When a company or part of a company is purchased, it is not uncommon for the purchaser to pay more than the sum of the fair market value for the individual assets minus the liabilities. This excess is called goodwill. It is often attributed to good management, good location, outstanding reputation, or other such factors.

For example, if ABC company paid $5,000,000 for the net assets of LKI Company having a fair value of $4,800,000, the excess of $200,000 represents goodwill. This cost is treated as an intangible asset and amortized over the expected economic life of the goodwill. However, this life cannot exceed 40 years and it cannot be written off all in one lump sum.

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