M&A and Goodwill: Why financial executives are missing the point

There’s a new report out summarized under the headline Goodwill Impairment Holds Steady this week on the Business Finance site.


The article is full of data on things like total impairments, goodwill as a percentage of total assets, total reported versus total impaired goodwill, percentage of companies reporting impairment. All this data seems to indicate that there must be something important going on. I’m here to tell you it’s not.


What’s wrong with this picture? Instead of analyzing trends on the total amount of goodwill, someone needs to say STOP and ask why all this goodwill is there in the first place?


Because basically, goodwill is a plug number that gets booked when one company buys another. The accountants identify assets of the acquired company that can be added to the balance sheet of the acquiring company. According to an E&Y study right before the Great Recession, the acquirers' accountants can, on average, they account for 50% of the purchase price.  The rest goes into goodwill.


The reason for this is that most of the value in business today is in knowledge assets that are not eligible to be put on the balance sheet. Investments in intangibles wash through the income statement with current year operating expenses. Intangible infrastructure gets built but no one tracks it.


But when there is an acquisition, the imbalance of this approach quickly becomes apparent. Accountants have to account for the full purchase price but they don’t have any way of determining where most of the intangible value is (they usually can identify a few things like customer lists and trademarks). So they put the unidentified portion on the balance sheet and basically say that 50% of the value purchased is derived from a feeling of your customers—the “good will” that they hold for you in their hearts.


Then the charade continues as the accountants and valuators periodically recalculate the value of the business. Using fancy spreadsheets and projections, they determine if this “good will” has decreased which is then booked as a financial loss. Then, with studies like this one, the whole system just keeps rolling on. The conversation looks at all the factors that the accountants look at but nothing about the fundamentals of the underlying acquisitions.


Do you want to break away from this charade? I wish I could tell you to fire your accountants but you can’t—they have to play this game and will continue to play this game for years until accounting standards catch up with the shift away from the Industrial Era (yes, that’s where this problem started. But 10-15% goodwill back then was a logical concept. 50% is getting surreal….)


But you can develop ICounting expertise and hire an ICountant. They will help you identify all the “intangible” but very real assets you have built through years of investments in information technology, processes, data, networks, relationships, competencies (all of which are knowledge assets of one form or another). An ICountant can also help you measure these assets using both quantitative and qualitative means.


Just because the accountants call it goodwill doesn’t mean that’s what it is. Goodwill is an accounting construct. The reality is that there is a core of knowledge assets that drive the performance of a company. Don’t make another acquisition without looking beyond this artificial construct and identifying what you are really buying. 

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Comment by Mary Adams on February 14, 2013 at 12:35pm

Thanks Len -  There has always been a little more room in the standards than managers and CPA's took advantage of. I think this was due to the hesitation they had in looking like they were trying to create something out of nothing.

But I think that more and more businesspeople are realizing that intangibles are really loner-lived and more important than tangibles. It is a rare intangible asset that is more than a commodity. Commodities don't provide competitive advantage.

Key corporate intangibles are not commodities. Developed and used correctly, they provide both competitive and collaborative advantage.

How can we get the word out on this? How can Smarter-Companies help?

Comment by Len Ruggiero on February 14, 2013 at 11:25am

This post is right on target! When examining public company balance sheets for my M&A work, most of the larger companies have line items for intangibles as well as goodwill. So the large public accounting firms "get it." That leaves thousands of SMEs who may not have CPA firms which are willing to do more than simple fundamental 19th Century accounting for their clients.

The other point made clear when examining public company balance sheets is that not all intangible values on the balance sheet derive only from acquisitions. So, once again, the large CPA firms seem to get it and are apparently valuing assets which are internally  generated. What's going on here? I didn't think the IRS allowed valuation of internally generated assets?

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