FASB Turns Up the Heat on Goodwill Impairment Testing
Amortizing goodwill ignores key analytical and economic consequences
|Wednesday, February 12, 2020|
By Sandra Peters for CFO.com
The Financial Accounting Standards Board has recently elevated goodwill accounting to the top of its agenda, after political pressure stemming from high-profile company failures in the U.K., notably Carillion’s, pushed the International Accounting Standards Board to address the topic.
In the United States, the significant goodwill write-offs at General Electric and Kraft Heinz have been political fuel for FASB, which was already considering whether to revisit the idea of permitting or requiring public companies to amortize goodwill.
Going a step further, last July FASB issued an Invitation to Comment (ITC) that assumed the high cost of goodwill impairment testing exceeds the benefit to investors, and that change was necessary. The ITC referred to the current private company accounting for goodwill, which allows amortization over 10 years, again and again. It would appear that FASB is leaning in that direction.
We think the debate in the U.K. and the politically appealing nature of applying the private company approach in the U.S. have resulted in FASB undertaking this issue without considering the analytical and economic consequences.
Further, FASB has not justified a change in the definition of goodwill, which carries the presumption that it would be a wasting asset if amortization were adopted. Nor has FASB justified the basis for a change in the prior logic that supported impairment testing.
The Dramatic Impact on S&P 500 Financials
The ITC didn’t put the impact of a change in goodwill accounting into context. In 2018, U.S. public companies had $5.6 trillion of goodwill on their books. That amounted to 6% of their total assets and 32% of their equity. S&P 500 companies accounted for $3.3 trillion of such goodwill, representing 9% of their total assets and 41% of their equity.
CFA Institute’s comment letter to FASB provides the needed context. The letter highlights the S&P 500 companies with the largest goodwill balances (see list at the bottom of the article) and notes that 25% of S&P 500 companies have goodwill in excess of equity. Changing to amortization would be a problem, because it would schedule the write-off of this goodwill against equity.
The letter also highlights the $560 billion impact amortization would have on S&P 500 earnings, and that for some companies goodwill amortization would exceed their profits over the 10-year period.
Amortization: The Zero-Information Approach
Amortization of goodwill presumes that it is a wasting asset and schedules its write-off. If FASB allowed public companies to amortize, investors wouldn’t be able to distinguish between good and bad management as related to their acquisitive activities.
When companies do an impairment, which is the current approach to goodwill accounting, they’re writing off some goodwill because the forward-looking cash flows of the acquired entity don’t look good. That goes to the income statement. It says something to an investor or analyst. But with amortization, the income statement would not change.
Further, amortization of goodwill would, without question, lead to greater proliferation of non-GAAP profit measures. Companies, professing that investors want it, would eliminate amortization, indicating that earnings without amortization is a more useful tool and simultaneously demonstrating how amortization has made GAAP reporting less relevant.
Ultimately, there is no relevant information for investors in goodwill amortization. We call it the “zero-information approach.” By contrast, when impairment is taken in a timely manner, it provides investors with insight regarding whether management’s acquisitive activities were successful.
Impairment testing done properly also provides forward-looking information to both the company and investors and gives recognition to both the finite and indefinite elements of goodwill.
Costs and complexity surrounding impairment testing have surfaced as issues that augur for the amortization of goodwill. This argument rings false.
While we recognize that impairment tests can be challenging to perform, especially if acquisitions are substantially integrated with existing businesses, managements should be providing their boards with assessments of the performance of the acquisitions undertaken. Accordingly, there should not be substantial additional cost for providing this information to investors.
Investors are unified in their view that what they want from goodwill assessments are measures of the performance of acquisitions. For that reason, we believe requiring new disclosures — something IASB is debating — likely is a better first step than abandoning impairment testing for amortization.
If a zero-information amortization approach were adopted, we would recommend that it be combined with a range of objective, quantified, and company-specific disclosures that permit independent conclusions about acquisitions. Immediate write-off of goodwill is another option that we support over the amortization approach, given that amortization would be a routine non-GAAP adjustment and distort trends.
A Globally Consistent Solution Is Essential for Investors
In a world where capital flows freely across borders, investors need globally consistent information on the accounting for goodwill. While companies prepare financial statements as required by their jurisdiction of domicile or listing, investors make investments across borders and should not be left with the job of reconciling different accounting rules for goodwill under U.S. GAAP and International Financial Reporting Standards.
If investors are those for whom accounting standards are prepared, their need for value relevance, consistency, and comparability should have primacy.
Going Backward or Forward?
In a world where intangibles are becoming even more important to the economic value of U.S. public companies, the overlay of a rote amortization process would be taking a step back to the accounting of 20 years ago.
It would reduce the relevance of financial statements as well as the professionals that support their production. For investors, the value of accounting and audit professionals lies in their skill at evaluating estimates and issuing judgments in impairment testing. Such skills and value are likely to lay fallow with rote processes such as amortization that can increasingly be automated.
FASB must step back and evaluate the economic impact of impairment testing relative to its cost. In our view, improved disclosures — and a survey on the cost of impairment testing — would provide investors, who are paying for impairment testing, as well as standard setters with more useful information in evaluating the way forward on this issue.
The magnitude of goodwill balances warrants careful consideration of the impact of a switch to amortization.