What is goodwill and how is it created?

Goodwill is an intangible asset that appears only when one company acquires another. It equals the purchase price minus the fair value of the target's identifiable net assets. Identifiable means assets you can separate and value, such as PP&E, inventory, customer relationships, patents and brand names, less the liabilities you assume.

For example, if a buyer pays $1,000M for a company whose identifiable net assets are worth $750M at fair value, after writing up assets and recognizing new intangibles, goodwill is $250M. That residual reflects what the buyer is paying for that cannot be recorded separately: expected synergies, an assembled workforce, market position and growth prospects.

After the acquisition, goodwill stays on the balance sheet. Under US GAAP for public companies and under IFRS it is not amortized; instead it is tested for impairment at least once a year, and if the acquired business is worth less than its carrying value, it is written down. In the rare case where the price is below the fair value of net assets, the buyer records a bargain purchase gain on the income statement.