Financial reporting advisory

The love hate relationship of goodwill

Matthew Esposito
By:
Matthew Esposito
As far back as twenty years ago, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) changed the accounting of goodwill that still brings passionate debate to this day.
In this article

What is goodwill?

Goodwill is the excess of the consideration transferred (typically cash and/or stock) by the acquiring company over the fair value of the target company’s assets and liabilities acquired. Prior to that course correction in 2001, goodwill was amortised over a finite time period, sometimes as long as 40 years.

Goodwill amortisation elimination options

The elimination of goodwill amortisation was not taken lightly by the Boards. Various options were considered such as:

  1. Writing off all or a portion of the goodwill immediately
  2. Reporting goodwill as an asset that is amortised over its useful life
  3. Reporting goodwill as an asset that is not amortised but is reviewed for impairment
  4. Reporting goodwill as an asset, a portion of which is amortised and a portion of which is not amortised (a mixed approach).

An immediate write-off method was not selected as goodwill is considered an asset and an immediate write-off because it was worthless would undermine the very decision that it was an asset to be recognised. An amortisation method was no longer the preferred approach because not all goodwill was considered a wasting asset, a straight-line amortisation method did not match economic reality, and providing an option to amortise would result in financial statements that were no longer comparable for investors.

In addition, reporting a portion of goodwill as an amortisable asset was not practicable because it would be too difficult to split goodwill apart. This long-standing debate by the Boards and its stakeholders resulted in Option 3 (an asset that should not be amortised) as being the preferred approach post 2001.

However, the debate over amortisation never seemed to go away. Often times, when an entity reports a goodwill impairment which results in a large non-cash loss being reported, the entity will identify that loss specifically in their earnings releases and calls. Investors will then shrug it off as it does not affect operating cashflow. However, some stakeholders prefer the indefinite life – impairment approach as they believe an impairment indicates that management may have overpaid for an acquisition or did not derive the expected value from the acquisition. Such an impairment event would be useful for investors to know as it is a reflection on management decisions.
Those who prepare financial statements often criticise the impairment model.

Accounting for goodwill

I have been in meetings with Chief Accountants who have expressed an interest in just writing off goodwill on the acquisition date, so they don’t have to perform impairment tests subsequently and substantiate their results to their independent auditors. Other Chief Accountants have noted that may be too extreme and would have trouble explaining to their CEO why what may have been a good strategic decision resulted in an immediate loss. They would prefer returning to an amortisation approach which should alleviate the pressure of future impairment testing.

I have even come across discussions where business unit managers complained that they were being held accountable for goodwill that they did not create themselves nor could they pinpoint its origin as the acquisition occurred in periods well before they arrived in that role or to that company.

And last, some companies are so acquisitive that goodwill may be one of the largest assets on their balance sheet, and those companies would not want it expensed as it will drag down their earnings for years to come and may event transfer an equity surplus to an equity deficit.

Cracks in the goodwill accounting model

Fast forward almost twenty years and we are now seeing cracks in the goodwill accounting model that have developed in the United States. In December 2020, the FASB has tentatively decided to go back to the amortisation model for goodwill and is considering a straight-line approach for a period of no longer than ten years. This would be a significant departure from GAAP today and a divergence from IFRS where the two accounting regimes were mostly aligned. It’s amazing what a different composition of Board members can do to past decisions.

Some stakeholders saw this coming. In 2014, the FASB provided an option to private companies to amortise goodwill on a straight-line basis over 10 years. This option was extended to not-for-profit organisations in 2019. It was only a matter of time for the Board to reconsider goodwill amortisation for public companies. The FASB has yet to issue an exposure draft on returning to goodwill amortisation which means this tentative decision is not yet final GAAP.

It could still be a couple of years away as the Board will need to issue an exposure draft, receive comments, and then redeliberate before a final standard is issued. But many eyes are watching the Board’s progress and when issued as a final standard, those eyes may then turn towards the IASB to see whether the change in US GAAP will change their views under IFRS.

If you would like to discuss this topic further then please let me know, or speak to your local Grant Thornton member firm.