By Jean Eaglesham
This article is being republished as part of our daily
reproduction of WSJ.com articles that also appeared in the U.S.
print edition of The Wall Street Journal (January 22, 2020).
A brewing battle over how to treat more than $5.5 trillion in
assets on company books is pitting investors against businesses,
investment advisers against academics and even banks against their
own trade association.
At issue is an accounting term known as goodwill, which is the
premium a company pays when it buys another for more than the value
of its net assets. An unprecedented five-year boom in mergers and
acquisitions has added urgency over how to account for the
financial concept.
When Amazon.com Inc. bought Whole Foods Market Inc. for $13.7
billion in 2017, the e-commerce giant paid $9 billion more than the
value of the supermarket's stores and other net assets. That amount
was added to Amazon's books as goodwill.
As things stand now, Amazon is supposed to evaluate, or test,
that $9 billion every year to see if its value still holds. If not,
they have to write down a portion of it, a move that cuts
profit.
The Financial Accounting Standards Board, the accounting-rules
maker, is weighing whether to continue to assess goodwill by tests
-- or return to a similar approach to the guidelines of nearly 20
years ago, when companies wrote down a set portion of goodwill each
year for up to 40 years.
The FASB has asked for comments on the possible change, and
companies haven't been shy about weighing in.
Many companies argue the test approach is costly and subjective.
As it is, companies can be slow to write down goodwill, even when
stock markets are signaling that they no longer believe in the
value of the asset, according to research by academics and
analysts.
The annual review requires "an inordinate amount of time to
validate and document," Indianapolis-based drugmaker Eli Lilly
& Co. said in a comment letter to the FASB.
However, critics say the old approach, the so-called
amortization of goodwill year by year, allows companies to mask
problems and costs investors valuable information.
In addition, going back to the old rules could also be costly.
The CFA Institute, which represents chartered financial analysts,
said amortization might cause "the write-off of a substantial
portion of the assets and equity of U.S. public companies and ...
reduce profits to nearly zero for a significant number of companies
in the S&P 500" in a comment letter to FASB this month.
The recent wave of deal making has created a pile of goodwill.
There were $7.4 trillion in U.S. deals the five years through 2019,
the highest five-year tally for at least two decades, according to
Dealogic.
S&P 500 companies had $3.5 trillion worth of goodwill on
their books at the end of September, according to data provider
Calcbench. This was up 67% from 2013 and represented 9% of total
S&P 500 assets and 42% of total equity, the Calcbench data
show.
For all public companies trading on U.S. markets, goodwill
exceeds $5.5 trillion, according to the most recent figures from
Calcbench, based on company reports.
Goodwill doesn't only come from paying more than a company's net
assets. It can also be generated by hoped-for synergies from an
acquisition, intangible assets such as intellectual capital, as
well as a high price for the deal, said Daniel Wangerin, associate
accounting professor at the University of Wisconsin-Madison. "Large
goodwill is not necessarily a sign of overpayment," he said.
The FASB began requesting comments on goodwill last year by
starting with a simple question: "Question 1: What is goodwill?"
The board plans to discuss responses this spring, potentially
paving the way for a new definition that could significantly affect
corporate balance sheets.
While the old system was predictable, the current system leads
to some dramatic write-offs. Kraft Heinz Co. last year announced a
$7.3 billion goodwill impairment it said resulted partly from
falling profitability expectations for its Kraft cheese and Oscar
Mayer cold cuts businesses.
General Electric Co. stunned investors in 2018 by writing off
$22 billion of goodwill from its 2015 purchase of Alstom SA's power
business.
But headline-grabbing write-offs are comparatively rare.
Overall, the tally of goodwill added to corporate balance sheets
every year since the 2008 financial crisis has outstripped the
amount written-down due to soured deals or other issues, data from
valuation firm Duff & Phelps LLC show.
Going back to the old ways could cost investors valuable
information because the annual write-down of goodwill means
specific problems may not be separately announced, some analysts,
academics and investors said.
"The [standards-setting] board is seeking suggestions for making
information about assets more general, opaque and amorphous," Jack
Ciesielski, owner of asset-manager R.G. Associates Inc., said in
his comments to the board. "Reversion to standards that were
previously deemed unsatisfactory can hardly be called
progress."
Many companies disagree. Corporate giants Chevron Corp.,
International Business Machines Corp. and Pfizer Inc. are among
those advocating for goodwill to be amortized -- an option already
available to privately-owned firms.
Their concern: the costs of complying with the rules. Public
companies have to test at least once a year whether the goodwill on
their books needs to be written down.
Question marks also hover over the accuracy of the tests, which
estimate fair values for goodwill using assumptions about growth
and market conditions. The "estimation uncertainty is extremely
high," Ball Corp., the packaging company, said in its comments. It
added that the tests -- which have to be signed off by auditors --
create a "heightened risk of failed audits."
Not all companies, even within the same industry, agree on how
-- or if -- the rules should be changed. The American Bankers
Association in its comments backed a return to amortization,
calling the current regime "an arduous process that often provides
little value." But Citigroup Inc. and Wells Fargo & Co. in
their responses opposed amortization, saying it could damage the
quality of information reported by companies. Bank of America Corp.
added that a change could disrupt the U.S. deals market.
Thomas Linsmeier, a former member of the Financial Accounting
Standards Board, said he thinks there is "momentum on the board to
move toward amortization." A "driving factor of concern ... is the
amount of cost in the impairment test," Mr. Linsmeier, a professor
of accounting at the University of Wisconsin-Madison, said.
One option for the future is to combine amortization with
reduced testing, say only in the first three years after a deal or
only if something triggers a likely write-down. Any change will
likely happen at the glacial pace that characterizes most
accounting reforms. The FASB plans to discuss the comments later
this year, before deciding whether to move forward with proposals.
"The project is in a very early stage," a spokeswoman said. "We
look forward to hearing all the feedback."
Write to Jean Eaglesham at jean.eaglesham@wsj.com
(END) Dow Jones Newswires
January 22, 2020 02:47 ET (07:47 GMT)
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