The value of a company purchased will normally exceed the value of its net assets. The difference is goodwill. This represents assets not shown in the statement of financial position of the acquired company such as the reputation of the business, brand and the experience of employees.

Goodwill arises because the investor would rather buy a ready made and established business than buy the individual components and set up the business themselves from nothing.

Fair value

When calculating goodwill (and non-controlling interests) the fair value method is used. This means that amounts are not calculated merely at their reported book value.

Goodwill is the difference between the amount paid to acquire a shareholding and the value of the assets acquired. However, the amount paid is rarely a simple cash transaction. With large companies shares are often purchased for cash plus an additional payment that is deferred into the future. Often the deferred payments are contingent upon achieving certain performance targets. Alternatively shares are swapped, i.e. a company purchases shares in a subsidiary in exchange for shares in their own company. All of these elements of the 'consideration' have to be valued in today's monetary terms.

The value of the shareholding must also be considered. The net assets are usually calculated by totalling the assets reported on the SoFP and deducting liabilities. The book values, however, often do not reflect their true market value. This is most common with property, plant and equipment. Property often appreciates in value, whereas in the financial statements of some companies it is stated at historic depreciated cost. Therefore the fair value of all assets and liabilities must be determined.

Created at 10/25/2012 2:48 PM  by System Account  (GMT) Greenwich Mean Time : Dublin, Edinburgh, Lisbon, London
Last modified at 11/29/2012 2:34 PM  by System Account  (GMT) Greenwich Mean Time : Dublin, Edinburgh, Lisbon, London

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