Accounting

What is Goodwill?

Goodwill is the value of a business above its net assets - representing things like reputation, customer relationships, and brand value.

Example

Buy a business for £200k with £150k net assets. The £50k difference is goodwill.

Key Dates

Recorded when a business is acquired

How Goodwill Works in Practice

Goodwill is an intangible asset that arises when one business acquires another for more than the fair value of its identifiable net assets. The excess payment represents the value of things that do not appear on the balance sheet individually: the company's reputation, customer loyalty, a skilled workforce, established supplier relationships, brand recognition, and future earning potential.

Goodwill only appears on a balance sheet when it is purchased as part of an acquisition. You cannot recognise 'internally generated' goodwill - that is, you cannot put a value on your own company's reputation and add it to your balance sheet. This is a fundamental principle under both FRS 102 (UK GAAP) and IFRS.

Under FRS 102, purchased goodwill must be amortised (written off) over its useful economic life. If you cannot estimate a reliable useful life, the maximum period is five years. Many companies amortise goodwill over 5 to 20 years depending on the nature of the business acquired. Each year, the amortisation charge reduces your profit in the P&L and reduces the goodwill balance on the balance sheet.

Goodwill must also be reviewed for impairment at each reporting date. If there are indicators that the acquired business is worth less than the remaining goodwill balance (for example, loss of key customers or declining revenues), you must write down the goodwill immediately. An impairment charge is a one-off hit to your profits.

Step by Step

When your company acquires another business, you first identify and value all the tangible and intangible assets (property, equipment, contracts, customer lists, patents) and liabilities (debts, obligations) at fair value. The difference between what you paid and the total net fair value of these identifiable assets and liabilities is goodwill.

For example, you pay £300,000 for a business. Its identifiable assets are worth £250,000 and liabilities are £50,000, giving net assets of £200,000. The goodwill is £300,000 minus £200,000 = £100,000. This £100,000 goes on your balance sheet as an intangible asset.

You then amortise the goodwill over its estimated useful life. If you estimate 10 years, you would charge £10,000 per year to your profit and loss account. This reduces your taxable profit and therefore your Corporation Tax bill, which is a significant benefit of the amortisation. However, the tax treatment of goodwill depends on when it was acquired and the nature of the business - HMRC has specific rules for the tax deductibility of goodwill amortisation.

Practical Tips

  • When acquiring a business, invest in a proper fair value exercise to identify all separable intangible assets before lumping everything into goodwill - this can provide better tax relief on specific assets
  • Document your rationale for the goodwill amortisation period in your accounting policies so auditors and HMRC can understand and accept it
  • Review goodwill for impairment at every year end - if the acquired business is underperforming, you may need to write down the balance
  • Take specialist tax advice before acquiring a business to understand the Corporation Tax relief available on goodwill and other intangibles

Common Mistakes to Avoid

  • Trying to put internally generated goodwill on the balance sheet - only purchased goodwill from an acquisition can be recognised
  • Amortising goodwill over too long a period without justification, which flatters short-term profits but may require a larger impairment charge later
  • Assuming that goodwill amortisation is always tax-deductible - the tax treatment changed significantly from April 2002 and depends on the nature of the acquisition
  • Failing to test goodwill for impairment when there are clear indicators of declining value, such as loss of key customers or revenue decline in the acquired business

Frequently Asked Questions

Is goodwill amortisation tax-deductible?

It depends on when the goodwill was acquired and what type of business was purchased. For goodwill acquired on or after 1 April 2002 relating to unincorporated businesses, tax relief is generally available. For goodwill acquired from a related party after 3 December 2014, tax relief is restricted. Always check with your accountant.

What is the difference between goodwill and other intangible assets?

Other intangible assets (like patents, customer lists, or brand names) can be separately identified and valued. Goodwill is the residual amount that cannot be attributed to any specific identifiable asset. It represents the premium paid for the business as a going concern.

Can goodwill have a negative value?

Yes. Negative goodwill (or a 'bargain purchase') arises when you acquire a business for less than the fair value of its net assets. Under FRS 102, negative goodwill is recognised in the profit and loss account in the periods in which the non-monetary assets acquired are recovered.

How long should I amortise goodwill?

Under FRS 102, goodwill should be amortised over its useful economic life. If you cannot make a reliable estimate, the default maximum is five years. Many acquisitions justify a longer period of 10 to 20 years, but you need a clear rationale documented in your accounting policies.

Does goodwill affect my company's value if I want to sell?

Buyers typically look through the accounting goodwill on your balance sheet and form their own view of what the business is worth. However, a large unamortised goodwill balance might concern buyers as it could indicate an overpayment for a previous acquisition.

Source: HMRC Corporate Intangibles Research & Development Manual CIRD10000 - Intangible fixed assets: introduction and overview

Related Terms

Amortisation

Amortisation is like depreciation but for intangible assets (software, patents, goodwill). It spreads the cost over the asset's useful life.

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