Goodwill: An Elusive but Valuable Asset

Goodwill might be the most valuable asset on your company’s balance sheet. It might also be the most difficult to place an accurate value on. As important as goodwill is to the health of your organization, it remains an intangible and elusive quality that presents risk and audit professionals with a unique and demanding set of challenges.

In terms of valuation, goodwill represents the value of a company over and above the net asset value of tangible assets and financial holdings. Hard assets are relatively easy to account for in dollars and are also (generally) easier to acquire. It’s goodwill that suitors are willing to pay a premium for in their takeover bids. It’s goodwill that competitors are really after when they propose mergers.

Goodwill, however, goes beyond accounting. It represents the essence of a company. It is the stuff that makes one company different than another. It is a summation of reputation, status and organizational character. It’s the invisible force that attracts clients and customers. It is the biggest component of a brand.

All of which is to say that goodwill is something to be taken seriously by the entirety of an organization, including the accounting department.

Goodwill in Merger and Acquisition Accounting

KnowledgeLeader has identified the most critical goals in the goodwill accounting process and integrated them into an accounting policy and finance template we call our Accounting for Goodwill Policy. Our subscribers have full, unlimited access to this comprehensive and customizable policy and procedures guide and, based on the feedback they’ve provided to us, many of them find it an invaluable resource.

This policy document was written in accordance with SFAS 142 “Goodwill and Other Intangible Assets” and, as such, is particularly beneficial when used in preparation for a potential or imminent merger or acquisition. It was designed to be a guide and policy outline for risk, audit and accounting personnel who are tasked with providing accurate and timely valuation analyses to interested parties.

The Two Most Important Objectives of Accounting for Goodwill

Determining Book Value and Fair Value

Determining and reporting on the overall value of a company has both an objective and a subjective component. Book value is a mostly objective data point. Fair value, on the other hand, is somewhat subjective. The buyer of a company will often have a very different conception of fair value than the seller of that same company will have.

KnowledgeLeader’s Accounting for Goodwill Policy focuses on finance procedures that help accountants establish a legitimate fair value that both buyers and sellers will find honest and reasonable.

Several techniques for establishing fair value are suggested, including:

• Quoted and/or published prices on stock or other markets
• Current (trailing) and estimated (forward) price and revenue ratios
• Other methods such as extrapolating fair value from the acquisition price
• Mix and match various proven methods

We also remind accounting pros that the fair value of goodwill is not to be measured directly but should be calculated residually.

Discovering and Disclosing Goodwill Impairment

One of the biggest responsibilities of the accounting manager is to identify any impairments to goodwill and to fully and fairly disclose them to company management, potential buyers, the investing public (for publicly traded securities) and government regulators.

Impairments represent value destruction that can happen when a company’s goodwill is damaged or, for one reason or another, has been lost. Impairments might be the result of a series of product recalls that call quality and customer satisfaction into question. They can also happen when scandals or crimes involving company management are uncovered. The new technology that supersedes or eliminates a comparative advantage will likewise erode goodwill. Anything that devalues a company by hurting its brand image is an impairment of goodwill.

Impairments are at the heart of SFAS 142 because that directive from the Financial Accounting Standards Board back in 2001 precludes the amortization of goodwill. Goodwill is now rightly recognized as a conceptually perpetual asset that can maintain value, increase in value or decrease in value. In the absence of amortization, decreases in the value of goodwill must be recorded as “impairments.”

Our goodwill accounting policy template encourages:

• Robust and continuous testing for goodwill impairments
• Identification and mitigation of potential changes that could trigger impairments
• Assignment of appropriate units for impairment testing and reporting
• A plan for valuing (determining valuation impact) and accounting (recording) for impairments
• Management review and approval of accounting entries to ensure compliance with GAAP

How To Test for Goodwill Impairment

The goodwill accounting tools produced by KnowledgeLeader do more than just remind audit and risk personnel of jobs to be done. We endeavor to show innovative and up-to-date methods of actually doing them.

The tool we’ve been highlighting in this article — the Goodwill Accounting Policy —recommends a two-step process for the implementation of a goodwill impairment testing procedure.

Step One

The first step involves the controller (or an authorized individual appointed by the controller) comparing the established fair value of a company (or unit) with its carrying amount, which will include goodwill.

Before making determinations on appropriate reporting, the controller will consider various factors, including:

• Revenue and expense activity levels
• Results as reviewed by management or other decision-makers
• The reliability and availability of discrete financial data

Step Two

The second step is where the dollar value of impairment is determined. This is done in a straightforward calculation that compares the implied fair value of the goodwill that’s being evaluated with the carrying value. If the carrying amount is found to be higher than the implied fair value, an erosion of goodwill has occurred and the controller will direct the proper reporting of that fact.

When to Test for Goodwill Impairments

Qualified risk professionals know that goodwill impairment testing must be conducted at least annually and will take direction from the company’s CFO as to the timing of these annual audits. Once a year, however, may be insufficient in today’s constantly changing business environment.

Our Goodwill Accounting Policy takes this into account and proposes a set of “triggers” or “tripwires” that prompt interim impairment testing in between regularly scheduled examinations. They include:

• Changes in the legal or regulatory landscape
• Changes in the general business climate
• An increase in competition by new or existing competitors
• Loss of or unanticipated changes to key personnel

Required Disclosures

SFAS 142 was a welcomed change to GAAP but it did impose a new set of required disclosures to be aware of. One of the services KnowledgeLeader provides to subscribers is to create accounting checklists so critical items are not neglected.

Our Goodwill Accounting Policy closes with a useful list of some of the most important disclosures in this vital aspect of accounting. Some key disclosures to remember are:

• Descriptions of events that led to goodwill impairment
• Goodwill stated in aggregate amounts
• Goodwill attributed to the disposal of a business unit
• If an impairment is merely estimated (as opposed to finalized)
• Any reliance on or compliance with other SFAS directives (such as SFAS 146)