How is goodwill valued in a small business?

In the accounting standard described below, goodwill is the leftover. First the cost of the acquisition is measured, then the identifiable assets and liabilities are valued, and goodwill is what remains. So the useful question is how each of those numbers was reached.

The accounting view: goodwill as the remainder

IFRS 3, the international standard for business combinations, sets out the core steps. The acquirer measures the cost of the acquisition, allocates that cost to the acquired identifiable assets and liabilities on the basis of their fair values, and allocates the rest of the cost to goodwill. Goodwill is therefore a result of the other numbers, not an input to them. Ask which accounting framework applies to the business you are dealing with.

The business is valued first

BDC explains that a valuator may use one or more valuation methods, depending on available information and the type of business and transaction, and that each method may yield a different value. It describes earnings-based approaches as commonly used for established businesses that generate reasonable returns and whose value is greater than that of their assets alone.

When a formal valuation is needed

Among the situations in which the CBV Institute says to engage a Chartered Business Valuator: your financial statements need acquired assets or goodwill valued, whether that involves allocating a purchase price or testing goodwill for impairment. The Institute also says a tax event calls for a supportable value. Ask your accountant whether your deal needs a formal valuation.

Where tax comes in

The Canada Revenue Agency lists goodwill among the property included in capital cost allowance Class 14.1 starting January 1, 2017. How a purchase price is split between goodwill and other assets is a tax question for both sides, so ask your accountant before the allocation is agreed. For the selling side, see how goodwill affects the price. For the buying side, see how to judge whether the goodwill is worth paying for.