Goodwill, going concern

A going concern is an established business with a developed clientele and/or reputation. Because the business is “up and running” and has a following, such a business, if sold, will command a price higher than the BOOK VALUE of its ASSETS as listed on its BALANCE SHEET. The excess of price over the book value of the firm’s assets is called goodwill, which can be recorded only when it is purchased; that is, a buyer may claim goodwill only when he or she pays for it. Goodwill is a long-term, intangible asset and is listed with the other long-term assets of the newly purchased firm. Until 2002, goodwill was amortized over a period of time not to exceed 40 years. Under new rules, companies can leave goodwill on their balance sheets indefinitely, as long as it does not become impaired. After the Enron fiasco, many companies are taking a closer look at their accounting practices and incurring “impairment” charges under the new rules. Companies are now required to test the value of goodwill they carry on their FINANCIAL STATEMENTS every year and write it down if it is excessive. Discounted cash flow is often used to test the value of assets acquired. It is not the seller of a going concern who determines the amount of goodwill associated with the firm; rather, goodwill is market-determined. If the market (selling) price is above the book value of the assets of the firm being sold, then the market views the established nature of the firm and its clientele as desirable and more profitable than a new, start-up firm. If the firm’s selling price is in line with the book value of its assets, then the market does not view that any goodwill has developed over the life of that firm.