Estimated reading time: 4 minutes

The article in brief:

• Total goodwill assets on the balance sheets of S&P 500 companies stand at an estimated $3.57 trillion.
• Impairment write-downs, which spiked in the early months of the pandemic, have moderated, leading to continued increases in net goodwill.
• The continued growth of goodwill raises the stakes for U.S. & international standards setters considering changes to the way companies account for the assets.
• Some investors worry that the leading approaches under consideration will diminish the information they currently get from financial statements.

Over the last several decades, the pendulum on how companies account for goodwill has made some giant swings:

It’s an asset.

Wait, no, it’s not.

No, it really is an asset.

OK, it’s an asset; test it for impairment.

Actually, don’t – amortize it.

Meantime, the stakes keep getting bigger and bigger.

Total goodwill assets on the companies’ balance sheets in the S&P 500 nearly topped $3.6 trillion this year, a net increase of more than $880 billion since 2017. And the asset is not exclusive to larger-cap companies; looking at all public companies in the U.S., the figure is estimated at roughly $5.6 trillion.

With net goodwill continuing to grow, the stakes keep getting higher as both U.S. and international accounting standard setters consider modifications to its treatment.

To help make sense of the uncertainty, VRC Co-CEO PJ Patel joined Calcbench CEO Pranav Ghai and CFA Institute Head of Financial Reporting Sandra Peters for a panel discussion on “What’s New in Goodwill.” The discussion framed up the scope of the issue and raised important questions about the direction the U.S. Financial Accounting Standards Board, in particular, appears to be taking and whether it will serve those who use financial statements to make investment decisions well.

GHAI: ‘Your eyes sort of bug out a little.’

Ghai, whose Calcbench is a market data company, brought receipts. He showed that 459 of the S&P 500 companies are carrying goodwill on the balance sheet and that the average company is carrying an estimated $7.8 billion. For perspective, S&P 500 companies’ combined goodwill of $3.6 trillion is well over their combined cash and equivalents holdings of roughly $2.2 trillion.

Moreover, Ghai added, “when you start looking at goodwill as a percentage of book value, then your eyes sort of bug out a little bit.” He explained that calculating an adjusted book value for S&P 500 constituents that do not include goodwill would result in 88 companies flipping to negative book value.

PETERS: ‘It’s important to pay attention—it’s a big number.’

Peters, whose CFA Institute is a global association of investment professionals who rely on financial statements to make investment decisions, has expressed significant reservations about proposals to allow public companies to amortize goodwill, underscored the importance of getting goodwill right. “It’s not hard to say that it’s important to pay attention to because it’s a big number!” she said.

Peters previewed a forthcoming survey of Institute members that found broad support for regular testing of goodwill for impairment as a useful gauge of management’s skill at identifying accretive acquisition targets and successfully integrating them and skepticism about amortization. She agreed with the majority of the members: “Amortization over a straight line period tells you nothing. Impairment … says that something you acquired didn’t turn out, and users of financial statements should ask more questions.”

Peters added that in practice, many investors perform their own impairment analysis with much less information than the companies have, suggesting it is valuable to them and may not be as onerous and costly as proponents of amortization suggest.

Finally, Peters noted that international standard setters [IFRS] appear to be moving away from the idea of amortizing goodwill, so a U.S. move that embraces the approach would create headaches for users of financial statements.

PATEL: ‘Discipline in the system.’

VRC’s Patel has worked with hundreds of companies to monitor the value of their goodwill. The amount of goodwill on company balance sheets continues to increase steadily. After a brief pause last year—when the pandemic caused a temporary slowdown in deals (additions to goodwill) and prompted some companies to test for impairments and announce write-downs (reductions in goodwill) — he said goodwill growth is right back on its growth trajectory.

Patel echoed Peters on the utility of goodwill for investors but said regular and transparent impairment testing could ultimately benefit companies too by acting as a check on aggressive deal-making. “The current system for accounting for goodwill provides a lot of discipline in the system,” Patel said.  “My public company clients worry: ‘If we do this deal, is it likely to be impaired? Are we paying too much? Is the purchase price OK? What benefits do we get, and what is the risk of impairment. There is always pressure to do the deal. Companies and their executives fall in love with the deal, but before the move to impairment testing nearly 20 years ago, there was a lot less rigor in  reviewing them.”

Against the Historical Tide

With more than $3.6 trillion riding on the outcome, the panelists agreed that U.S. standard setters are appropriately deliberate and circumspect as they consider a dramatic pivot to amortization.

In addition to going against the grain of what their international counterparts are contemplating, Patel noted that amortization would, in many respects, go against the evolutionary tide of U.S. financial reporting which, over the last several decades has generally moved towards improving transparency of a company’s financial position. In many ways, the question to ask is, “what does the FASB need to do the help users get a better understanding of a company’s financial position and performance?”  New standards like CECL, lease accounting, and revenue recognition seem to point to a forward-looking perspective, but amortizing goodwill is a focus on the past.