When is an asset not really an asset?

04 April 2014

By John Hitchins

…When it is called goodwill, of course!

This little quip tends to elicit a reaction only from the most technical accountants. For everyone else, goodwill is now accepted widely as an asset. The debate in the past few years has focused not on whether goodwill should be recognised, but rather what to do once it is on the balance sheet. And most recently, regulator scrutiny of impairment and disclosures has amplified the discussion.

Few people seem to challenge the concept of goodwill as an asset. After all, if one party pays £100 in an arm’s length transaction, it seems only reasonable to assume that they received £100 of value in return. This rationale supports the basic principles of business combination guidance in IFRS but it is also widely accepted under multiple frameworks (goodwill is acknowledged in multiple GAAPs, in several jurisdictions for tax purposes, etc). It is the reason goodwill is calculated as a residual.

Yet, the more times I participate in this debate, the more I wonder – if the concept of goodwill disappeared tomorrow, would anyone really notice?

The obvious answer here is ‘yes.’ And in the short-term, I would agree.

Management would have to explain large charges to income in the period of acquisition; after all, our double-entry system means the residual has to go somewhere. Valuation experts would have to re-shape their service offerings. Regulators would need to identify the next hot topic, and so on.

That said, I think we would adapt quickly. In the long term I am not sure many would notice the absence of goodwill.

Several studies show that markets have minimal reactions to most goodwill impairment charges. In many cases, the market has become aware of, and adjusted for, the underlying business issues that led to the impairment well before it is reported in the financial statements.

In addition, the majority of large companies strip out one-time charges from their key performance metrics. This means that impairment is not included in those numbers today; if goodwill were to disappear, the one-off charge taken to income at acquisition would likely be viewed the same way.

Collectively, this treatment of impairment implies that the goodwill ‘loss’ is almost meaningless to both preparers and users. If that is the case, perhaps it never actually represents a meaningful value on the balance sheet.

And if those thoughts are not enough to convince you, we should not forget the most basic argument supporting goodwill’s disappearance - its own definition. Goodwill is defined as “an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified”.

The definition is a paradox. How can something represent the future economic benefits of assets that are not identifiable? If the assets cannot be identified, any related future economic benefits seem to lack the level of certainty required to recognise an asset on a balance sheet.

With that thought, we have an answer to our original question – when is an asset not really an asset? When it is called goodwill.

As usual let me know what you think!

John Hitchins:
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Agreed! Perhaps goodwill should be written off immediately, as it once was. Of course that would call attention to the bloated purchase prices of many acquisitions. Maybe - just maybe - that would have the effect of making acquisition bids more realistic.

We accountants and lawyers spend a lot time putting definitions to ideas that are inherent in business every day. We care because it is our job, but business leaders generally look at the big picture and generally don’t have patience for this stuff. The idea of goodwill is a function of this dynamic; it is based part on speculation and assumptions that need to be addressed in accounting because we cannot really determine the components of value.
Can you live without it? Of course you can, but our framework would not be complete without the existence of goodwill. How can we take the concept of goodwill out of accounting and undermine 200 years of established precedence in our accounting profession trying to better represent the economics of transactions?
As simple it might sound, the potential problem with goodwill is using the result of the formula as a line item in a balance sheet without validating the data. As we all know, goodwill may include not only the value of growth potential, synergy, and premium of control, but also overpayment for the acquisition (like in HP).
I think the problem with goodwill recognition as an asset is when it is inaccurate, when there is overpayment and misleading information. As a result, companies that cannot avoid taking the impairment loss have to apply the goodwill impairment model, which is costly and by the time the write-off is made, the market had already internalized it, making us think that the impairment model is a failure.
Having said that, it seems to be that there is always a market reaction to the goodwill write-off, and the degree of impact in the company’s stock price depends on whether the write-off is expected or not by the market. Also, it is clear that a key trigger for impairment write-offs is the decline in the stock market price due to the application of accounting policy, and after this adjustment is made there is still a residual effect in the stock market price.


Good to see what the mixed attribute model of valuation, false promises and dreams and deferred cash flows can do to you! We need to focus on entities and track objects and value them separately with deep industry understanding. Then goodwill will be a thing of the past and it will be easier to forecast the future. Goodwill bye, bye.

What is the real question: whether goodwill is an asset, or whether we don't know how to name it?

Expensing goodwill at acquisition date implies that there is no future economic benefits associated to this number and that management has therefore made a bad investment and has destroyed value to the shareholders. If this is case, then yes, P&L expense is the right treatment as it becomes a component of the performance of the entity.

But this is not deemed to be the case! Goodwill is the residual of the allocation of the purchase price : how to explain that a portion of the investment, deemed to reflect the market value, goes to P&L? What about goodwill embedded within equity accounted investments, joint ventures, AFS...? Should they all go to P&L as well?

The real problem is the day 2 accounting. Indeed, the market does not seem to care much about impairment charges. Even worse, management take the risk of being disinfranchised by recognising impairment charges too late ("management does not know what the market knows" - said to me recently a financial analyst). What matters is to know how capital is used, and how an entity obtains the return on the capital employed.

A measure of performance that takes into account the full cost would seem to get closer to the users' needs. This would imply a systematic amortization of goodwill. I have recently tested reactions from French preparers to this approach: out of 48 responses, 24 were in favor of systematic amortization, 14 in favor of annual impairment tests and 10 did not care. Said differently, 2/3 of the preparers who care prefer the systematic amortization. Will the IASB accept to reopen this door? Isn't it what the FASB is already doing?

Intangible assets, as defined, have no physical substance. That makes them the same as ghosts.

The main problem with ghosts is that most people don't believe they are real. The other side of the problem ghosts have is that people who do beleive in them will never be convinced they are wrong.

The more you try to pursuade people goodwill doesn't exist the more entrenched their viewpoint becomes.

This reminds me of several conversations I have had with an investor who believes that, in the ideal world, financial statements should include a "Value statement" showing how much value has been created or diminished over the period by management. Goodwill tries to capture when an acquisition has added value and put this on the balance sheet - in my mind anything that permits accounting to capture more value creation is useful.
The problem is that there are acquisitions that reduce value instead of create value (i.e. overpayment). If there was a way to determine whether an acquisition was a "good" acqusition or a "bad" acquisition, then we could reflect this as "goodwill" or "expense" as appropriate. Accountants don't yet have crystal balls, and management will always affirm they made a "good" acquisition. Until then,recognizing goodwill (and impairing it) seems just as valid as expensing the excess purchase price.

Agreed. Your post sums it all up. Goodwill has no place in the Balance Sheet because no future economic benefit will be derived. Maybe Goodwill should become a part of the Purchase Consideration in Future. It basically has no value to the owners of the company.

An interesting perspective: coming from a financial institutions specialist, such a view on goodwill is not surprising. However, from a ROE/COE and ROI perspectives and over time, it is helpful to keep track of goodwill actually paid at T-naught and its movements: it gives valuable info on the management's views of the acquired business' expected trajectory from the excess returns (i.e. excess over own cost of capital) and earnings growth points of view. Sectors in which capital requirements are regulated assign nil value to goodwill anyway (i.e. when determining various prudential ratios, etc.). Perhaps not wise to alter the current state of affairs, as it would diminish availability of information relevant when conducting analyses.

We had a discussion on this as the IFRS 3 PiR is on the go, and one thought that come up and that I do think has merit is to do away with the difference in accounting for an acquisition of a group of assets and a business combination. This would imply that the whole purchase amount be allocated to the assets and liabilities(based on their relative FV)that has been acquired and if deferred tax is not raised that residual amount above the assets acquired above fair value is also smaller.

This would solve a few problems: What is goodwill represents, how should it be accounted for, is special rules for impairment required etc., and take away the arbitrary debate on what is a business and what is not.

The only question that then arises what to do with the additional amount allocated to assets that must be carried at FV, i.e. financial instruments, but that I think is a very small issue compared to the problems we have with Goodwill.

We have been debating internally this issue for years now since we believe that Goodwill is significanly inflating Balance Sheets worldwide. In my opinion, on acquisition Goodwill should exist and I tend to disagree to take it to Profit or Loss immediately but throught out the years that Goodwill is reflected in the Profit or Loss and I would tend to go back to a mechanical amortization of goodwill rather than the impairment model which is subjective.

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