No, 500 more than the book value. The issue you are taking about is that book value doesn’t equal asset value perfectly for a variety of reasons.
Goodwill is basically a carrying error.
Goodwill is basically a carrying error.
In supply-demand situations like houses, the seller can list a price they are okay with receiving. If it has more interested parties, they can make an offer higher than the asking price. When selling a company, there's similar practices of looking at the current annual income, project growth over a few years, and offer a price based on that. Explaining in terms that are logical, non-accountants can keep up. Making comments of "we value at $500, but paid 2x that for goodwill" just makes no sense
I would disagree. It’s not very logical to value software companies (for instance) at their book because a lot of their worth is in know-how, workforce and the products themselves. Unless you believe that’s worthless “goodwill” makes perfect sense. The issue is that these intangible assets are notoriously hard to value.
Of course if we’re talking about utility companies for instance it’s quite different.
> current annual income, project growth over a few years, and offer a price based on that
These are not a tangible assets. Future growth expectations are included in “goodwill”.
> Making comments of "we value at $500, but paid 2x that for goodwill"
Nobody does that, or should do it anyway. There is a lot of inefficiency in acquisitions that’s true but no company is going to just say “well we value it X but going to pay 2X”. In most cases there is no real way to calculate future growth without a very wide margins of error anyway..
Anyway there is no point in getting too worked up about this. The main purpose of goodwill is to prevent a massive decrease in company’s assets after they acquire another company. You can deduct depreciation in goodwill from your tax bill anyway. One of the few issues I can think of is this distorts GAAP earnings data for public companies. e.g. look at AMD it looks as if they have not been making any money for the past year or so, which is far from the truth. They just get to depreciate ~$2 billion in goodwill from the Xilinx acquisition depressing their reported net income.
Precisely. That practice is establishing the goodwill value of the company. This is another word for expected future cash flows.
If you've ever had a small company be acquired for more than it's asset value - you were the beneficiary of "goodwill".