The category into which the goodwill of a company will fall depends upon the fact that how that company got its goodwill. Did it purchase the goodwill like any other asset or did it earn the goodwill on account of its standing in the business. Hence goodwill of a business concern can be divided into two categories from accounting point of view.
1) Purchased Goodwill
2) Non purchased Goodwill.
We will explain the concept of purchased and non purchased goodwill with the help of examples. Let us assume that You purchased the business of a company XYZ ltd. The purchase consideration that you paid is $20 million. But the value of net assets acquired by you against the purchase consideration is only 19 million. This extra one million $ that you are paying as a part of purchase consideration represents the amount of goodwill that you purchased from XYZ Ltd along with other assets. So if the purchase consideration exceeds the value of net assets taken over by you, the difference is called purchased goodwill. Purchased Goodwill arises on the acquisition of an existing business concern. It can be calculated with the help of purchase consideration and the value of net assets acquired. You can show the value of this Goodwill in your Balance Sheet like any other asset. The cost of the purchased Goodwill is determined by the future maintainability of profits.
Let us again assume that while working in the same business due to some positive factors you have earned a value for your business which the other business concerns on the same level of activity do not possess. This value, athough not exhibited by your financial statements, yet it makes you stand apart form your rivals. It can fetch a good market standing to you. It has given a loyal customer base to you. This positive image of your business reflects in the trust of your creditors and bankers which they have on you. This value for your business that you have earned yourself is called Non Purchased Goodwill. Non purchased goodwill, as it is clear from the name itself is not purchased from any other entity. It is the goodwill that has been earned by you over a period of years on account of many favorable factors that increase the value of your business. Non purchased goodwill is the goodwill which the business has generated on its own due to its location, managerial efficiency, credit worthiness, brand value, product quality, public image and many more other factors. It is also called Raised Goodwill or Inherent Goodwill. It has been generated by the company itself so no consideration is paid for it and hence no cost can be placed on it. It is not shown in the Balance Sheet of the business.