When a company acquires other company, usually price paid is more than the book value. This excess price paid is called goodwill and reflected on the asset size of the balance sheet. Recollect that an asset is a resource which has the economic value for the organization with the exception that it will provide the economic benefit in future. So we can say that goodwill resulting from the acquisition is expected to provide the future benefit to the company.
If the price paid is less than adjusted book value that usually does not occurres. In such case’ Negative Goodwill’ is generated. It means that company is purchase at Bargain and same is treated in the same year P&L.
Goodwill is an indefinite-lived intangible assets recorded on acquirer balance sheet post acquisition if the purchase price paid is more than adjusted book value of Target Company.
Company A acquires Company B for USD 25bn and fair value of net assets is USD 15bn. Here goodwill generated from the acquisition is USD 10bn (USD 25bn-USD15bn) and will be shown as assets under balance sheet.
What does Goodwill measure
In common, Goodwill sounds goods for an organization but actually it is just the overpayment over the purchase price. To bring more transparency for investor, goodwill is tested for impairment rather than amortization every year and impairment charged in upcoming year is a clear sign of Bad acquisition. Since wealth transfer immediately to the Target Company at the time of acquisition therefore investor cannot wait too long when impairment will be charged, it might be too late.
Clearly magnitude of goodwill does not reflect weather the acquisition was a right move or not. What else comes with the acquisition does matter a lot, what else means the value of growth assets, control (efficiency) and synergy etc.
Goodwill amount more than the value of these growth assets, control (efficiency) and synergy is fragile and impact of the same will be reflected in market correction.