Calculation of Goodwill in Acquisition?
Can someone verify for me how to calculate Goodwill in an LBO?
I think it's: Equity Purchase Price - Book Value of Equity = Goodwill.
And BVE = Retained Earnings.
But what if BVE is > than Equity Purchase Price? Then Goodwill is negative? That doesn't seem to make sense to me.
Please clarify where I'm going wrong.
What is Goodwill?
Goodwill makes up part of the premium that is paid in an acquisition of a company. If a company is purchased for more than it is worth on the books, the company is paying for intangible elements such as skilled employees, brand recognition and other similar items. It is important to note that items such as patents or trademarks are accounted for in different line item.
Some examples of Goodwill are:
- Brand name
- Customer loyalty
- Proprietary production methods (i.e. the recipe formula for Coke).
Whenever a company is acquired for an amount higher than the book value, a write up of intangible assets and PP&E along with goodwill usually account for the difference.
New goodwill = Purchase Price (equity) - BV of Equity - Write Up in PP&E - Write Up in Intangibles + Deferred Tax Liabilities (from Write Up in PP&E) + Existing Goodwill
Purchase Price of Equity Less Than Book Value of Equity
If the company that is being purchased has a book value of equity greater than the value that the acquirer is paying for the company - you will create "negative goodwill" which creates a "gain on the acquisition."
One of two things happen if you have negative goodwill:
- You must take an extraordinary gain to income
- You write down your non-current assets until there is no negative goodwill left
I worked on a project where a company with $5B on their balance sheet was acquired for $140M. We wrote down all their assets to equal the $140M.
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