 Hello, and welcome to this session in which we will discuss the concept of goodwill. What is the big idea? Well, goodwill is created when one company purchases another company, paying a price in access of the fair market value of the identifiable asset. Simply put, we have company A and company B. Company A purchases company B. And the fair market value, we're going to go a little bit in details about this, is 100,004 company B. However, company A, for some reason, paid, for example, 150,000. Well, they paid 50,000 in access of the fair market value of company B. Now, this is the basic idea, but we're going to have to look at more details information. The first thing you need to know about goodwill is it's not internally generated. There is no internally generated goodwill. In other words, it only happens when one company A purchases another company B. It's considered to have an indefinite life intangible asset. So it's an intangible asset. It lacks physical existence. You cannot touch goodwill, but it has an indefinite life. What does that mean? Well, what we learned in intangible asset, that indefinite life intangibles, they have, they're not subject to amortization. We don't amortize them, and the reason is simple, because they have an indefinite life. To amortize something, it means to expense it over the period in which it contribute cash flow. Well, if the period for this goodwill is indefinite, therefore there's no limited amount of time, therefore we don't amortize goodwill. Now goodwill is subject to amortization, I'm sorry, subject to impairment, not amortization. Now certain companies, smaller companies, they might be subject to special rules about goodwill, but we're not going to go into this discussion. The best way to illustrate the concept of goodwill is to actually look at a simple example. Let's assume Adam Agricultural Company decided to diversify its risk, so it's an agricultural company, by buying 100% of drone ink, it's a drone company. And Adam Company paid $415,000. So we're going to look at this company and try to illustrate the concept of goodwill. We're going to start by looking at the drone company balance sheet. This is what they have on their balance sheet in terms of assets. They have cash, account receivable, inventory, property, plant and equipment, total assets of $303,000. So cash 36, account receivable, $42, inventory, $55, property, plant and equipment. Under liability sites, they have current liabilities of $60,000. Common stock of $100,000, retained earnings of $143, liabilities plus equity equal to $103, they should equal to the assets. So this is the balance sheet based on the book value or the accounting figures of the company. Well, when you buy a company, what you have to do is you have to compute the fair value of their assets and the fair value of their liabilities in order to find out what is the amount of the goodwill to determine whether you have a goodwill or you don't have a goodwill. You might have something else. You might have what's called a bargain purchase. Before we look over the fair value, I would like to remind you whether you are an accounting student or a CPA candidate to take a look at my website, farhatlectures.com. I don't replace your CPA review course. I'm a useful addition to your CPA review course. I can help you understand the material better. I explain the theory behind the concept. I go a little bit slower than your CPA review course. I give you additional resources, multiple choice CPA questions that's going to help you understand the concept better, which will help you with your CPA review material. Your risk with me is one month of subscription. That's your commitment. 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Share it with other connect with me on Instagram, Facebook, Twitter and Reddit. So now we're going to examine the fair value of the assets and the fair value of the liabilities, the cash fair value. So the book value, we have $36,000 in cash. Well, the fair value of cash is usually the same unless we have some foreign currency, a counter receivable. We expect to receive 42,000 and the fair value of it is 42,000. Inventory will be different. Inventory on the books is 55, but the inventory is worth $86,000. And that's usually true because the inventory you sell it for more than its cost property, plant and equipment on the books is 170 property, plant and equipment fair value is 210. And then that's always the case. If you have property, plant and equipment, especially buildings, they might go up in value or land usually. Now, what we did is we identified another asset that was not on the balance sheet of drone ink initially. So notice here, we just added an asset. We find out that they have a patent and that patent is worth $20,000. You might be saying, how come does, why don't a drone ink, which is a drone company, don't have that patent on their balance sheet? And there isn't a simple. That patent might be internally created. So if you create a patent internally, you cannot record it or if you record, it's a small amount. So simply put, we identified this patent because it's internally created. Now we are purchasing the patent. Now it's part of our assets. So it's, it's identified. Notice the fair market value of identifiable asset. Now it's, it's an identifiable asset. Then we have liabilities. We're going to assume it has the same market rate as the book value. Now, if we take the assets, subtract the, take all the assets minus the liabilities, we find out that the fair value of the company is $334,000. Hold on a second. If the fair value of the net asset, which is assets minus liabilities equal to $334,000, why are you paying $415,000? Simply put, why are you paying the extra? Well, the extra you are paying the extra. It could be for many reasons. It could be the reputation of the company, the management of the company, the location of the company. It could be that Adam agriculture went into a bidding war with another company. And Adam really wanted to buy drone ink. It's the ego of the management of the agricultural company. It doesn't matter. For some reason, we paid extra and we cannot pinpoint why we paid the extra. Now we know we paid $20,000 extra for this. So what does that mean? It means we paid $415,000. Well, the book value of the company, let me show you what the book value of the company is. The book value of the company is 243, which is common stock and retained earning, which is the net equity of the company because assets 303 minus 60, which is assets minus liability. This is all book numbers. So if we take 303 minus 60, it's going to give us 243. 243 is really the book value, the book value of the equity. So simply put, for this $415,000, the first $243,000, we paid for the book value. Then of the $415,000, we paid for the amount above the book value. For example, we paid for the difference between receivable was good. The difference between inventory 55 and inventory 56 of 86. So if we take 86 minus 55, we paid 31,000 extra for the inventory, for the fair value of the inventory and for the property, plant and equipment, the book value was 170 and the fair value was 210. We paid an additional, so if we take 210 minus 170, we paid an additional 40,000 for property, plant and equipment. Then we identified a patent worth 20,000. So let's see, if we take the $415,000, $415,000, we paid for the book value, $243,000. That's going to bring us down to 172. Then we allocated 31,000 to the inventory. We allocated 40,000. We allocated 40,000 to the property, plant and equipment. And we allocated 20,000 to the patent. Well, if we allocated those $415,000 to all of this, what's going to be left with, we're going to be left with 81,000 that we cannot allocate to anything. Well, if we cannot allocate to anything, guess what we're going to call it? We're going to call it Goodwill. Now we identified, we're going to put a new asset called Goodwill. So simply put, what we can do is we can take 415 minus the fair market value, a fair value of the net asset 334. But notice what I did. I took the $415,000 and I broke it down for you, what we paid for. We paid for the book value of the company. We paid for the extras for the inventory value, the extras for the property, plant and equipment, the extra for the 20,000 proper patent that was not identified in what's left is our Goodwill. Or you can take what we paid versus the fair value of net asset. This is what I started with. What I told you, it's what we pay in excess of the fair value. Now let's look at the journal entry to see how this all works. So now we purchased this company. We're going to debit cash 36,000. We're going to debit a counter-recible 42. So we're going to put everything on the books based on the fair value because we purchased them. This is cost for us. Inventory is 86, property, plant and equipment 210, patent 20,000. We paid 415. We bring the liabilities as well. And what's left to balance is an account called Goodwill of 81,000. So this is what Goodwill is. Goodwill is an intangible. Remember, it is an intangible. It's not amortized because it's considered to have an indefinite life. Now, what happens if we pay for this company rather than 334? We paid 300,000. What would happen? What would change? Well, if we paid 300,000 for a company that's worth 334, well, the cash cannot be 415. The cash will be 300,000. Obviously, we will not have Goodwill because we paid less than the fair value. So what happened under under those circumstances to make the entry balance, not to make the entry balance. What happened is we have a gain. We have a gain. We purchased. We had a purchase bargain and we have a gain of 34,000, which is the difference between what we paid and the fair value of the net asset of the company. So make sure there's no negative Goodwill we have a gain. Now, the best way to learn about Goodwill is to work additional multiple choice questions. Now, bear in mind this topic is covered more in advanced accounting. So you want to know more about Goodwill in your advanced accounting course, but this is for intermediate accounting. This is good enough. At the end of this recording, once again, I'm going to remind you whether you are a student or a CPA candidate to take a look at my website, farhatlectures.com. I don't replace your CPA review course. I'm a useful addition. I am. I can help you understand the material better. You're going to study for your exam, for your accounting career once in your lifetime. Make the right investment. My subscription will not break you. It's going to just kind of make you a little bit stronger. It's going to help help you understand the material. Make this investment. It will pay you dividend down the road. The CPA exam is worth it. Good luck, study hard, and of course, stay.