In our opinion, FASB’s analysis provided in Basis for Conclusion of FAS 141, Business Combinations provides well-structured and cohesive conceptual understanding of what goodwill is. This understanding can be used in addressing practical valuation and accounting questions related to transactions with businesses.

Conceptually, according to FASB’s analysis, goodwill has two components. One component is the fair value of the going concern element of the acquiree’s existing business. This value stems from the synergies of the net assets of the business, as well as from other benefits (such as factors related to market imperfections, etc.). Second goodwill component reflects the fair value of the expected synergies and other benefits from combining the acquirer’s and acquiree’s net assets and businesses. In short, goodwill includes two types of synergies that can be referred to as “internal” and “external”. Note that the impact of market participant synergies is included in estimated fair value of net assets and, therefore, is excluded from goodwill.

Current accounting guidance in ASC 805, Business Combinations includes specific requirements so that practical calculations of goodwill do not include certain components, which are not considered part of goodwill, based on FASB’s conceptual analysis.

For example, the excess of the fair values over the book values of the acquiree’s net assets is excluded from goodwill. From the current GAAP prospective, this is done as part of the accounting requirement to measure assets and liabilities of the acquired business at fair value, subject to certain exceptions.

Conceptual understanding of goodwill helps address a number of valuation and accounting questions, including those related to preparation of prospective financial information (PFI), estimating fair of purchase price in all-stock transactions and allocation of goodwill to reporting units.

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