The accounting charges that laid bare deep problems—and led to multi-billion dollar writeoffs—at Kraft Heinz Co. and General Electric Co. could get a makeover.
U.S. accounting rulemakers are mulling changes for reporting goodwill, the intangible asset that can make headlines when a merger goes sour. Under one option, companies would be allowed to amortize the asset over time—a move that would no doubt make it easier for pubic companies that are complaining about onerous reporting requirements, but it could also make it tougher to detect troubles lurking inside other companies, critics say.
“The reality is that the GE or the Kraft Heinz acknowledgment that something that didn’t go as forecast when they first priced the acquisition and completed the acquisition, this is information that is relevant to investors,” said Carla Nunes, managing director at valuation firm Duff & Phelps LLP. “When you amortize something over 20 or 40 years, you have no idea” that the acquisition didn’t go well.
Goodwill represents the difference between what a company pays to buy another business and the fair market value of its assets. Essentially, it represents management’s hopes to recoup the overpayment for the acquisition through potential new customers, brand recognition, and cost savings.
When these plans don’t materialize, the company must take a writedown. In the cases of Kraft Heinz and GE, the goodwill impairments were seismic—$7.1 billion and $22 billion, respectively.
In most cases goodwill impairments aren’t nearly so drastic. For relatively routine impairments, they are the source of constant complaints from companies and auditors who say the process to calculate the drop in value is overly complex, costly to calculate, and results in information that investors and analysts largely already know.
“Impairments tend to come after a pretty prolonged period of bad things,” said Ryan LaFond, deputy chief investment officer at Algert Global LLC in San Francisco. “It would be rare to find a company that took an impairment and the average investor thought things were going great.”
The Financial Accounting Standards Board expects to hear lots of views like this when it calls for feedback in the coming months on how to change the goodwill accounting model. But on the complex topic of how to keep companies accountable for ill-fated and expensive acquisitions, it will hear plenty of opposing opinions, too.
If FASB veers too far from existing accounting rules, some critics say, it could risk letting companies mask the buildup of goodwill that can lead to jaw-dropping impairment figures from companies such as GE and Kraft Heinz.
“That’s one of the things we’ll be looking at,” FASB Chairman Russell Golden told Bloomberg Tax. “That’s why we’re putting this out.”
Bad Feelings Toward Goodwill
For decades, accounting rules allowed companies to amortize, or steadily write down, their goodwill in small chunks for up to 40 years. The steady reductions dinged earnings in a predictable way.
In 2001, FASB said it wanted to shed more light on overpriced acquisitions. It called on companies to keep goodwill on their balance sheets forever until the value of the asset declined. At that point, the company would then either record an impairment for a portion of it, or even the whole thing.
In theory, the concept was simple. But the test to quantify the decline in value caused angst. Companies have to make complex judgment calls, pin numbers on hard-to-value intangible assets, and then face off against auditors to prove they got the figure right. Public companies must perform this exercise at least yearly.
“You have to go through a painful exercise and probably pay valuation experts,” said Douglas Reynolds, partner in the accounting principles consulting group at Grant Thornton LLP.
Minimal Tweaks So Far
FASB has tried three times since 2011 to fix the test. It’s reduced the number of steps, introduced a screening test to stave off the need to wade into complex math in certain situations, and in 2014 allowed private companies to almost revert to old accounting rules, letting them amortize goodwill for up to 10 years.
Private companies can forgo the mandatory yearly impairment test and only check for drops in value if there is a so-called triggering event like a shakeup in management or a recession.
In the midyear proposal, FASB is expected to float the idea of allowing public companies to amortize goodwill and test for impairment only when there is a triggering event. Kraft Heinz in February disclosed that several factors prompted its impairment charge, including a steadily declining stock price and expectations about weak natural cheese sales in Canada.
The idea of allowing goodwill amortization did not sit well with members of the FASB’s main investor advisory panel when FASB brought up the idea at a meeting last June. While members of the group told the board that the current goodwill accounting model isn’t perfect, they said allowing companies to steadily write it off their books over an arbitrary period isn’t the right solution, either. They said allowing goodwill to slowly disappear from a company’s books would hide how much a business overpaid for an acquisition.
“I am very much against amortizing it,” said Janet Pegg, an analyst at Zion Research Group and a member of the investor panel. “Resources went out of the company in order to acquire this asset.”
But other analysts say that if FASB allows amortization, it is easier for them to pick it apart and run their own models.
“The nice thing about the amortization approach is it’s pretty easy, very auditable, and investors can essentially undo it,” LaFond said. “It might be the least bad solution.”
The Look Ahead
Few expect FASB to completely revert to pre-2001 accounting rules, forgoing impairment testing entirely.
If FASB maintains some semblance of an impairment test with the goodwill amortization, investors would still potentially get the red flags companies send out when they record an impairment, said Olga Usvyatsky, vice president of research at Audit Analytics, an accounting research firm that studies goodwill impairments.
The dollar figure of these impairments could be lower because the companies would be steadily chipping away at the goodwill on their balance sheets via amortization every year from the date of their mergers.
In the exceptional cases of Kraft Heinz and GE, however, the deep problems within the companies would still prompt major impairments, even with amortization, she said.
“Both Kraft and GE would have had to record massive impairments at the triggering event date. That would not change,” she said.