What Is Goodwill?

Goodwill frequently arises when one company buys another; it is defined as the amount paid for the company over 澳洲幸运5官方开奖结果体彩网:book value. Goodwill is an intangible asset, as opposed to 澳洲幸运5官方开奖结果体彩网:tangible assets such as buildings, computers and office equipment, and related physical goods, including inventory and related forms of 澳洲幸运5官方开奖结果体彩网:working capital. In other words, goodwill represents an acquisition amount overꦬ and above what the purchased firm's net assets are deemed to be valued on the balance sheet.

When Goodwill Goes Bad

Let's consider an example from the past decade. Back in November 2012, when it released its fourth-quarter results, computer giant Hewlett-Packard (HP) announced that it would be taking an $8.8 billion charge to write down a botched acquisition of U.K.-based Autonomy Corporation PLC. The write-off, which was described as a non-cash charge for the impairment of the Autonomy purchase, included goodwill and intangible asset charges.

In the case of HP's acquisition of Autonomy, given the charge announced in November, it is clear that most of the original $11 billion 澳洲幸运5官方开奖结果体彩网:purchase price was over and above the book value, or 澳洲幸运5官方开奖结果体彩网:net asset value of Autonomy, a fast-growing software company. According to a Bloomberg study, Autonomy listed total assets of $3.5 billion right before it was acquired. At the time of acquisition, HP initially accounted for $6.6 billion toward goodwill and $4.6 billion toward other intangibles. These numbers were later changed to $6.9 billion and $4.3 billion, respectively.

HP's mistake, in addition to questions over the amounts it initially decided to write down goodwill by and subsequently booked, demonstrates that the concept of goodwill is uncertain and open to interpretation. 澳洲幸运5官方开奖结果体彩网:To determine goodwill amounts, companies usually rely on their own accountants, but they will also turn to 澳洲幸运5官方开奖结果体彩网:valuation consultants to help estimate.

In reality, other tangible assets, including the 澳洲幸运5官方开奖结果体彩网:depreciated value of land and equipment, are also subject to estimates and other interpretations, but these other values can at least can be linked with either a physical good or asset. In contrast, goodwill is more difficult to place a firm value on. A 2009 article in The Economist described it as "an intangible asset that represents the extra value ascribed to a company by virtue of its brand and reputation."

From HP's perspective, there is little question that it had high hopes for Autonomy, which was based on its reported profit levels and the expectation that its rapid growth would continue well into the future.

How Goodwill Is Written Down

Once an acquisition is made—and provided it was a sound purchase—goodwill 澳洲幸运ꦅ5官方开奖结果体彩网:remains on the acquiri🧔ng firm's balance sheet indefinitely. Prior to 2002, goodwill was 澳洲幸运5官方开奖结果体彩网:amortized over 40 years, much the way a piece of equipment might be depreciated over a period, depending on estimates of its 澳洲幸运5官方开奖结果体彩网:useful life. But since then, rules have gotten more stringent: Goodwill can be amortized on a 澳洲幸运5官方开奖结果体彩网:straight-line basis over a period not to exceed 10 years. If at any time, the value declines, as happened in a rapid fashion with goodwill related to Autonomy, then an impairment charge is required.

A business is required to monitor and evaluate 澳洲幸运5官方开奖结果体彩网:goodwill impairment-triggering evenᩚᩚᩚᩚᩚᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ𒀱ᩚᩚᩚts throughout each reporting period. A triggering event exists when there are indicators that a fair value of a reporting unit or entity is below its carrying value. An entity is also required to consider whether an event has occurred or circumstances have changed that would more likely than not reduce the fair valu🐎e of a reporting unit or entity.

Private and not-for-profit entities may elect an accounting alternative to perform the goodwill impairment-triggering event evaluation.

Firms that end up writing down significant amounts of goodwill are quick to point out that a 澳洲幸运5官方开奖结果体彩网:goodwill impairment charge is non-cash, and so does not affect 澳洲幸运5官方开奖结果体彩网:cash flows. It represents, however, a huge past mistake that drained the corporate coffers. In regard to HP, which funded the Autonomy purchase through 澳洲幸运5官方开奖结果体彩网:cash reserves, it ended up destroying billions in 澳洲幸运5官方开奖结果体彩网:shareholder value, since the company is worth only a fraction of its earlier estimated value.

The Bottom Line

Goodwill impairment charges don't hurt current-year cash flows, but they demonstrate mistakes made in the past by management teams. In HP's case, the decision to purchase Autonomy without sufficient 澳洲幸运5官方开奖结果体彩网:due diligence and tire-kicking represented one of many instances where a serious lapse in judgment was made.

For other companies, goodwill impairment charges are generally less significant, but they still require analysts to investigate just🦩 what went wrong and if the mistake is likely to be repeated in the future,𝓡 to the detriment of existing shareholders.