Goodwill is the value of a business that is determined by calculating the difference between the values of the assets minus the liabilities. It is an intangible asset reflecting the company's name, reputation and earning power.
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Goodwill originates from several aspects of a business -- going concern value (which represents a company's intangible assets), excess business income and expectation of future economic benefits. These factors determine the value of a business' goodwill. Goodwill is typically only recorded when it is included in a business purchase.
The cost method values a business' goodwill in terms of how much it would cost to recreate the business starting from scratch. If it would take two years to match the business' current income of £65,000 a year, the amount of goodwill is then £130,000.
The market method bases goodwill on the purchase price of the business minus the total value of net assets. This is the simplest method to calculate.
The income method is the most common method used. Goodwill is calculated by taking the difference between the total business value, or purchase price, and the fair market value of all assets.
Capitalised Excess Earnings Method
This method begins with the estimated fair market value of all assets. A fair rate of return is determined and used to calculate the value of the assets. The asset value is subtracted from the total business earnings for a year, which calculates excess earnings. Each asset is then capitalised with a portion of the business' earnings. The remaining amount determines goodwill.
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