The Push to Revisit Goodwill Accounting
As we set forth in our comment letter to the Financial Accounting standards Board (FASB), the political pressure applied to the International Accounting Standards Board (IASB) in the wake of high-profile failures (e.g. Carillion) in the UK that inaccurately point to goodwill as a basis for such failures followed by significant goodwill impairments in the U.S. (e.g. GE and Kraft Heinz) have been used as political fuel to elevate this issue to the top of the FASB’s agenda – even prior to the IASB seeking consultation on the issue.
Recent business failures in the United Kingdom and the related media attention again have raised the question of audit quality. Much in the press has inflamed the reaction of many stakeholders, including investors, politicians, pension trustees, and the broader public. We certainly don’t disagree that such business failures are problematic and create significant consequences not only for investors but also for other stakeholders to an organization. Although extensively reported on by the UK media, significant analysis is lacking of the causes of such business failures and the degree to which audit failures, aggressive accounting, fraud, and market conditions that resulted in liquidity issues contributed to the lack of timely recognition of such business failures.
Audits do not necessarily prevent business failures. Business failures stem from a lack of cash resulting from liquidity issues that can manifest quickly. Additionally, audit failures are not necessarily indicative of underlying business issues. Much in the press seems to inaccurately conflate accounting, auditing, and business failures.
For example, the accounting for goodwill has drawn the attention of media outlets, such as the Financial Times and Economist. The write-off of goodwill does not create business failures, business failures create the write-off of goodwill. Certainly, recognition of such impairments can be more timely, but amortization of goodwill — as some of the articles suggest — will not resolve these business failures. Amortization of goodwill will only artificially improve ratios, such as return on assets over the amortization period.
Sophisticated investors (i.e., price makers) generally write off goodwill long before management, understanding the moral hazard of management’s assessment. The cash related to the generation of goodwill is long gone. We disagree with the notion that some managements like to communicate, when experiencing a write-off, that goodwill is a noncash write-off. Rather, it is recognition and communication that the cash previously exchanged was not well spent. We highlight the issue of goodwill not to debate the merits of the accounting for goodwill, but rather to highlight the media’s flawed analysis of many of the accounting, auditing, and business issues.
Media attention on the issue of goodwill in the United Kingdom increased political pressure on the IASB to reconsider, beginning in 2018, the issue of goodwill amortization, rather than impairment, under IFRS. Simultaneously, a significant write-off of goodwill by GE (see “GE’s $23 Billion Write-down Stems from a Bad Bet on Fossil Fuels” and“GE’s $23bn Write-down Is a Case of Goodwill Gone Bad”) in October 2018, followed by the Kraft Heinz goodwill write-down (see “Kraft Heinz Plunges After $15 Billion Writedown, Dividend Cut and SEC Probe” and “Kraft Heinz Goodwill Charge Tops Consumer-Staples Record”), appear to have created an opportunity for certain stakeholders to request that the FASB address the accounting for goodwill for US Generally Accepted Accounting Standards.
Delayed write-downs by poor management at several high-profile companies, or in connection with high-profile corporate failures, should not be seen as widespread evidence of the need to replace impairment with amortization of goodwill. Amortization of goodwill, and certainly amortization without impairment, would not have cured what ills these acquisitions — especially given that they failed rather quickly. Rather, one could argue that the impairment test facilitated or forced recognition that the companies overpaid for these acquisitions. For that reason, we do not believe these examples should be used as the basis by some stakeholders to further reduce the economic relevance and meaningfulness of financial statements.
We believe the IASB and FASB must be resolute in the need for financial statements to provide economically relevant information. Delayed recognition of impairment is the problem that needs to be addressed. We do not believe that amortization is the best response to this problem.
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