Goodwill is an intangible asset that arises in a business combination when the fair value of the consideration paid exceeds the fair value of the identifiable net assets acquired. In other words, goodwill represents the premium paid for the business over and above the value of its individual assets and liabilities. Goodwill is recognized as an asset on the acquirer’s balance sheet and is subject to impairment testing.

According to AASB 3 Business Combinations, goodwill should be recognized as an asset at the acquisition date, measured as the excess of the consideration transferred, which is typically the fair value of the acquirer’s shares, over the fair value of the identifiable net assets acquired. The accounting treatment of goodwill is based on the idea that a business combination creates synergies that are not available to the individual entities, such as economies of scale, increased market power, and enhanced intellectual property.

For example, suppose Company A acquires Company B for $100 million. The fair value of Company B’s net assets is $80 million, and the excess consideration paid is $20 million. In this case, Company A would recognize $20 million of goodwill on its balance sheet. Goodwill represents the expectation of future benefits that arise from the combination of the two companies and is subject to impairment testing annually or whenever there is an indication of impairment.