Sifting through the wreckage for goodwill Accounting

Friday, 20 April 2001


    Accounting’s jack-in-the-box popped up again back in February when US standard setters flagged their intention to stop accounting for goodwill using amortisation over a set period of years. Amortisation would be replaced by an approach where goodwill would be written off only when operations were impaired and that would be determined by looking at the damage happening to a company.

    Accounting's jack-in-the-box popped up again back in February when US standard setters flagged their intention to stop accounting for goodwill using amortisation over a set period of years. Amortisation would be replaced by an approach where goodwill would be written off only when operations were impaired and that would be determined by looking at the damage happening to a company. This proposal, described in detail in an exposure draft issued by the Financial Accounting Standards Board, is a shift in the debate over how goodwill should be accounted for and it has added fuel to the fire in the push by some business leaders and corporate lobby groups for the AASB to issue a pronouncement on the "jack" that keeps bobbing up: identifiable intangible assets. Before discussing the implications, scene setting needs to take place. The FASB has spent almost four years looking at how best to deal with the problems posed by the pooling method of accounting for business combinations. The FASB's tentative decisions to jettison pooling and mandate the purchase method mean that accounting for goodwill stays. A question before the FASB was the nature of goodwill and how to deal with the quirks of same. One of those quirks is goodwill's fuzzy nature. Just imagine you've been blindfolded and someone is guiding you to put your hand in a box. You have no idea what's there, but you know there's something in the box you've paid for.

    You paid for something in excess of the fair value of the assets acquired and that excess is the fuzzy number sitting on the balance sheet as goodwill. The FASB knew the fuzziness was always going to be difficult to handle, but the board also acknowledged that amortisation over a given period of years using a straight-line amortisation approach has its drawbacks. One of those identified by the FASB and often wheeled out by anti-amortisation critics is that economic benefits expire over time but they seldom expire in a uniform or systematic fashion. The seven members of the FASB decided to go with the impairment model only after being content that impairment of the goodwill would be assessed on the basis of individual reporting units and their real or forecast performance. According to the exposure draft, a reporting unit will have goodwill allocated to it during the accounting process that occurs when a business is acquired. The goodwill amount that is associated with a reporting unit sticks with that unit until it is either completely written off as a result of impairment or disposed of because the reporting unit to which it applies is sold. In other words, if you flog off the reporting unit to another business the goodwill you attributed to it must go as well. There won't be any goodwill "padding" left behind to hand to some other reporting unit that might need some accounting "respite".

    Accounting for 'bad news' Impairment approaches do look more appealing on the surface because they don't ravage the bottom line in a consistent manner over a strictly defined period. Accounting for asset impairment is arguably better because of the requirement to conduct regular impairment tests on reporting units. The impairment model has an emphasis on accounting for bad things when they happen or are forecast to happen. An amortisation approach such as the current one has the virtue of certainty and predictability, but the impairment model does not have the same creature comforts unless companies work out some cutesy manner of arguing the same number of bad things happen to a company each year over a specified period in order to achieve predictability. There will be recognition that impairment is the right way to account for some intangibles that arguably have an indeterminable life such as broadcast licenses. The technical reasoning behind these moves is, interestingly, a repeat of what was originally dealt with in two dissenting opinions in the late 1960s that were published in the old Accounting Principles Board's standards on business combinations and intangible assets.

    Pooling was attacked in the APB's Opinion 16 as being the wrong way to account for business combinations by a dissenting minority and amortisation of intangibles over a period not exceeding 40 years was criticised by a minority of the APB as well.

    Political issues US standard-setting operates in a different political environment to the Australian process. Aussie GAAP has shunned pooling of interests for many years so the pooling element of the US debate is generally a non-issue for Australian companies and their advisers. Major companies in the US had presented their case against the abolition of the pooling method during hearings of the US Senate last year. Some US companies had much at stake, at least in their eyes, if pooling was prohibited and purchase accounting became the way. Goodwill write-offs would have made their financials look less beautiful and their self-interested opposition to change is explicable. The Australian call for our standard setter to closely examine the FASB proposals is somewhat ironic given the general push towards a common accounting framework using the International Accounting Standards Committee's pronouncements as a basis. It is easy to forget the harmonisation objectives that were so much a part of the debate during the 1990s when the opportunity to find a way out of the AASB 1015 predicament became apparent.

    AASB 1015 was partly disallowed by the Senate last year and some accountants view the US proposals on goodwill as a convenient way to bypass the requirement to write-off goodwill on a systematic basis. It is one way of living with the Senate-imposed changes to AASB 1015 that banned book value transactions for internal reconstructions, according to some advocates of the US exposure draft. While a hit to the bottom line is not entirely avoidable in an impairment model it might be easier to bear if shareholders were getting some kind of dividend before parts of an operation took a dive of some sort. Companies fear and detest volatility in accounting, particularly when accounting rule makers issue standards that require fair value measurement. Regular complaints in this vein include the whine that unrealised gains and losses resulting from fair value accounting distort the results from operations and are unreliable to investors. Some business groups are arguing the US approach with its inherent downward volatility is more appropriate for goodwill. That is, no systematic write-off although the impairment model means the corporate sector would need to cop hits to the bottom line when bad things happen. There is also no upside because all you can go is down.

    Companies will face these issues when they examine the outcomes of the FASB processes later this year.


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