When you buy a business, whether to expand your current enterprise or to venture into new entrepreneurship, you will encounter an element of accounting known as goodwill. The simplest definition of goodwill is a premium paid above the market value for tangible assets such as equipment.
For example, buying a business might result in obtaining equipment worth $20,000, plus office supplies valued at $400, as well as a $600 computer and a truck with a $30,000 market value. Based on face value, if you acquired these items separately, they would cost you a total of $51,000. If you pay $60,000 to buy the business, the extra $9,000 is a cost for goodwill. It covers the intangible value that is above and beyond the tangible assets you acquire.
Each of the types of items you purchase must be accounted for separately in your books, so identifying the fair market value for each tangible asset is crucial. A business buyer and a seller always agree on the fair market value for tangible assets, and the buyer designates the premium paid as goodwill. The seller also needs to know how much goodwill you’re buying, since that’s the amount of goodwill he’s selling. A seller’s tax calculations depend on the cost for each item sold, including the goodwill.
Keep in mind, goodwill is another asset on your business balance sheet. It is not an expense that you deduct. Your bookkeeping should record distinctive amounts for inventory, supplies, various categories of equipment, and goodwill. Additionally, different tax treatment applies to each type of asset. Consult with your financial professional to ensure goodwill is accounted for correctly when paying taxes.