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Chapter 5

4.2 Goodwill

Goodwill is the difference between the fair value of a business entity as a whole and
the aggregate of the fair values of its separable and identifiable assets and liabilities.

When a business entity first commences trading, it is either created by its owners or
purchased from an existing entity. In the latter case there will have been a certain
amount of negotiation over the purchase price. The vendors will obviously seek to
obtain the highest price possible, whereas the purchaser will seek to minimise the
price. It is likely, however, that the final price will be greater than the purchaser’s
valuation of the separable net assets taken over. This is accepted because the price
includes the rights to the existing entity's customer base, such as its name, staff
experience and expertise, and so on. This difference is the goodwill and, more
precisely, is said to be purchased goodwill.

However, whether the entity is created as a new start-up business or is the result of
the acquisition of another entity, new goodwill is earned or created by the new
owners over a period of time. This is known as non-purchased goodwill.

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