When a limited company purchases another business, the amount that it pays is known as the purchase consideration. The purchase consideration is often different from the net value of the business that is being purchased, so the difference is recorded in the books of account. If the purchase consideration is more than the net assets, the difference is known as positive goodwill.
Goodwill is an intangible asset that arises when a company has a good reputation. The following are some reasons for positive goodwill:
- The business has a good reputation.
- It has a loyal customer base who will continue to purchase from the new owner.
- It has a high-quality workforce that is efficient and reliable.
- It is situated in a strategic location where it attracts a lot of customers.
- It maintains a strong, long-term relationship with its suppliers.
Positive goodwill can be calculated using the following formula:
(Purchase consideration) – (Net assets of the business)
Keep in mind that you should consider the net assets at their revalued amount rather than their original amount.
It may be recorded as a non-current asset in the balance sheet of the limited company that is purchasing the business. According to the Generally Accepted Accounting Principles (GAAP), goodwill can be recorded in a company’s financial statements only when an entire business or a portion of a business is being purchased.
On the other hand, negative goodwill arises when the purchase consideration is less than the net assets of the business. This might happen when the business has an inefficient workforce or is seen as unreliable by its suppliers. Negative goodwill is usually recorded as a capital reserve.