Goodwill arises when a company buys another business at a price greater than the value of its assets. The excess of the amount paid over the NAV of the acquired business, is shown in the balance sheet of the acquiring company.
As goodwill does not have any relationship to future cash flows, but only the past, it is often ignored by investors. The use of profit measures such as EBITDA and EBITA is widespread. Measures of financial strength such as gearing should also exclude goodwill.
The value used in calculating goodwill on acquisition (under IFRS) is not the book value shown in the acquired business's accounts before it is bought but the fair value. This is also (necessarily) the value at which assets themselves are shown in the acquirers' accounts.
Under UK accounting standards, companies amortise goodwill if it is positive, even adding it to the profit and loss account (P & L) over several years if it is negative — either way, the impact is evenly spread over several years.
IFRS 3 requires companies to add negative goodwill to profits in whole and immediately. Positive goodwill (which is usual) is shown as an asset but is not amortised every year. Companies that have goodwill on their balance sheets are required to review the value of the goodwill annually and, if its value has been impaired, take the amount of the impairment as a cost in the P & L. If the value of goodwill is not impaired its can be shown in the balance sheet indefinitely.