Goodwill vs Business Reputation

Have your reputation been ever written off? It is probably disaster, isn’t? However, it is quite usual thing for accountants to review reputation of the company and decide whether to leave it or write it off.

Surely, I am talking about Goodwill (GW). According to Oxford Dictionary of English, goodwill is the established reputation of a business regarded as a quantifiable asset and calculated as part of its value when it is sold. Not too "accounting -accounting" definition : )

IFRS 3 sounds much better: GW – is an asset representing the future economic benefits from  other assets acquired in a business combination that are not individually identified and separately recognized.   

To understand better,  mathematically simplified it is just purchase consideration minus fair value of net assets of acquired company. My old Becker CPA book have good illustration of that:

Here starts the story… Two years ago I met my former colleague who was in charge of  corporate reporting in her company and encountered audit that period. She told me, that new fashionable audit idea of the season is to write off GW, because of crisis…

On September 2010 I came across interesting article in Financial Times “Goodwill games”. Guys from investment bank  Houlinah Lokey have carried out remarkable survey.

According to US GAAP and IFRS, GW is subject to annual review and recalculation. Recalculation is based on discounted cash flow which acquiree able to generate in future. If cash flows fall, the GW is written off. Quiet reasonable.

The FT, Lex Column constitutes:

‘What seemed strange is how little effect the unexpected recession has had on the value of GW. Between the boom years of 2005 and 2008, Europe’s top 600 companies spent 1,700bn euro on acquisitions and booked about 900bn euro of GW in the process. Those deals were based on expectations of steady growth in  real gross domestic product; as late as 2008, the International Monetary Fund forecast GDP would be 15% higher in 2013 than in 2007.

As of the end of 2009,  that forecast of GDP was below 5%. Logically that should have triggered a big fall in the potential earnings for acquired companies. But since the recession  began, barely 4% of companies’ GW has been written down,  excluding the 32bn euro write-off at Royal Bank of Scotland’.

   Just look at this illustrative figure about GW write-offs and IMF’s GDP forecasts provided by Houlinah Lokey:

Good looking charts aren’t they! In the end of the article authors suggest that “cosy relationships” between auditors and their clients are reason for such  insufficient conservativeness in accounting for GW.

Personally, I think that if GW is not written off because of “cosy relationships” it is not good. Potentially it could harm not only goodwill of client, but also business reputation of audit firm.      

      

References:

Becker CPA Review. (2008) Financial Accounting and Reporting. DeVry/Becker Educational Development Corp.

Financial Times. (2010) Goodwill games. 28^th of September 2010, p. 16