What is goodwill in accounting? Meaning, value and examples

Published Friday 7 November 2025

Table of contents

• Why goodwill is important in accounting
• Goodwill versus other assets
• Types of goodwill
• How to calculate goodwill in accounting for small businesses
• Methods for calculating goodwill valuations
• How to record goodwill in your books
• Aspects of goodwill to keep in mind
• Conducting goodwill impairment tests
• How to calculate goodwill for acquisition
• Managing goodwill with the right tools
• FAQs on goodwill in accounting

Key takeaways

• Record goodwill only when acquiring another business, calculating it as the premium paid above the fair value of net assets, and list it as an intangible asset on your balance sheet.

• Conduct annual impairment tests using income or market approaches to determine if goodwill has lost value and needs to be written down on your financial statements.

• Apply the goodwill formula (Consideration paid + Fair value of non-controlling interests + Fair value of equity interests – Fair value of net assets recognized) to accurately calculate goodwill during business acquisitions.

• Recognize that goodwill represents intangible value like customer loyalty and brand reputation that cannot be sold separately from your business, making it crucial for understanding your company's true worth during valuations or sales.

Why goodwill is important in accounting

Goodwill can be positive or negative on an income statement. Positive goodwill means your business is valued higher than its assets and liabilities. Negative goodwill means your business is valued lower than its assets and liabilities.

If you plan to sell your business, understanding your goodwill helps you know how it affects your business’s value.

High goodwill usually means your business has a competitive advantage. This can increase value to investors and influence strategic business decisions. Monitoring goodwill helps you spot changes in your business’s performance.

Goodwill is also important for your financial records. Both Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) require you to show goodwill annually on your financial statements. Goodwill appears on your business’ balance sheet as an intangible asset.

Goodwill vs other assets

Goodwill versus other assets: Goodwill includes extra business value that you cannot tie to specific assets.

What goodwill excludes:

• tangible assets such as equipment and buildings that you can sell separately
• other intangible assets such as patents, copyrights, and trademarks with specific legal protections

Key differences between goodwill and other intangible assets:

• you cannot sell goodwill separately, but you can sell patents and trademarks
• goodwill can last indefinitely, but patents expire after set periods
• you cannot develop goodwill internally for accounting purposes, but you can develop other intangible assets
• goodwill is harder to identify and value precisely

Example: Patents have a set legal lifespan, you can sell them separately from your business, and they often have a more precise value.

Types of goodwill

There are two main types of goodwill in accounting: inherent goodwill and purchased goodwill.

Inherent goodwill (also called internally generated goodwill) is value you build within your business over time. It comes from outstanding customer service, strong brand recognition, and competitive advantage you develop.

Key characteristics:

• develops naturally as your business grows
• becomes quantifiable only when someone wants to buy your business
• cannot be recorded on your balance sheet under most accounting standards
• still represents real business value and competitive advantage

Purchased goodwill is the extra amount you pay when buying another business above its net asset value. This happens when you pay more than the fair market value because of the target business’ reputation, customer base, and market position.

Key characteristics:

• originates from external business transactions
• must be recorded as an intangible asset on the buyer’s balance sheet
• is not reduced in value over time (no amortization)
• is tested annually for impairment to ensure it maintains its value

How to calculate goodwill in accounting for small businesses

You can calculate goodwill using a straightforward formula, but working out each component’s value can be complex.

The goodwill formula:Goodwill = Consideration paid + Fair value of non-controlling interests + Fair value of equity interests – Fair value of net assets recognized

Formula breakdown:

• Consideration paid: the total amount you pay to buy the target business
• Fair value of non-controlling interests: Value of any portion of the business you don't own, calculated at fair market value on the purchase date
• Fair value of equity interests: Value of any stake you already owned in the business before the full purchase, calculated at fair market value on the acquisition date
• Net assets recognized: Fair value of all tangible and identifiable intangible assets minus the business's liabilities

Example: You decide to buy a bakery:

• you pay $1.2 million to own 90% of the bakery
• you previously owned 5% of the bakery, valued at $50,000
• you do not own the remaining 5%, valued at $60,000
• on the date you purchase the bakery, the fair value of all tangible and identifiable intangible assets is $550,000

Using the formula, goodwill is $760,000:

Goodwill = $1.2 million (what you paid) + $60,000 (the value of the 5% you do not own) + $50,000 (the value of the 5% you already owned) – $550,000 (the value of net assets recognized)

Methods for calculating goodwill valuations

Three methods for calculating goodwill valuations help you estimate intangible asset value based on your business’ financial history and future outlook.

Average profits method

• Best for: businesses with stable, predictable cash flows
• How it works: calculate average past profits and multiply by the number of years needed to recover the goodwill investment
• Formula: Goodwill = Average profit × Years of acquisition
• Why use it: simple and straightforward for small businesses

Capitalization method

• Best for: Businesses where profit-generating ability and tangible assets are the main focus
• How it works: Divide average net profit by the capitalization rate, then subtract tangible assets
• Formula: Goodwill = Capitalized average net profit – Tangible net assets
• Why use it: Emphasizes the business's ability to generate returns

Weighted average profit method

• Best for: Businesses with fluctuating profits where recent years are more predictive
• How it works: Give different weights to different years' profits based on their relevance to future performance
• Formula: Goodwill = Weighted average × Years of acquisition
• Why use it: Accounts for profit variations and trends over time

How to record goodwill in your books

When you acquire a business, only the purchased goodwill is recorded in your financial statements. It is listed as an intangible asset on your balance sheet.

Unlike other assets, goodwill is not amortized or depreciated over time. Instead, you will need to assess it for impairment each year to make sure its value has not dropped significantly.

For example, if you buy a company for $500,000 in cash, and the fair value of its identifiable net assets (assets minus liabilities) is $400,000, the remaining $100,000 is goodwill. Record this transaction in your accounting software to reflect the new assets, liabilities, and the goodwill you have acquired.

Aspects of goodwill to keep in mind

Goodwill can change depending on how your business is performing. If you have negative goodwill, you can improve it by making positive changes.

Goodwill signifies a competitive advantage, but its value mainly arises when you value your business for a sale. You cannot sell goodwill on its own, and it has no value separate from your business. You can benefit from goodwill by using it to build market share and earn more revenue. In some cases, negative goodwill may reduce revenue and lower your business’ tax burden.

Calculating goodwill exactly can be difficult. There are ways to determine it, but the value of goodwill can change depending on timing and how your business performs. Because it is not subject to wear or tear and has an unlimited useful life, there is no depreciation or amortization. You must record it on your business financial statements annually, including impairments.

Conducting goodwill impairment tests

Goodwill impairment testing shows whether your goodwill has lost value and if you need to write it down on your financial statements.

When impairment occurs: Goodwill value falls below its recorded historical cost. This can happen if your business loses customers, faces new competition, or sees changes in performance.

There are two main approaches to testing goodwill impairment:

Income approachWhat it does: Estimates future cash flows the business will generateHow it works:

• Predict earnings for several years ahead
• Convert future earnings to present-day value
• Compare to current book value

If your book value is higher than the present value of future earnings, you may need to adjust your goodwill.

Market approachWhat it does: Compares your business to similar businesses in the marketHow it works:

• Analyze what comparable businesses sell for
• Compare market values to your recorded goodwill
• Look for significant differences

If your book value is much higher than similar businesses, you may need to adjust your goodwill.

How to calculate goodwill for acquisition

Before an acquisition or merger, you need to establish goodwill. As a buyer, understanding the value of goodwill helps you avoid overpaying for a business. As a seller, it helps you make sure you are paid fairly.

A goodwill evaluation should include analyzing the business's:

• brand strength and reputation
• customer relationships and employee satisfaction
• intellectual property
• competitive position

A business appraiser or valuation expert can help you determine goodwill in a business.

Managing goodwill with the right tools

Calculating goodwill and tracking assets can feel complex, but the right tools make it simpler. Cloud accounting software gives you a clear, real-time view of your business’ financial health. When it comes to big decisions like buying another business, having organized books is essential.

You can easily pull reports, understand your cash flow, and work with your accountant to accurately value assets and liabilities. This clarity helps you make confident decisions and manage your business, not just your books. Start your free Xero trial to see how easy it can be.

FAQs on goodwill in accounting

Here are some common questions about goodwill.

What is goodwill in accounting in simple terms?

In simple terms, goodwill is the extra value of a business that isn't tied to a physical item. It's things like a strong brand name, loyal customers, or a great reputation that make a business worth more than the sum of its parts. It's only officially calculated when one company buys another.

Is goodwill an asset?

Yes, goodwill is considered an intangible asset. When a business is acquired, the purchased goodwill is recorded on the buyer's balance sheet as a long-term asset.

What is an example of goodwill?

A great example is a local coffee shop with a huge following. The shop's physical assets (espresso machine, tables, inventory) might be worth $100,000. But because of its amazing reputation, loyal customer base, and prime location, a buyer might pay $150,000 for it. That extra $50,000 is the goodwill.