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Accounting question about the "mark to market"


bookie71
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Is it a fair to assume the reason many companies are taking large goodwill write-downs now is because

 

1) non-cash charge

2) can create an income tax credit and get a cash refund!

 

Other reasons ?

 

I'm not an Accountant but my understanding of Goodwill is that the rules changed as a result of the dot-com scenarios which saw one company acquiring another for more than it was worth but the acquired company already had $x of Goodwill on the books so you got values after two or three takeovers which got a little out of whack.  The example that comes to mind was when I shorted Laidlaw back when it was $10.75 a share. They bussed 80% of all the kids in North America to school every day and yet carried Goodwill on their books greater than the value of the buses!!  They had made a crummy acquistiton of a company that had made crummy acquistitons (Safety Kleen).  It seemed like a prime candidate for a short and it was. 

 

The rule change meant that a company has to look at the Goodwill number every year and adjust according to reality.  For instance if they were to re-buy the same asset today, how much Goodwill would be attached?  That is the new number and they adjust it accordingly on the Balance Sheet but only downwards if necessary.

 

So you're right, Goodwill is a non-cash charge (although at some point it was paid for!!!)  and it does reduce the tax liability but it is only partially discretionary in that it has to have some basis in reality.  I think the write-downs are simply a case of the reduced prices of everything causing estimates of the cost of acquiring similar assets to also be reduced and hence the Goodwill charges.

 

 

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US & CDN GAAP require you to means test goodwill every year. Specific value streams are quantified & discounted to arrive at today's PV & goodwill is written down to that PV. The write-off is permanent. The dot.com era generated some transitional rules which have now mostly expired.

 

IFRS permits write-ups & treats goodwill the same as any other asset subject to MTM accounting - but with the gain passing directly to other comprehensive income (direct to equity in GAAP terms). Example: Merge coy A & B, quantify the synergy value stream, & discount at a high risk free rate to produce a low PV; but ... if next year the discount rate is far smaller & the value stream essentially unchanged, the PV will be higher .. & will generate a goodwill write-up.

 

Keep in mind that this also applies to capitalized expenses, deferred charges, etc. & that for many companies this might be the biggest asset on their GAAP BS.

 

SD

 

 

 

 

 

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Also - the equity and assets will be smaller in future years, thereby increasing the ROE & ROA.  Of course, most company executives would never consider taking a hit in a bad year (when everyone does so and the shareholders are therefore more likely to forgive you) to increase their potential bonus in outer years...

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If you write down good will then the only way you can recapture the value on the companies books is through future earnings or through the sale of the asset. Goodwill write downs are particularly annoying to me it seems that companies are all too often making acquisitions that future events indicate were not justified. A good will write down should be a call to action for shareholders to get rid of the board responsible for approving  the acquisitions you rarely see BRK write down good will because they understand the difference between price and value a concept that seems totally misunderstood in most boards rooms of corporate America.

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