M&A Vocabulary – Understanding the experts: “Goodwill”

Goodwill (business or company value) generally represents the difference between the enterprise value and the sum of the fair values of the individual assets that can be identified under the applicable accounting rules.

Under both IFRS (International Financial Reporting Standards) and the German Commercial Code (HGB), a distinction between internally generated and acquired Goodwill is required. Internally generated Goodwill is an intangible asset created by the company itself, representing profit expectations arising from ongoing operations that cannot be specifically attributed. As a rule, internally generated Goodwill may not be recognized on the balance sheet because it does not meet the recognition criteria and there is an explicit prohibition on recognition. This applies both under the HGB (§ 248 (2) HGB) and under IFRS (IAS 38.48).

Acquired Goodwill is far more important in practice. Acquired Goodwill is defined in § 246 (1) sentence 4 HGB as follows: “The amount by which the consideration paid for the acquisition of a company exceeds the value of the individual assets of the company less the liabilities at the time of acquisition (purchased business or company value) shall be deemed an asset with a limited useful life.” As the definition indicates, acquired Goodwill arises from a purchase for consideration as part of an acquisition. Put simply, acquired Goodwill therefore reflects the difference between the purchase price and the fair value of the acquired assets less the liabilities.

Example of acquired Goodwill: On 31/12/2020, Company A acquires Company B via a share deal for a purchase price of EUR 10 million. As of 31/12/2020, the book value of Company B’s assets is EUR 12 million. The current market value of the assets, however, is EUR 14 million. As of 31/12/2020, Company B’s total liabilities amount to EUR 8 million. The book value of the liabilities equals their market value. The acquired Goodwill resulting from the transaction is:

EUR 10 million (purchase price for Company B)

less EUR 6 million as the balance between the market value of the assets of EUR 14 million and the market value of the liabilities of EUR 8 million
= EUR 4 million

Acquired Goodwill must be recognized as an asset under both the HGB and IFRS. It must be presented separately under intangible assets and amortized in accordance with the respective provisions.

Under the HGB, acquired Goodwill must be amortized on a straight-line basis over its individually estimated useful life. If the useful life cannot be estimated, it must be amortized over a period of 10 years (§ 253 (3) sentences 3 and 4 HGB, DRS 23 para. 120–123).

Under IFRS, systematic amortization of acquired Goodwill is not applied, as an indefinite useful life is assumed (IAS 38.107). IAS 36 requires that intangible assets with an indefinite useful life be tested for impairment. Under IFRS, impairment means that the carrying amount of an asset exceeds its recoverable amount (IAS 36.6). The impairment review (the so-called impairment test) must be performed in each period—i.e., at least annually—and in particular when there are indications that an asset may be impaired (IAS 38.108). Any impairment must be recognized as an expense in the income statement.

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