Goodwill

In a full business acquisition, goodwill is, in simplified terms, the amount by which the purchase price exceeds the fair value of the net assets acquired. It represents expected benefits that cannot be recognised as individual assets, such as those arising from the business working together or from synergies. In a share acquisition it appears in the buyer's consolidated accounts, while the separate accounts initially show the investment. It can only arise through an acquisition, since internally generated goodwill may not be capitalised under either German GAAP or IFRS.

It is determined in the purchase price allocation as a residual: the net assets acquired, meaning identifiable assets less assumed liabilities, are deducted from the purchase price. Previously unrecognised intangibles such as customer relationships, brands, technology and order backlog are identified separately beforehand where recognition criteria are met. The remaining difference is goodwill. Subsequent measurement differs considerably: under IFRS it is not amortised but tested for impairment at least annually, while German GAAP requires amortisation over its useful life. This distinction affects the buyer's future reported earnings without changing the acquired business's ongoing cash flows. Tax deductions additionally depend on transaction structure and should be considered separately when evaluating the price. A large goodwill balance is therefore above all an indication of past acquisitions and of the prices paid for them, and should therefore be assessed alongside the performance of those acquired businesses.

Analysis should test whether the earnings and synergies expected at acquisition are being delivered and how much valuation headroom remains under slower growth or a higher cost of capital. Credit analysis frequently considers an equity ratio adjusted for goodwill, because the item cannot be sold separately and provides no independent collateral in an asset-by-asset realisation. In a sale of the continuing business, however, the underlying earnings potential can still have value.

Note: This explanation is for general information only and does not constitute tax advice. Tax treatment depends on the individual case and may change with new legislation. For a binding assessment, please consult a qualified tax adviser.