goodwill accounting

goodwill accounting

Goodwill Accounting: Maximizing Value and Transparency

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1. Understanding Goodwill Accounting

Goodwill is an asset that arises when a company acquires another, but pays more than the fair value and more than the identifiable assets at fair value and liabilities at their fair value. Differences between the fair value of the consideration exchanged and the fair value of the net identifiable assets of the acquired business are generally accounted for as the noncurrent intangible asset goodwill. This paper examines the alternative models for accounting for goodwill, contrasts them with those under US GAAP, and addresses the relevance and decision-making implications of adopting either the current US GAAP goodwill accounting standards or an alternative development model. In addition to the influence of different accounting treatment for goodwill assets, the relative disclosure levels of IAS (International Accounting Standard) 36 and US GAAP serve as a basis for evaluating the potential dual impact of goodwill accounting on transparency for decisions regarding cross-country investing (trading) in developed and developing markets.

In the current complex operating environment, corporations are also finding that mergers and acquisitions are effective tools to expand market scope, diversify product lines, increase economies of scale, and enter new markets. When two companies combine, the purchase price of U.S. Generally Accepted Accounting Principles (US GAAP) accounting for such transactions results in “goodwill,” which represents the excess of the purchase price over the intrinsically perceived value of the acquired entity. The measurement process has been best described as “an abstruse and arcane transaction that apparently has more to do with financial alchemy than sound reasoning.” One result of the complexity and controversy surrounding the calculation of goodwill is that managers and investors are challenged to understand the degree of success in the combination.

2. Importance of Goodwill in Financial Reporting

Is goodwill good? The 100 or so of publicly traded UK companies we are able to survey in the pre-IFRS U.K. and Colonial U.S. fields had substantial percentages of goodwill relative to total assets which were divisible by 20, and were on opposite sides of subsequent investor returns. Although a situation akin to the placebo effect is possible (where corrective goodwill write-downs may artificially depress returns), we find that it does not explain the differential performance pre-IFRS. Rather, we offer an alternative explanation: our superior firms’ shareholders were informed of the actual collective advantages their firms possessed, which creditor-oriented historical accounting methods tended to under-represent, at the time investors formulated their return expectations.

Goodwill (the excess cost paid to investment in a company over and above its individually identified assets and liabilities) represents over 75% of enterprise value in the average acquisition, and globally accounts for well over $1.3 trillion of market capitalization. It signifies the acquirer’s anticipation of synergies or superior management, technology, location, marketing, etc. – the latter often known as “soft,” “unidentified,” “undiscounted” or even “intangible” assets. It is telling to note that average annual growth in goodwill is double that of GDP. Also, it’s quite intriguing to observe that analyst and administrator adjustments of goodwill impairments in the USA and UK have grown to 50-100% of the losses firms actually report; the increase is so unusual that it cannot be explained by macroeconomic events or the general increase in goodwill asset values themselves.

3. Challenges in Assessing and Measuring Goodwill

Before examining the particular goodwill accounting measures, it is useful to think broadly about intangible assets. The most simple distinction is that of separable versus inseparable intangibles. Known also by the less precise term ‘strategic’ assets, inseparable intangibles result from most investment in intangibles such as advertising, consumer feelings, training of employees, customer relationships, and research and development. Growth rate and accounting returns to less tangible investment. With little empirical literature on specific treatments of goodwill, our research to date is tested with two alternative descriptions based on implied historic and forecasting goodwill assets. Such disclosures, by contrast with reporting only an inseparable component of goodwill at acquisition, would help stakeholders to critically evaluate whether the eventual goodwill asset inflating the survivor parent consolidating unit’s balance sheet as a result of an acquisition event is exactly a reflection of true, additional acquired assets of the target, or rather a blend of acquired and inseparable ‘other’ intangible assets at (above book) cost, other overpayment costs to shareholders, or even destruction of acquired acquiring assets such as from incurring M&A agency costs.

Challenging to assess, challenging to measure, and challenging to track—goodwill as an accounting item is viewed with skepticism by some market participants. One of the core mandates of the International Accounting Standards Board (IASB) is to increase transparency and provide decision useful information, and they have responded to critics of the goodwill accounting standards with an exposure draft proposing additional disclosures. In this paper, the authors, Graham Holt, director of professional studies, and David Cairns, senior lecturer in accounting and finance, both at the Business School at Manchester Metropolitan University, explore goodwill and the IASB proposal in more detail. This paper provides a critical overview of the accounting treatments developed to date and the implications of the proposed IASB changes for research and useful, transparent financial reporting. The authors propose a more efficient, piecewise measure of goodwill in the explains how that measure relates to parent, survivor, and target firm values.

4. Enhancing Goodwill Disclosure and Reporting

The financial statements of publicly traded firms include two key goodwill components, neither of which are disclosed for transactions. In the indirect goodwill component class, goodwill is the difference between the total implied non-taxable fair values of a firm’s identifiable balance sheet assets, liabilities net tax operating loss carryforward, including any cost basis acquired in process research and administrative and marketing intangible assets, and the fair value of the firm’s equities (stock, options, warrants) during a non-impairment quarter. Direct goodwill consists of the running proposed impairment threshold liability cap costs basis intangible acquired and up to a purchase price premium cash similarity superdividend equivalent with a direct goodwill synergistic expensive increase over future acquired operating net tangible and residual and non-operating acquired intangibles that has practical lifetime expectation.

Using the annual report of a standalone S&P firm’s CEO-chair firm from the date of an acquisition, we document goodwill component and synergy (adjusted value far above proposed impairment threshold) disclosure features for each standard’s appraisals. Non-GAAP disclosures, despite some proposed impairment threshold liability cap benefits, are found not feasible but promising for RET capital market explanatory and forecasting objectives with empirical evidence of expected one-year discounts and volatility.

Investors and other financial statement users need better information about acquired intangibles and goodwill. They need to understand why an acquiree is worth more than its book value using fair value accounting, and how an acquiring firm is extracting economic benefits from a combo. The income tax law operations of the GAAP versus non-GAAP other-than-temporary difference timetable shortcut are in an IRS reserves acceleration deferred GAAP tax deferral when and if the transaction becomes taxable. Proponents argue that the fair value standard can squeeze as little as possible of the economic goodwill and upward distort a combo’s assets, while promoting periodic and event-driven (loss recognition, impairment) downward distortions by separate asset values and depreciation still following depreciating amortization baselines.

5. Best Practices for Goodwill Accounting

We study the effects of these improvements over the previously reported coefficients and the ability of these models to measure goodwill in an accounting framework. It is important to assess the practical merits of these options in order to encourage them to become recognized as “better documentation of the transaction.” By sharing our method with the investment research audiences, we also contribute to the reconciliation of research and reporting stances in the field of goodwill asset valuation. Despite the institutional mechanisms that have been advocated and implemented recently by both scholarly communities and standard setters, investment researchers also adhere to a degree of independence that has become necessary for any self-standing discipline to survive and flourish. Yet the same level of independence has by and large created a division of theoretical interests that made a reconciliation of financial reporting standards and academic research outcomes necessary in the first place. It is important to anticipate the trade-offs that recurrently emerge in this kind of reconciliation and examine the best solutions we can introduce in this setting to interpret empirical results in the context of better practice guidelines and vice versa.

An advanced approach to goodwill accounting should seek to maximize the level of information about the available information for decision-makers, while also maintaining coherence and consistency with not only reporting standards but also other metrics across times. Common challenges to goodwill accounting best practices are either not controlling for some or other relevant factors most times, nor addressing both positive and negative impacts of the acquisition separately, and most especially, not accounting for the full extent of executive compensation that is either embedded into the purchase price or determined, but not reconciled, as a response to the transaction.

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