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Goodwill Accounting Could Go Back to the Future

Nov. 15, 2019, 11:00 AM

It was the end of the dot-com bubble and the height of mega mergers like America Online and Time Warner Cable.

The economy was changing rapidly, and to keep up the Financial Accounting Standards Board in 2001 issued what was considered a major change. It forced companies to own up when mergers don’t go as planned and write down the intangible asset known as goodwill when its value declined.

The change killed a long-standing practice that allowed companies to amortize, or write down in chunks, the value of the asset—like a purchased company’s brand name—that arises when one company buys another.

Almost 20 years later the move remains unpopular, and FASB is now considering going back to the way things were—allowing companies to once again amortize goodwill.

Critics argue the test to assess impairment is too complicated. Barring high-profile write-downs like the one that made Kraft Heinz Co.’s stock price plummet in February, many analysts also believe the test reveals too little impairment, too late.

“We did not anticipate all the complaints,” said Ed Trott, member of the FASB from 1999 to 2007.

The board in July released an exploratory document asking the public for input and will hold a Nov. 15 hearing on the topic.

Too Complex?

When FASB first considered the idea of nixing the amortization of goodwill, many companies agreed with the proposal. Microsoft Corp., Motorola Inc., and General Mills Inc., all signed on as supporters, according to comment letters from that era. That’s because amortizing goodwill forces periodic hits to earnings.

Getting rid of this constant drag on earnings was appealing, said Bob Laux, who was Microsoft’s director of external reporting in 2001.

“I’ll be honest, there was that kind of pressure within the company—‘boy, this sounds like a good thing’,” Laux said.

But Laux and others didn’t expect how complex the final product would be.

“I don’t think we realized how difficult it would be, how much judgment there would be—and how much double guessing,” Laux said.

The way FASB carried out the process to test for impairment is the ultimate problem, said Trevor Harris, an accounting professor at Columbia Business School.

“The impairment test they adopted was nonsensical,” Harris said. “They made a whole complicated way of doing it and never tied it to the actual acquisition process. When all of this was done, people were not taking impairments when they were actually real.”

For the people who were the strongest backers of an impairment model, the prospect of FASB going back in time makes no sense, though.

“The problem is, if you make an acquisition, there’s no accountability for that if you just amortize it over some arbitrary period,” said Harris. “Partly because if it declines over time and no one’s recognizing or evaluating the real cost.”

Goodwill details

Determining what is goodwill isn’t easy either, critics say. When one company buys another, it adds up the fair market value of all the hard assets it acquires as well as intangible assets like patents. The company compares the sum to the total price of the deal. What’s leftover is called goodwill.

The acquiring company must keep goodwill in a separate section of its balance sheet indefinitely. It stays there until its value declines.

FASB has tried three times since 2011 to make the test for drops in value less complex. It’s reduced the number of steps and introduced a screening test to stave off the need to wade into complex math in certain situations, and in 2014 allowed private companies amortize goodwill for up to 10 years. But complaints persist.

“Impairment makes a lot of conceptual sense,” said Stephen Ryan, a professor at the New York University Stern School of Business. “In practice, it’s very difficult for a number of reasons.”

To contact the reporter on this story: Nicola M. White in Washington at nwhite@bloombergtax.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergtax.com; Meg Shreve at mshreve@bloombergtax.com