Goodwill is the value of a firm’s reputation and its good brand name in the market. A firm earns goodwill through its hard work. Goodwill helps a firm in winning the trust and faith of the customers by fulfilling their demands in both qualitative and quantitative aspects. It can be said that the goodwill of a firm is a result of the past efforts made by it which helps a firm to earn higher profits in present and in the future as well. In other words, positive goodwill helps a firm to earn supernormal profits as compared to the other firms that earn only normal profits. Goodwill is considered an intangible asset of the firm. It means it cannot be seen or touched like other assets of the firm. It plays a very crucial role for any firm to survive and compete in the market. Following are the types of Goodwill
Types of Goodwill
Goodwill is mainly two types
- Purchased Goodwill
- Self-generated Goodwill
Whenever a firm is sold to another firm generally a consideration is paid in cash or kind because the buyer will enjoy the benefits of the brand image that has been created over the years once the purchase is complete. This kind of goodwill is recorded in the books of accounts since the amount paid can be fairly determined. This goodwill arises when, for instance, the value of assets is greater than the liabilities at the time of purchase and hence, it is a balancing figure. For example, Aman owns a shop that is known for its quality and has a large number of loyal customers and Ravi offers to buy his shop as it is. As a result of this purchase, Ravi will be able to acquire the pool of customers and should therefore pay for it as well apart from the assets.
Characteristics of Purchased Goodwill
- This goodwill arises when a business is purchased or acquired for reasons like brand image, customers pool, business connections, etc.
- It is recorded in the books of accounts since its value has been determined in the form of consideration paid.
- Like any other asset, this kind of goodwill is a valuable intangible asset for a firm and hence shall be recorded under the head Assets in the balance sheet of the firm.
- The valuation of goodwill cannot be objectively determined and is based on the seller’s perception.
- The benefit of goodwill can be enjoyed only for a limited period of time owing to the fact that the benefit derived from it cannot be justified in quantitative terms after a certain period. Hence, it should be amortized at the earliest.
Unlike the previous kind, this goodwill is not purchased or bought for consideration but rather generated as a result of the hard work and efforts of the members of the firm. It, therefore, arises because of factors such as consistent quality, satisfied customers, favorable location, etc. Since all these factors are internal to an organization hence the goodwill is an internally generated goodwill boosting the revenues for the firm.
Features of Self-generated Goodwill
- As mentioned above, it arises out of the efforts of a firm over the years and hence is internally generated.
- Since the value of internally generated goodwill cannot be traced back to a cost source hence its accurate and reliable value is very difficult to determine.
- The valuation is based on the perspective of the valuer and hence is completely subjective.
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