Goodwill is the value of a business beyond its physical and financial assets. It is an invisible but important part of any company’s worth. This extra value helps one business stand out from others. There are many types of goodwill in business accounting. These types help us understand where goodwill comes from and how it affects buying and selling companies.
In simple terms, goodwill is the reputation, trust, and customer love a business earns over time. When one company buys another, it may pay more than the actual value of the assets. That extra amount is goodwill. It shows the company’s brand image, loyal customers, and market strength.
There are different types of goodwill, such as purchased goodwill, inherent goodwill, self-generated goodwill, and more. Some goodwill comes from the company’s work. Others come when a business is bought. Understanding these helps in making smart business decisions.We use accounting for goodwill in financial reports. It helps investors and owners know the full value of a company.
What is Goodwill in Accounting?
Goodwill in accounting is the part of a business’s value that is not physical. It is the extra value that comes from the name, location, customer base, or brand trust. This value shows the strength of the business.
When one company buys another, it may pay more than the value of its buildings, machines, or stock. That extra price is called goodwill. It is often seen in the books during mergers or acquisitions. Goodwill can help a business grow faster, get more customers, and make more profits.
For example, a popular bakery in Delhi may have strong goodwill. If someone wants to buy it, they may pay more because of its brand and happy customers. That extra money is goodwill.
Types of Goodwill
There are different types of goodwill. Each type tells us where the value came from. The company creates some types over time. Some come when one company buys another company. Understanding these types helps owners, buyers, and accountants know how to treat goodwill during business deals.
Let’s explain each type of goodwill in simple terms:
Purchased Goodwill
Purchased goodwill is the type of goodwill that comes when one business buys another. This goodwill is easy to see and record in the books. It shows the extra money paid for the business beyond its physical things like buildings and machines.
Why It Matters
This type of goodwill is part of a business deal. It is real because someone paid money for it. When a company buys another, it may pay more because of the business’s good name, loyal customers, trained workers, or prime location. That extra money becomes purchased goodwill.
Example
If Company A buys Company B for ₹50 lakhs, and Company B’s assets are only ₹40 lakhs, then ₹10 lakhs is the purchased goodwill. This value goes into the buyer’s balance sheet under intangible assets.
Features
- It is paid in cash.
- It can be shown in financial records.
- It helps the buyer get a working business with a strong market.
- It may change in value if the business grows or falls.
Purchased goodwill helps show the real price of a business. Investors look at this to judge if the company paid a fair price. It also tells us how strong or trusted the bought company was. In accounting, this goodwill stays in the books and can affect profits if the business fails to grow as expected.
Self-Generated Goodwill
Self-generated goodwill is the value created by the business itself. It grows over time with the company’s hard work, good service, and happy customers. It does not come from buying any other business.
Understanding Self-Generated Goodwill
This type is also called inherent goodwill. It comes from years of effort, better products, customer care, and brand trust. It does not appear in the books like purchased goodwill because no money is paid for it. But it still adds real value to the company.
For example, a small coaching center in Lucknow may grow over the years by giving good results. Students trust it, and more people join it. Even without big buildings or assets, the center becomes famous. That fame is self-generated goodwill.
Why It’s Important
- It shows the company’s image and service.
- It is hard to record in books, but it adds great value.
- It helps in customer loyalty.
- It helps in future growth and profits.
Self-generated goodwill is useful for small businesses in India. Many family-run shops or small service firms grow this goodwill by word of mouth. Even without showing it in records, it helps them earn better than others.
This type of goodwill also helps when the business plans to sell or merge. Even if it is not on the balance sheet, the buyer will see it as a plus.
Inherent Goodwill
Inherent goodwill is the same as self-generated goodwill in many ways. But there is a slight difference. Inherent goodwill shows the future profits a business expects due to its standing in the market.
Nature of Inherent Goodwill
Inherent goodwill is not bought or paid. It exists in the business from its way of working. It is based on future hopes. A business that has a good image, good customer care, and brand value may have inherent goodwill. This value comes without being recorded.
For example, a 10-year-old stationery shop in a busy market may have great footfall. Its customers trust it and keep coming back. This creates inherent goodwill.
Features of Inherent Goodwill
- It is based on future income.
- It changes with business performance.
- It helps build brand trust and long-term value.
- It cannot be bought.
This goodwill gives a good image to the business even if it is not in records. It affects buyer interest during business sales. People prefer buying businesses that have strong inherent goodwill. It makes growth easy and saves marketing costs.
Institutional Goodwill
Institutional goodwill is based on the systems, employees, and brand trust of an organization. It is mostly seen in large firms, banks, colleges, or healthcare centers.
Key Elements
This goodwill does not depend on just the owner or one person. It comes from the whole setup — like how the staff treats people, how good the results are, and how trusted the brand is in society.
For example, a hospital in Mumbai may have top doctors, fast service, and happy patients. Over time, it builds trust in the city. This becomes its institutional goodwill.
Benefits of Institutional Goodwill
- It builds customer faith in the brand.
- It helps in long-term success.
- It is useful in getting new customers easily.
- It stays strong even if leadership changes.
In India, many coaching centers, schools, and clinics build this type of goodwill. People don’t come for one person but for the name and setup. This goodwill is stable and long-lasting. It gives strength to the business and helps it grow without much effort.
Institutional goodwill is strong and hard to shake. It is one of the most valuable types of goodwill in business.
Professional Goodwill
Professional goodwill is the goodwill earned by a person or a small team based on their skills, name, and service. Doctors, lawyers, architects, and tutors build this type of goodwill.
Real-Life Examples
A well-known doctor in Jaipur may have built goodwill over 15 years. Patients know the doctor by name and trust the care. The goodwill is linked to the doctor, not the clinic.
Features of Professional Goodwill
- It is personal and not easy to transfer.
- It comes from years of hard work and trust.
- It is strong but may fade if the person retires.
- It may not stay if another person takes charge.
This goodwill helps solo professionals grow faster. They do not need big ads or marketing. Their name brings business. Students preparing for CA or ACCA exams in India see such goodwill in top faculties who are famous by name.
Capitalization and Super Profit Methods to Value Goodwill
We use two main ways to find the value of goodwill — The capitalization method and the Super profit method.
Capitalization Method
In this method, we use normal profits and capital to find goodwill.
Formula:
| Goodwill = Capitalized Value – Net Assets |
This method suits stable companies.
Super Profit Method
Here, we compare actual profits with expected profits. Extra profits are called super profits.
Formula:
| Goodwill = Super Profit × Number of Years’ Purchase |
This is popular for fast-growing companies.
Use in Real Life
- Capitalization helps long-term business planning.
- Super profit suits new and fast-moving businesses.
- Both help in mergers and sales.
Using the right method helps in finding fair value. Accountants use these to record goodwill correctly. It also helps tax planning.
Types of Goodwill FAQs
Q1. What are the types of goodwill?
The main types of goodwill are purchased goodwill, self-generated goodwill, inherent goodwill, institutional goodwill, and professional goodwill.
Q2. What is the difference between purchased and self-generated goodwill?
Purchased goodwill is paid during the buying of a business. Self-generated goodwill is built over time by the business itself.
Q3. Is goodwill shown in balance sheets?
Only purchased goodwill is shown. Other types are not recorded as they are not paid.
Q4. How do we value goodwill?
We use methods like the capitalization method of goodwill and the super profit method of goodwill to find its value.
Q5. Why is goodwill important in business?
Goodwill adds value, trust, and customer loyalty. It helps in getting better deals, growth, and a strong image.
Q6. Can goodwill be negative?
Yes. If a business has a bad name or poor service, it may have negative goodwill.
Q7. What is meant by accounting for goodwill?
It means recording goodwill in company accounts during a business sale or merger.
Q8. Is there goodwill in small businesses, too?
Yes. Many small Indian shops and services have strong self-generated goodwill from loyal customers.
