Every subsidiary intangible (such as patents and databases) that meets either of the official criteria is consolidated by the parent at fair value. Any excess price paid over the total fair value of these recorded assets (the extra $1 million in this question) is also reported as an asset. It has a cost and an expected future value. The term that has long been used to report an amount paid to acquire a company that exceeded all the identified and recorded assets is “goodwill.” Some amount of goodwill is recognized as a result of most corporate acquisitions. In this example, it specifically reflects the value of the customer loyalty and the quality of the subsidiary’s workforce. If Giant pays $16 million for the stock of Tiny when its reportable assets have a value of only $15 million, the following entry is made by Giant to consolidate the two companies. As shown, the additional $1 million is labeled as goodwill, which will then be included within the intangible assets.
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The acquisition of one company by another can require months of intense negotiations. One company wants to collect as much as possible; the other wants to pay as little as possible. Compromise is frequently necessary to arrive at a figure that both parties are willing to accept. In most cases, the new parent has to pay more than the sum of the value of all individual assets to entice the owners of the other company to sell. Sometimes, as in the initial example with the customer loyalty and talented workforce, the reason for the added amount is apparent. More likely, the increased payment is simply necessary in order to make the deal happen. Because the extra amount is sacrificed to gain control of the subsidiary, it is still labeled by the parent as an asset known as goodwill. The rationale does not impact the accounting. Any extra acquisition price settled on to acquire a subsidiary appears in the parent’s balance sheet as goodwill and is shown as an intangible asset.
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