FASB considering updating guidance for goodwill
What is goodwill? This was a question posed by the Financial Accounting Standards Board (FASB) when they asked stakeholders for comments on the current treatment of goodwill for public companies under GAAP last year. FASB is evaluating those comments and other input from stakeholders as it considers changing the treatment of goodwill.
As a recent Wall Street Journal article points out, the consequence of the current treatment is that public companies have an aggregate $5.5 trillion in goodwill on their books. Since 2008, the amount of goodwill on books has risen, even with headline-grabbing, dramatic write-offs. For example, in 2019, Kraft-Heinz wrote off $7.3 billion in goodwill impairment losses related to its Kraft and Oscar Meyer brands.
What is goodwill?
My accounting textbooks defined goodwill as the excess of the purchase price of a business over the fair market value of the identifiable assets purchased. This means goodwill only gets on the books when a business is bought.
But, what is it? If a buyer pays a premium for a business, there must be a reason. Maybe, the acquired company has a strong and valuable brand identity, or proprietary knowledge. Perhaps, this company has workplace processes that create efficiency, or a well-trained workforce that will stay on.
In some cases, goodwill may represent future economic benefits for a company, or it may represent the opportunity to enter a new market with a key acquisition. The ability to enter the grocery market is likely why Amazon put $9 billion of goodwill on its books for the purchase of Whole Foods. Some critics say that goodwill is not much more than a plug figure.
GAAP and goodwill
Prior to 2001, when Statements on Financial Accounting Standards (SFAS) 142, Goodwill and Other Intangible Assets, was released, goodwill was amortized straight-line over a period not to exceed 40 years. However, stakeholders complained that an annual goodwill amortization expense didn’t provide any useful information. Goodwill doesn’t always lose value over time, and if it does, it’s not at a straight-line rate over an arbitrary time period.
Under SFAS 142, amortizing goodwill stopped, and instead, goodwill was subject to periodic impairment testing. Goodwill is impaired when the fair market value of the business unit that gave rise to the goodwill is less than the value of those assets on the books.
This can happen when expectations for synergies from a merger don’t materialize, or when unpredictable market conditions change. Write-downs also occur when there is a “triggering event,” such as the loss of a key customer, an economic downturn, or competitive pressure.
Business owners and accountants argue that impairment testing is subjective and costly, and the benefits of impairment testing don’t justify the costs to do so. Many stakeholders simply disregard goodwill and impairment losses as irrelevant.
In a successful merger, the acquired business is fully integrated into the parent, and organic goodwill may develop. This may mask impairment of the goodwill from the acquisition.
In response to complaints from stakeholders, FASB has modified the original guidance several times to ease the compliance burden. Recently, FASB simplified the rules for private companies, allowing them the option of amortizing goodwill over ten years.
A tweak, not a complete overhaul
When FASB solicited comments, they made it clear that they were not looking for input on whether goodwill should be recognized in business combinations at all. Rather, FASB was interested in the subsequent measurement of goodwill.
If we return to amortization, should there be a cap on the period for amortization? How should this period be estimated? Or, perhaps, the two methods – amortization and impairment testing – should be combined, as they are presently under the simplified rules for private companies.
As some commenters noted, any changes to the treatment shouldn’t depend on how many stakeholders advocate amortization and how many favor impairment testing, but rather, “what should be considered is whether there is relevant information that is provided in financial statements when impairments do (or do not) occur, and whether the cost of supplying that information justifies its benefits.”
As noted earlier, the old rules of amortizing goodwill aren’t useful to investors. Impairment testing may not be any better. Reverting to the old rules of amortization could result in significant increases to expenses, and could decrease average earnings per share, as analysis in the CPA Journal shows.
If FASB does update the guidance for goodwill, the new rules won’t take effect for several years. In the meantime, an understanding of the intangibles that produce value for companies will help you become a trusted advisor!