Hunting for the real value of goodwill….
Australian Accounting Standards (AASBs) 3 and 138 provide for goodwill that has been “acquired” to be taken up as an intangible asset on an entity’s balance sheet. However, the treatment for internally generated goodwill means the costs are more likely to have been expensed in the statement of profit and loss. This raises the question of the value of goodwill on the balance sheet and is arguably why this historical goodwill is of little interest to management. A goodwill balance based on past events is of limited use to management and investors who are more interested in the future and, more likely, in determining a goodwill value based on future earnings rather than using future earnings in assessing the value of historically acquired goodwill primarily for financial reporting purposes.
Two similar businesses may have developed in different ways, one via acquisitions with potentially significant goodwill on its balance sheet and one by developing and expanding its own business and intangible assets, with therefore little or no purchased goodwill on its balance sheet. The different treatment of these outlays may have an impact on the profit and loss and balance sheet of each business, even though they may have spent similar amounts building their businesses and market share. This makes the comparison of these businesses more difficult for the investor and other users of the financial statements.
AASB136 requires annual impairment testing of goodwill and other intangible assets, such as brands. The assessment of impairment testing can create headaches for both management and auditors as they are required to make significant judgements on several fronts including:
- Assessment of appropriate cash generating units
- Valuation modelling
- Future profit estimates
- And cash flows.
It is no surprise the assessment of goodwill has been the source of many Key Audit Matters (KAMs) in the 2017 financial reporting season. The Australian Securities and Investments Commission again highlighted “impairment testing and asset values” as an area of its enforcement focus in its Quality of financial report alert in May 2017. Management and auditors are also more likely to take a more conservative approach to future profitability during difficult economic times leading to impairment of intangible assets and a potential hit to the bottom line when it would be least welcome.
The question of how these intangible assets can be taken off the balance sheet also needs to be considered. As a business grows and develops the purchased goodwill booked at historical cost may have little connection with the ongoing business. In the past, these intangible assets would have been amortised over time, however the only option is to impair the balance, despite possible continued strong profitability and no impairment indicators.
Potential investors and analysts tend to eliminate balances such as intangible assets and impairment expense when determining their own assessment of the goodwill of relative businesses. This is likely to have little or no correlation with the value of goodwill on the balance sheet, raising the question as to the usefulness of the carrying value of goodwill in accordance with AASBs to the users of financial statements.