What is goodwill accounting? Tips + best practices

Riding the wave of entrepreneurship feels exciting, but sometimes, selling your business is the smart next step in your journey. According to QuickBooks Small Business Data, roughly 20% of new businesses fail within the first year, and by year five, half of them close up shop. When preparing to sell, it's normal to get buried in receipts and forget to track hidden assets like the value of your reputation, loyal customers, or star employees.

Goodwill accounting illuminates these hidden treasures to reveal what makes your business strong. Learn more about goodwill accounting, why it matters for small businesses, and simple tips for setting it up in your favorite accounting software.

What is goodwill in accounting?

How to calculate goodwill for your small business

What is goodwill impairment?

Hazards and considerations of goodwill accounting

The importance of goodwill accounting for businesses

Managing acquisitions is easier with the right tools

Invest in long-term financial health through sound accounting

What is goodwill in accounting?

When you're preparing to sell your business, goodwill represents brand reputation, customer loyalty, and employee expertise. Essentially, the intangible value that sets your company apart.

In accounting terms, goodwill is the extra amount paid over the actual value of a company's assets and liabilities when it is bought. This premium is recorded as an intangible asset called goodwill on your balance sheet, reflecting the strength and potential of your business's intangible qualities.

Goodwill includes intangible factors such as:

• Brand reputation
• Customer base
• Proprietary technology
• Employee relations
• Established distribution networks
• Regulatory approvals or favorable compliance history
• Market position or dominance
• Proprietary business processes or methodologies
• Geographic location advantages
• Favorable supplier relationships
• Management expertise and leadership quality
• Established distribution networks

Why goodwill accounting matters when selling your business

Properly accounting for goodwill is essential when selling your business because it:

What is the purpose of goodwill accounting? 

Goodwill accounting helps you see and track the extra value you get when you buy another business. It lets you:

• Capture intangibles: Record things you can’t touch, like your brand name or loyal customers.
• Plan confidently: Know what you really paid for so you can set budgets and growth goals.
• Stay transparent: Show lenders and investors the full picture of what your business owns.
• Spot trouble early: Review each year for any drop in goodwill so you can fix issues, like a slipping reputation, before they cost you.

Key considerations of goodwill assets

Goodwill assets are intangible, so all major traits of this asset category apply to them, including:

• Inseparable: You can’t sell goodwill independently. It's intrinsically linked to the business and only realized upon the sale of the entire company.
• Indefinite useful life: Goodwill is considered to have an indefinite lifespan, remaining on the balance sheet as long as the business continues to operate.
• Impact on financial statements: You record goodwill as a long-term asset on the balance sheet. If impaired, the loss is recognized on the income statement, reducing net income.

How to calculate goodwill for your small business

Generally, goodwill measures the premium paid in an acquisition above the net fair market value of a target company’s identifiable assets and liabilities. 

Under the International Financial Reporting Standards (IFRS), it can also include noncontrolling interests and prior equity interests, but it boils down to the same principle: capturing intangible factors that don’t appear on a balance sheet but add real value to your business. Here's the formula:

Goodwill = Purchase Price - (Fair Market Value of Net Assets)

1. Determining the purchase price

This is the total consideration paid by the acquirer—cash, stock, assumed debt, and any earn-outs.

Example: If Company B pays $250,000 in cash and shares to acquire Company A, the purchase price equals $250,000.

2. Determining the fair market value of assets

You value each identifiable asset at what it could sell for today, not its original cost. These assets can be equipment, inventory, patents, or trademarks.

Example: Say company A’s machinery, inventory, and patents are appraised at a combined fair market value of $500,000 at the acquisition date.

3. Determining the fair market value of liabilities

You estimate all assumed debts and obligations—loans, accounts payable, warranties—at what you’d pay to settle them right now.

Example: Say company A’s outstanding loans and payables total $50,000 at fair market value.

What is goodwill impairment?

Goodwill impairment is the level to which a company's selling price exceeds its value on the balance sheet. If it does, you recognize an impairment loss to bring goodwill down to its recoverable amount.

You must test goodwill annually or whenever a triggering event occurs, such as a big drop in sales, a market downturn, or a major restructuring of the acquired unit. If goodwill is impaired, record a noncash loss on your income statement and reduce the asset on your balance sheet. Let’s take a quick look at some key aspects of goodwill impairment.

The annual impairment test

You start by comparing the reporting unit's fair value (including goodwill) to its carrying amount (book value).

Imagine you paid $1 million goodwill for a division, and today its fair value is only $900,000. Since $900,000 < $1 million, you recognize a $100,000 impairment loss.

Income approach vs. market approach in impairment testing

You can determine the fair value of a reporting unit in two primary ways: the income approach and the market approach.

The income approach estimates the present value of future cash flows expected from the reporting unit. It involves forecasting future earnings and discounting them to their present value using an appropriate discount rate. It’s particularly useful when the unit's value is primarily driven by its ability to generate future income.

The market approach estimates fair value based on market data, such as the sale prices of comparable companies or assets. It involves analyzing and comparing the assets and liabilities of similar companies in the same industry. It’s beneficial when there is sufficient market data available for comparable entities.

Indicators of impairment

Beyond the annual test, you must test whenever you spot red flags, such as:

• A big fall in the acquired unit’s revenue or profit 
• Adverse shifts in the market or industry outlook 
• A restructuring or disposal of the acquired business

For instance, if sales drop 30% in a year and your sales forecast now shows lower cash flows, that signals you to run an impairment test, even if it isn’t your annual test date.

Accounting for impairment losses

When you confirm impairment, write down goodwill by the loss amount on your balance sheet. Simultaneously, record the same amount as an expense in your income statement to reduce net income for the period.

Say your test shows a $100,000 impairment. You debit impairment loss $100,000 and credit goodwill $100,000. Your balance sheet now shows goodwill at its recoverable amount, and your profit and loss statement shows a $100,000 expense.

Hazards and considerations of goodwill accounting

Goodwill can give you a fuller picture of what you bought, but it also brings risk. You rely on rough estimates and judgments. If you aren’t careful, you could overvalue or even lose that extra asset without warning. Here are some main cons of goodwill accounting.

Challenges in valuing goodwill 

Putting a number on goodwill feels a bit like guessing a painting’s future worth—you use clues, but you can’t know for sure. When you value assets and liabilities today, you lean on appraisals, market trends, or expert opinions. 

One appraiser might say your customer list is worth $50,000; another might peg it at $70,000. That gap shows how much judgment goes into the calculations.

When a purchase price is too low

Sometimes you get a bargain purchase when you pay less than the net fair value of the assets you pick up. That negative goodwill (also called badwill or a bargain purchase) happens if the seller needs to offload the business fast. 

For example, if you buy a small coffee shop with assets valued at $100,000 for only $80,000, you record $20,000 of badwill. It’s like finding a designer bag in a clearance bin—you paid less than it’s worth.

Goodwill’s role during financial troubles

Goodwill depends on keeping the business running. If your company goes under, that extra value vanishes. No one buys a brand name or customer list from a bankrupt firm. 

Imagine owning the naming rights to a local festival. Those rights would be worthless if the festival hadn’t happened. In insolvency, goodwill has zero resale value, and secured creditors focus on hard assets only.

The importance of goodwill accounting for businesses

Understanding goodwill accounting gives you a clear view of what you truly paid for beyond tangible assets. This ensures you won’t be blindsided by hidden value or unexpected losses. It also helps you stay in line with different types of accounting rules and make smarter decisions about financing, growth, and tax planning.

Here are some key reasons to get goodwill accounting right:

Managing acquisitions is easier with the right tools

With the right accounting platform, you can keep every acquisition detail organized and audit-ready. QuickBooks helps you do just that by letting you record purchase entries and track asset values in one place. Here’s how it makes managing acquisitions easier for you.

Tracking acquisition transactions

A robust tool records the total purchase price—cash, stock, and assumed debt—and the fair-value entries for each asset and liability at closing. QuickBooks even logs every change in its Audit Log, giving you a clear trail of who entered what and when.

Generating financial reports

Your balance sheet should list goodwill as a separate intangible asset, and any impairment loss should flow through your income statement as an expense. With QuickBooks’ built-in report builder and custom chart tools, you can display your carrying value of goodwill alongside impairment trends over time.

Monitoring acquired entity performance

Performance tracking means watching revenues, expenses, and cash flows from newly acquired units—key inputs for your annual impairment test. QuickBooks lets you create dashboards and charts by class or custom dimensions, so you can see exactly how the new business is doing and flag any red flags early.

Invest in long-term financial health through sound accounting

Getting goodwill right keeps your balance sheet honest and helps you see if acquisitions add value or quietly hurt performance. It also ensures you meet Generally Accepted Accounting Principles (GAAP) and IFRS rules and stay ready for audits, boosting confidence among investors and lenders.

QuickBooks simplifies setting up intangible-asset accounts, recording acquisition entries, and running annual impairment tests right in your workflow. Automated reminders and clear dashboards let you monitor goodwill balances and spot write-downs early, so you can protect your true business value every step of the way. 

Start streamlining your accounting practices today with QuickBooks Online.