Final answer:
Goodwill is recognized when another company is acquired, reflecting the excess of purchase price over fair market value of the acquired company's net assets. Other scenarios like undervaluing intangible assets, asset impairment, or paying less than fair value for an intangible do not lead to goodwill recognition.
Step-by-step explanation:
Goodwill is an intangible asset that may only be recognized when another company is acquired. This occurs because goodwill represents the excess of the purchase price over the fair market value of the acquired company's identifiable net assets at the time of acquisition. It encompasses elements like customer relationships, brand reputation, and proprietary technology that don't have a standalone value but contribute to the company's future earnings.
Goodwill is not recognized simply because intangible assets are undervalued, assets are impaired, or a company pays less than fair value for an intangible. These scenarios do not satisfy the accounting criteria for recognizing goodwill. When assessing the value of a company during an acquisition, a detailed analysis is performed to distinguish between the tangible and intangible assets and liabilities to determine any excess purchase price that should be recorded as goodwill.
The purchase of a company by shareholders results in a complex financial transaction. The company obtains money from the sale through the payment received from the acquirer, which is often a combination of cash, stock, or other considerations. The purchasing company must then allocate the purchase price to the acquired assets and liabilities, with any remaining amount being recorded as goodwill on their balance sheet.