To many investors, the never-ending debate on goodwill impairment is largely a waste of time. Just because there is an asset on the balance sheet, it does not follow that the asset is real or has any value.
Let’s step back a moment and consider what goodwill actually is – an artificial creation to ensure that the holy grail of double-entry bookkeeping remains sacrosanct. Goodwill is created simply to make the balance sheet still balance when a company has paid a premium over net asset value. As IFRS Standards-setter the International Accounting Standards Board (IASB) has admitted, goodwill cannot be measured directly, as it simply does not exist as an independent entity.
A dubious asset
Imagine trying to explain goodwill impairment to an intelligent and numerate non-accountant: ‘We have an “asset” that we cannot measure directly and is really just a balancing item. We are then going to test the robustness of this “asset” by doing a very subjective, long-term, cashflow-based assessment on a business unit that may well be different from the unit the goodwill belongs to.
‘We will have to make lots of subjective judgments in this process, and any resulting impairment will not result in new and useful information for investors. And we will have to pay experts to do this every year.’
To make matters worse, some goodwill is in effect reclassified as other intangible assets (customer lists, brands, etc) even though IFRS Standards expressly forbid the creation of such assets organically. These assets are virtually impossible to value with any accuracy, and the amortisation period is an educated guess at best.
These assets are virtually impossible to value with any accuracy, and the amortisation period is an educated guess at best
Ignored by investors
In my experience, most investors ignore goodwill impairments and strip out the amortisation of quasi-goodwill intangibles. There is quite literally no point in analysing these numbers as they contain no useful information. Goodwill impairment is just a belated admission (usually by new management; where does a change of management feature in the standard?) that an excessive premium was paid.
When the reported operating profit suddenly increases because the acquired customer list has been fully amortised, has the company suddenly become more valuable? No. I know some companies that trumpet annual improvements in return on capital that are largely due to the quasi-goodwill assets being amortised. The return numerator of course excludes the amortisation charge.
What this arcane debate completely misses is the importance of stewardship and return on capital. Investors are very interested in how much money has been invested in a business and what returns are being generated. The way that goodwill and quasi-goodwill intangibles are currently reported makes it very difficult to establish both the economic value of invested capital and the clean operating profit.
The Corporate Reporting Users’ Forum (CRUF) has been pushing for better disclosure on acquisitions for many years, and the IASB’s discussion paper contains welcome suggestions that would enhance investors’ ability to understand what has been bought and what benefits are expected to accrue.
Simple solution
There is an easy answer to the impairment debate that would be cheap to implement and radically improve transparency: keep goodwill on the balance sheet forever unless the entity is closed or sold. And get rid of these quasi-goodwill intangibles and call them what they really are: goodwill.
Suddenly we would be able to see the real capital invested in acquisitions and we wouldn’t have meaningless non-cash amortisation charges going through the income statement. More importantly, we could get back to what really matters: a true and fair view of the business. Now that would be radical.
