge the legitimacy of what happened in the manner prescribed by law. Business reputation, although it is a rather abstract concept, nevertheless, is a rather valuable intangible asset of an enterprise.

Goodwill definition

Entrepreneurs invest heavily in brand development and advertising. Business reputation, or, as it is also called, goodwill (not to be confused with the goodwill of the filter), is quite expensive for business entities, and therefore they value it at the appropriate level.

So, what is this concept? Consider the question in stages:

• A strong team of good advertisers and a well-developed brand promotion strategy should always be the basis;
• followed by top-level work to promote the company;
• as a result, the company must be distinguished by its good corporate culture and well-established relationships with counterparties.

In other words, goodwill is a general assessment of the business, which as a result - due to its reputation - allows you to increase your own working capital, because people want to consume this particular product and no other. Interestingly, many business entities tend to exaggeratetheir own importance, and it turns out quite fruitfully for them - the value of the company increases markedly.

Interpretations of goodwill in economic theory

With the passage of time and the dynamics of business change, the interpretation of this concept has changed depending on external circumstances. For example, have you heard from your parents, and even more so from your grandparents, who lived, say, under Stalin, about such a term as goodwill? Nobody in the Soviet Union knew what it was. This concept simply did not exist. In the theoretical aspect, the term "business reputation" was listed, but it had rather a certain psychological definition. It could be defined as the cumulative opinion of consumers about a particular company, but at the same time, there was not even talk of goodwill as a valuable intangible asset. This is understandable - in the planned economy regime of that time, there was simply no need to expand this concept.

The term "goodwill" came to us from the USA, and there even a hundred years ago it meant a certain established value of business contacts, which subsequently could lead to a profit increase by several points. In other words, in America this intangible asset has always had a value.

How it differs from other assets

What is goodwill according to accounting standards? This is a special intangible asset that has a number of specific features that distinguish it from others:

• under no circumstances can goodwill exist independently from a specifically linkedcompany;
• he is immaterial, which means that his absence as such may not be noticed;
• goodwill has no initial input or operating cost and is valued at a symbolic amount of a few dollars in some reporting templates;
• if the value of other intangible assets in terms of value is distributed according to the volume of output, then the amount of goodwill can be repaid at any time, and at the same time, as such, it will not disappear.

Goodwill as an economic category

Goodwill - what is it? This is a complex concept that can be classified according to several criteria. For example, in terms of how it can affect the financial statements of a business entity:

• positive - when we use it, we also get a good income;
• negative - accordingly, it not only does not bring profit, but also underestimates the estimated value of the enterprise as such.

Or in the form of existence, goodwill happens:

• created - developed over the years, through a competent marketing policy;
• accounting - purchased for a certain cost in cash and included in the financial statements.

It can also be classified according to the documentary method of reflection in these characteristics of the company:

• market - when not only the purchase price, but also the profit received is involved in the procedure for assessing its value;
• normative - when defining itvalue is also taken into account the auction value in the market.

Income valuation methods

Often, the estimation method of goodwill is to determine the profit that it can bring to the enterprise. So, there are two profitable methods for determining its value.

For example, goodwill can be valued as the residual value between the difference between the total expressed value of the company's assets and its full price. It is clear that there will be no problems with the first deductible - all you need to do is sum up all the indicators. As for the cost of the business itself, it should be approached comprehensively: either apply a comparative analysis, or be based on profitability indicators.

Or business reputation can be determined based on the existing excess profits. In this case, the main thing is to determine the planned profitability without using goodwill in business, and then calculate how much it can bring.

Other Goodwill Methodology

Business reputation can be assessed based on data on the operating activities of a business entity. So, for example, the cost of goodwill is calculated based on the volume of products sold:

(Net operating income received - industry profitability levelTotal cost of goods sold)/Intangible assets capitalization indicator.

You can also attract the cost to assess business reputation. This calculation of goodwill is somewhat similar to the method of calculating excess profit,however, now we are evaluating not the dynamics of changes in the latter, but how the application of the concept we are considering affects the total cost.

And the last, least frequently used - qualimetric. In this methodology, we evaluate the overall utility of the activity of a business entity and compare it with the value of direct goodwill.

Peculiarities of goodwill in different countries

So, as we have already found out, the term “goodwill” itself did not exist in Soviet Russia, but nevertheless, if we recall the tsarist times, the authority of this concept was still present, albeit behind the scenes. Imagine how local merchants would cope if they did not have a good business reputation among neighbors and residents of surrounding areas. And in our time, despite the active use of this concept in business, there are no legally regulated documents that determine the status of goodwill. But still, professional appraisers of business reputation are gaining wide popularity in Russia now, who will not only select the best way to calculate its value, but also carry out all the necessary calculations.

But in the USA, on the contrary, goodwill is not only actively taken into account in the development of one's own business, but is also regulated by law by the Ministry of Finance and the Internal Revenue Service.

Need to measure goodwill

Determining the value of goodwill often has good reasons, since this procedure is quite expensive and complicated. As a rule, it is carried out if the business is plannedsell or buy in the near future.

Undoubtedly, the value of the company's tangible assets is a very important factor of influence, but no less important is the reputation the manufacturer has earned over the years of its activity, how much consumers trust him, and how popular his product is. After all, as mentioned above, it is these factors that can significantly increase the value of a business.

Goodwill is also assessed in case of a merger or acquisition, since here it is also important to understand what things are going in hand. After all, if in an intangible aspect a deal is not profitable enough for one of the parties, then why conclude it?

How to prepare for a business reputation assessment

What is goodwill? This is primarily an intangible asset, and therefore it must be valued accordingly. So, for the procedure for determining the value of business reputation, the following documents are required:

• full financial statements for the last three years;
• if any, audit reports;
• complete inventory of assets held by the company;
• other decoded and explained information about the property of a business entity;
• information on receivables in the context of contracts;
• if there are subsidiaries, their full financial statements.

Every year the service sector is becoming wider and wider: we are offered legal and accounting advice, and hairdressers and beauty salonsso many that you can stumble upon them literally at every step! But this does not mean at all that each of these establishments brings unprecedented profits to its owner. First you need to earn a decent reputation, gain an impressive customer base. This is what the goodwill of the enterprise is all about.

Who especially needs goodwill

Since there are not so many tangible assets on the balance sheet of such business entities, and in order to set a decent price for a property in the form of a cafe or a nail salon, it is necessary to offer the buyer a brand of the proper level. It is business reputation in this case that will take almost half of the cost of the enterprise.

Accounting for goodwill in Russia

Given that many enterprises are successfully moving to International Financial Reporting Standards (IFRS), we will consider goodwill accounting in this aspect.

According to postulate No. 38, goodwill can only be reflected when buying or selling an enterprise, but not otherwise. Since it is incorrect to evaluate an asset, which, in fact, is practically not such, and it is very wrong to reward it with any nominal value based on subjective considerations.

Furthermore, in accordance with standard No. 22, after the sale and purchase transaction, the recorded value of goodwill must be allocated to some non-current assets. Since value as such is paid for, it follows that something needs it.back up with material. Often, the latter are fixed assets that have their own level of depreciation.

What to do if goodwill is negative

Goodwill - what is it? This is an intangible asset that is not customary to identify and acquire separately from a business entity.

Sometimes situations arise when funds are paid for a particular enterprise, which in fact is less than the estimated value of all business assets suggests. In this case, the conclusion follows that goodwill played a decisive role here, and the transaction was completed at a loss to the seller.

Therefore, if a positive business reputation as an intangible asset is further distributed according to the value of fixed assets available at the enterprise, then a negative one, in turn, will be reflected on the balance sheet of a business entity under account No. 192. And do something with it, alas, will not work until the conclusion of the next deal.