Goodwill Formula: Company purchase price - fair market value (shares outstanding * current stock price) or Company purchase price - book value of equity?
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Market Value of equity = # of Shares outstanding x Current share price Book Value of equity = Assets - Liabilities
Goodwill refers to the premium paid over the BOOK value of equity not market value of equity.
Are book value and fair market value the same thing?
Technically speaking no... it depends on the situation. In my accounting classes when we go over book value goodwill compared to market value goodwill we are talking about two different things. Book value goodwill refers to the goodwill that is created at the date of the transaction. For example, say I buy a company for $100 and have a goodwill plug of $20 because the companies book value is only worth $80. Fair market value goodwill basically refers to a situation in which your goodwill is impaired. So say again I bought this company for $100 but after two years of ownership I realize my fair value of the reporting entity is only $80 and the fair value of these assets is $70. This would mean that my goodwill is now actually only worth $10 and you would have a goodwill impairment charge. Hopefully this clears things up a little.
This makes so much sense - thank you!
When a company is acquired, the purchase price paid for the business is spread across all of the acquired assets and liabilities (i.e. the target's balance sheet is reset to fair market values for each balance sheet line item on the new parent's consolidated balance sheet). If after going through that exercise, there is still un-allocated purchase price, then that amount is classified as goodwill. It is GAAP's way of recording that "X Factor" of a business that made it enticing to the acquirer to pay more than the fair market value of a target's identifiable net assets when buying the business.
In short, goodwill represents the excess of the purchase price over the fair market value of an acquired company's indentifiable net assets.
To put it more in your original post's terms: Purchase Price Paid - FMV of identifiable net assets = Goodwill recorded.
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