Written by Merrick Today blog contributors Mikhail B. Pevzner, professor of accounting and Phillip J. Korb, associate professor of accounting. The team also contributed to the blog Audit Analytics on Oct. 8, 2019 in an article titled “Goodwill and Intangible Asset Impairments in S&P 500.”

Acquired goodwill represents the excess of cost over the fair market value of the net assets acquired as a result of a business combination. We believe that it is a premium paid by management in recognition that the combined entity will create more value than the two entities operating separately.

This value proposition does not occur immediately, but requires the full integration of the operations of the two enterprises over time. Unfortunately, a large amount of research shows that acquisitions, in particular stock-for-stock acquisitions, actually under-perform the market, and thus expected synergies from acquisitions often do not materialize. ^[1] For this reason, some prominent finance scholars (most notably Aswath Damodaran who is one of the foremost valuation experts in the finance academic profession) seriously questioned the usefulness of the capitalization of the acquired goodwill^[2]. Thus, if acquired goodwill is to remain capitalized on the balance sheet, at a minimum, research should be conducted to determine the time period over which, historically this has taken place, as well as the time period over which this has not taken place in the case of unsuccessful efforts. In other words, the life of the synergies or failure to realize the synergies should be used as the amortization period. If a systematic approach to this cannot be found, goodwill should be expensed over a relatively short period of time (e.g. 3-5 years).

One way to come up with a meaningful way to amortize goodwill is to empirically examine the length of typical acquisition benefits across different industries. For example in some industries, benefits of acquisition could be relatively short-lived (e.g. if technology rapidly changes). In other industries (e.g. in more traditional manufacturers), acquisition can lead to longer benefits, especially if acquisition leads to greater market power. In some ways, the current goodwill revaluation approach tries to get at it, but given that most goodwill impairments are unduly delayed^[3], it does not appear to be successful. Our approach would be to amortize goodwill over this integration period so that future periods would not be burdened by a cost related to a fait accompli. In the case of underperforming acquisitions, the cost would be written off by the end of the amortization period. In other words, the cost to acquire the business would be allocated over the period of the benefit of the acquisition, i.e. the integration period. If the acquisition underperforms or is not realized, it would no longer exist as an asset at the end of the amortization period. Since assets represent resources expected to provide future benefits, writing off goodwill over this time period would at the end of the period reflect that goodwill has no future value. If the FASB concludes that this approach is too costly or burdensome on firms, it should strongly consider rapid amortization for goodwill.

We feel that this income statement approach more clearly reflects the financial position of the combined entity, rather than the current impairment of goodwill balance sheet approach, which is extremely subjective. Furthermore, until the impairment approach were to result in goodwill being written off, we feel an asset is being carried on the books whose future value may already have been realized.

If the amortization of goodwill is adopted, we feel that it should be shown in the income statement, because it is the result of a management decision affecting the operations of the businesses. It should not be shown in other comprehensive income or through adjustments to equity. This is because prior research shows that investors may not effectively understand OCI disclosures^[4].

In anticipation of objections to a uniform amortization period, research could be conducted by industry or line of business to provide industry specific periods or allow management a choice within a specific, but somewhat narrow range.

We feel that the current impairment approach has proven not to have met the Board’s standards required of financial information. The expected improvement, if any, in the quality of information to financial statement users has not been justified by the cost of generating and auditing the information. Furthermore, we believe the reduced cost of the amortization approach does not diminish the quality of the information, particularly because there is widespread evidence of the lack of timeliness of goodwill impairments, as we document above.

Mikhail B. Pevzner, PhD, CPA   
Professor, EY Chair in Accounting
Program Director, MS in Accounting/Business Advisory Services
University of Baltimore
Office: 410-837-5862
mpevzner@ubalt.edu

Phillip J. Korb, CPA, CGMA
Associate Professor in Accounting
Department Chair, Accounting, Finance and Economics
University of Baltimore
Office: 410-837-5080
pkorb@ubalt.edu

[1] See, for example, Gu, F., & Lev, B. (2011). Overpriced shares, ill-advised acquisitions, and goodwill impairment. The Accounting Review, 86(6), 1995-2022; Li, Z., Shroff, P. K., Venkataraman, R., & Zhang, I. X. (2011). Causes and consequences of goodwill impairment losses. Review of Accounting Studies, 16(4), 745-778; Fu, F., Lin, L., & Officer, M. S. (2013). Acquisitions driven by stock overvaluation: are they good deals?. Journal of Financial Economics, 109(1), 24-39; Harford, J., Humphery-Jenner, M., & Powell, R. (2012). The sources of value destruction in acquisitions by entrenched managers. Journal of Financial Economics, 106(2), 247-261; Akbulut, M. E. (2013). Do overvaluation-driven stock acquisitions really benefit acquirer shareholders?. Journal of Financial and Quantitative Analysis, 48(4), 1025-1055.

[2] See, for example, Damodaran’s interview to Forbes available at: https://www.forbes.com/sites/kevinharris/2018/07/17/professor-aswath-damodaran-on-valuation/#7dd373ac722c

[3] See, for example, Li, K. K., & Sloan, R. G. (2017). Has goodwill accounting gone bad?. Review of Accounting Studies, 22(2), 964-1003.

[4] See, for example, Maines, L. A., & McDaniel, L. S. (2000). Effects of comprehensive-income characteristics on nonprofessional investors’ judgments: The role of financial-statement presentation format. The accounting review, 75(2), 179-207.

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