Which of two facts about the goodwill impairment charge General Electric took in its 2018 third quarter was more eye-opening?
Was it the size of the write-down? The approximately $22 billion accounting hit was the biggest impairment charge (of any type) for a U.S. company since ConocoPhillips wrote off $25 billion of goodwill from its balance sheet in 2009.
Or was it the fact that the pre-tax, non-cash impairment related primarily to an acquisition GE made three years ago? The acquired asset, the power and grid business of France-based Alstom SA, changed hands in November 2015.
“We do not see disclosure of goodwill impairments driven by previously unrecognized intangibles very often,” Audit Analytics said in a report last week on GE’s accounting for the Alstom deal. However, that scenario also applied to the ConocoPhillips goodwill impairment, the result of revaluing intangible assets related to the 2002 merger between Conoco and Phillips.
In large part, the accounting for the Alstom acquisition “reveals how GE was so keen to get the job done that it paid too much,” stated an October Financial Times article.
That may have been an understatement. The Alstom businesses that GE acquired had gross assets of $21.3 billion and liabilities of $23.2 billion.
Goodwill is, of course, an interesting concept. It’s the difference between the purchase price for an acquisition and the fair value of all identifiable assets acquired and liabilities assumed in the deal. Goodwill is meant to be an accounting representation of the value assigned at deal closing to intangibles like brand name, customer base, employee relations, patents, and proprietary technology.
If, however, as in GE’s case, a company later discovers that certain intangible assets were misvalued or unrecognized in the deal accounting, the acquiring company must discount the previously recorded goodwill value.
GE wrote in its third-quarter earnings release that “the size of the charge results from the significant value associated with unrecognized legacy assets, principally our profitable services backlog, long-standing customer relationships, and our gas turbine technology. The value of these assets essentially squeezed out any remaining room for goodwill.”
Indeed. GE noted that there was no remaining goodwill associated with its power generation reporting unit and only $1.65 billion related to its grid solutions reporting unit.
GE was already under investigation by the Securities and Exchange Commission related to the timing of loss reserves charges and revenue recognition practices disclosed last January, Audit Analytics noted.
Now, the SEC has widened the scope of the investigation to include the impairment charge. Presumably the commission is looking at whether deficient controls led to the need for GE to take the big goodwill impairment charge.
With all the business challenges and performance issues buffeting GE over the past few years, the company can ill afford to suffer the worst-case result of the SEC investigation. That would be “a full restatement of previously stated financials that may require revising years of financial data and expose the company to additional legal actions,” Audit Analytics noted.
The SEC also could find that GE needs to make immaterial corrections to its financial controls. “That would be a negative development, but not severe,” said Audit Analytics.
Most optimistically, the commission could close the investigation without taking any action, as it did in 2014 after looking into IBM’s cloud revenue recognition practices.