Study Links Share Prices, Goodwill Impairments

When the equity market turned around and share prices started moving higher in 2009, using stock price as a key determinant in assessing goodwill i...
Kathy HoffelderOctober 5, 2012

Market price is a factor too often overlooked in deciding whether a company made a good acquisition or not, say the authors of a Duff & Phelps and Financial Executives Research Foundation (FERF) study released yesterday.

While the price an acquirer pays for a target may not be the sole indicator of the amount of goodwill impairment, it should be factored into the assessment of goodwill for financial-reporting purposes, they add.

Goodwill impairment, a term rattled off routinely by CFOs and other executives on earnings calls, means a company paid more for a business acquisition than the asset’s actual “fair value,” or estimate of the asset if it were to be sold. The amount shows up on the balance sheet as a noncash charge.

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“Impairments are in essence a reflection of poor transactions in some places in the past and performance not reaching expectations,” James Harrington, a director in the office of professional practice at Duff & Phelps and co-author of the report, said during a call discussing the study’s finding.

A corporation’s decision to use market prices in looking at goodwill impairment may not be clear-cut, however. “In the short run, market value declines may or may not be a symptom of developing financial problems in a business unit that call for the recording of [a] goodwill impairment charge,” says Charles Mulford, an accounting professor at Georgia Tech University and director of the Georgia Tech Financial Reporting & Analysis Lab.

If, for example, the business unit with the goodwill is financially healthy, profitable, and growing, the company has a strong argument against the need for an impairment charge regardless of what the market price of the consolidated entity is doing, according to Mulford.

Up until recently, market prices were used to gauge impairments. A decline in equity prices was routinely used as a measurement of goodwill impairment, particularly as the financial crisis turned most markets on their head and entire global markets went into a tailspin. But when the equity market turned around and share prices started moving higher in 2009, using stock price as a key determinant in assessing goodwill impairment was not as common.

The Duff & Phelps/FERF study, which looked at 5,000 U.S. public companies claiming goodwill impairments between 2007 and 2011, for instance, found an indirect correlation between goodwill impairment and share-price determinant during the key recessionary time period from 2008 through 2009. During that time, goodwill impairments ranked highest at $188 billion for U.S. public companies, and the S&P 500 Index hit a trough of 683.38. Likewise, goodwill impairments fell back to $29 billion for 2011, while the S&P 500 Index is currently back up to the 1,400 level.

The study unearthed a radical shift in the industry distribution of goodwill impairments between 2010 and 2011. For one thing, it found that far fewer financial companies took goodwill charges in 2011 compared with 2010: they were responsible for almost half of the goodwill impairments in 2010, compared with 20.1% in 2011. Making up the slack were companies outside of the financial, consumer staples, health-care, or consumer discretionary industries. Together those had 28.4% of the impairments in 2011, compared with only 14.7% in 2010.

IT-related companies, in particular, took a heftier slice of the goodwill-impairment charges in 2011 relative to 2010, the study found. The companies turned in 11.5% of the impairments in 2011 compared with less than 6% in 2010.

Those numbers for IT, however, could even be higher for 2012. Microsoft, for one, attributed $6.2 billion to goodwill impairment in July, and Hewlett-Packard said in August that as the result of its acquisition of EDS dating back to 2008, it would take a write-down of $8 billion in its services division.

Size, measured by the number of reporting units susceptible to impairment charges that a company has, could also play a factor in next year’s tally of impairment charges. The larger companies, says Duff & Phelps’s Harrington, have already been prone to more impairment. “Based on this survey,” he says, “it seems when a greater number of reporting units (within a company) are used, the goodwill is more exposed to impairment.” The majority of the companies in the study had 2–5 reporting units that could have goodwill impairment.

While all of the companies in the impairment study were public companies, a separate questionnaire that included private companies showed that more than 50% of both public and private companies blamed factors unique to their reporting units for causing the goodwill impairment in the first place. This compared with 20% of the public companies and 8% of the private companies citing overall market downturn as a reason for the charge.

Some help is on the way in determining what to include in goodwill-impairment analysis. The American Institute of Certified Public Accountants plans to release a working draft on qualitative assessment in the coming weeks and a final guide next year. The Appraisal Foundation is also working on a best-practices guideline for determining goodwill impairment, and the Financial Accounting Standards Board has also worked to improve testing of goodwill impairment.