When a company is bought, the buyer records the target's assets at fair value, not at the target's book value. The price is allocated in layers:
- Start from the target's book value of equity.
- Add write-ups: PP&E marked up to fair value, and intangibles the target never recorded (brands, customer lists).
- Subtract a deferred tax liability on the write-ups (write-ups x tax rate): the tax deductions on those assets stay at their old, lower values.
- Goodwill is whatever the price exceeds the fair value of net assets.
If the price is below fair value, there's no goodwill: the buyer books a gain on a bargain purchase instead. And goodwill already on the target's books is written off first, because it's replaced by the new goodwill.
Write-ups are depreciated and amortized like any asset, which lowers the buyer's future earnings; goodwill isn't amortized.