When is an asset not really an asset?
Published on 04 April 2014 12 comments
…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!