Goodwill; the Most Misunderstood Asset on the Balance Sheet

The FASB has been looking quite a lot at Goodwill lately.  First, they changed the impairment testing standard to allow an option of performing a qualitative test first.  While most public companies did not use this option, up to 30% of all companies (public and private) used the standard for at least some of their reporting units in 2012.  One of the biggest complaints about the qualitative test was not the test itself, but how the auditors were interpreting the requirements of the standard which resulted in almost as much or more work as performing a step one test in the first place.

The second action was taken by the Private Company Council (PCC) and recently approved by the FASB to allow private companies the option of simply amortizing goodwill over a default 10 year or other more appropriate period.  The amortization option would eliminate the required annual impairment test and only require an impairment test when certain triggering events occur; much like the way impairment testing for PP&E is handled today.

The PCC action caused the FASB to relook at the whole concept of goodwill and how it should be accounted for in the financial statements.  The FASB recently met to discuss possible options and the discussion was truly far ranging from whether goodwill is an asset at all to keeping it as an asset but changing the why we look at and test for impairment.

The question of goodwill being an asset is an interesting one. When it comes to goodwill as a distinct asset, you can’t buy it or sell it, but clearly companies paying more than the fair value of the hard and intangible assets of a company are buying something.  The questions are does that “something” diminish in value over time and should that “something” be supported solely by the acquired business or can you build new businesses that continue to support that value in the future.  Current accounting for goodwill would seem to answer those questions with a maybe and a yes.  Impairment would indicate the value can diminish, but because we don’t amortize goodwill, the diminishment is not a given.  In addition, the way goodwill is tested at the reporting unit level (rather than the acquisition unit level for example) would indicate that we believe goodwill can be supported by new businesses only tangentially related to the business acquired that created the goodwill in the first place.

The FASB has instructed its staff to look further into the issues around goodwill accounting by completing research on two alternatives to today’s accounting for goodwill.  The first is a simplified one-step impairment test process and the second is a much more radical direct write-off approach (although not necessarily through the income or comprehensive income statements).

The FASB is dealing with lots of questions about the costs and benefits of current goodwill accounting.  Goodwill impairments seem to have little to no impact on stock price which would seem to mean that there is little value (benefit) in the information provided by a goodwill impairment.  On the other hand, a direct write-off may eliminate important information of the return on assets that investors need to know and understand.

While not as impactful as revenue recognition, lease accounting or financial instruments, the accounting for goodwill might bring out the passionate accounting purest viewpoints much like happens whenever the topic of the accounting for share-based compensation is brought up. (If you want to start an argument with another technical accountant just take the position that share-based compensation is 100% expense or 100% an equity transaction see what happens).  This one might be worth keeping an eye on as the FASB continues to revisit the issue throughout this year.

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