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j Game Center explain the financial reporting and disclosures related to goodwill

e Discussions When one company acquires another, the purchase price is allocated to all of the identifiable assets
(tangible and intangible) and liabilities acquired, based on fair value. If the purchase price is greater than the
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fair value of the identifiable assets and liabilities acquired, the excess amount is recognized as an asset,
goodwill. To understand why an acquirer would pay more to purchase a company than the fair value of the
target company’s identifiable assets net of liabilities, consider the following three observations. First, certain
items not recognized in the acquiree’s financial statements (e.g., its reputation, established distribution
system, trained employees) have value. Second, a target company’s expenditures in research and
development may not have resulted in a separately identifiable asset that meets the criteria for recognition
but nonetheless may have created some value. Third, part of the value of an acquisition may arise from
improved strategic positioning versus a competitor or from perceived synergies such as operating cost
saving opportunities after the acquisition.

The subject of recognizing goodwill in financial statements has both proponents and opponents. The
proponents of goodwill recognition assert that goodwill is the present value of excess returns that a company
is expected to earn. This group claims that determining the present value of these excess returns is
analogous to determining the present value of future cash flows associated with other assets and projects.
Opponents of goodwill recognition claim that the prices paid for acquisitions often turn out to be based on
unrealistic expectations, thereby leading to future write-offs of goodwill.

Analysts should distinguish between accounting goodwill and economic goodwill. Economic goodwill is
based on the economic performance of the entity, whereas accounting goodwill is based on accounting
standards and is reported only in the case of acquisitions. Economic goodwill is important to analysts and
investors, and it is not necessarily reflected on the balance sheet. Instead, economic goodwill is reflected in
the stock price (at least in theory). Some financial statement users believe that goodwill should not be listed
on the balance sheet, because it cannot be sold separately from the entity. These financial statement users
believe that only assets that can be separately identified and sold should be reflected on the balance sheet.
Other financial statement users analyze goodwill and any subsequent impairment charges to assess
management’s performance on prior acquisitions.

Under both IFRS and US GAAP, accounting goodwill arising from acquisitions is capitalized. Goodwill is not
amortized but is tested for impairment annually. If goodwill is deemed to be impaired, an impairment loss is
charged against income in the current period, reducing earnings. An impairment loss also reduces total
assets, so some performance measures, such as return on assets (net income divided by average total
assets), may increase in future periods. An impairment loss is a non-cash item.

Accounting standards’ requirements for recognizing goodwill can be summarized by the following steps:

Step 1 The total cost to purchase the target company (the acquiree) is determined.

Step 2 The acquiree’s identifiable assets are measured at fair value. The acquiree’s liabilities and
contingent liabilities are measured at fair value. The difference between the fair value of identifiable
assets and the fair value of the liabilities and contingent liabilities equals the net identifiable assets
acquired.

Step 3 Goodwill arising from the purchase is the excess of (1) the cost to purchase the target company
over (2) the net identifiable assets acquired. Occasionally, a transaction will involve the purchase of
net identifiable assets with a value greater than the cost to purchase. Such a transaction is called a
“bargain purchase.” Any gain from a bargain purchase is recognized in profit and loss in the period
in which it arises.3

Companies are also required to disclose information that enables users to evaluate the nature and financial
effect of business combinations. The required disclosures include, for example, the acquisition date fair
value of the total cost to purchase the target company, the acquisition date amount recognized for each
major class of assets and liabilities, and a qualitative description of the factors that make up the goodwill
recognized.

Despite the guidance incorporated in accounting standards, analysts should be aware that the estimations of
fair value involve considerable management judgment. Values for intangible assets, such as computer
software, might not be easily validated when analyzing acquisitions. Management judgment about valuation
in turn affects current and future financial statements because identifiable intangible assets with definite lives
are amortized over time. In contrast, neither goodwill nor identifiable intangible assets with indefinite lives
are amortized; instead, as noted, both are tested annually for impairment.

The recognition and impairment of goodwill can significantly affect the comparability of financial statements
between companies. Therefore, analysts often adjust the companies’ financial statements by removing the
impact of goodwill. Such adjustments include the following:

excluding goodwill from balance sheet data used to compute financial ratios, and
excluding goodwill impairment losses from income data used to examine operating trends.

In addition, analysts can develop expectations about a company’s performance following an acquisition by
taking into account the purchase price paid relative to the net assets and earnings prospects of the acquired
company.

Goodwill Impairment

Safeway, Inc., is a North American food and drug retailer. On 25 February 2010, Safeway issued a press
release that included the following information:

Safeway Inc. today reported a net loss of USD1,609.1 million (USD4.06 per diluted share) for the 16-
week fourth quarter of 2009. Excluding a non-cash goodwill impairment charge of USD1,818.2 million,
net of tax (USD4.59 per diluted share), net income would have been USD209.1 million (USD0.53 per
diluted share). Net income was USD338.0 million (USD0.79 per diluted share) for the 17-week fourth
quarter of 2008.
In the fourth quarter of 2009, Safeway recorded a non-cash goodwill impairment charge of
USD1,974.2 million (USD1,818.2 million, net of tax). The impairment was due primarily to Safeway’s
reduced market capitalization and a weak economy. . . . The goodwill originated from previous
acquisitions.
Safeway’s balance sheet as of 2 January 2010 showed goodwill of USD426.6 million and total assets
of USD14,963.6 million. The company’s balance sheet as of 3 January 2009 showed goodwill of
USD2,390.2 million and total assets of USD17,484.7 million.

1. How significant was this goodwill impairment charge?

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Solution:

The goodwill impairment was more than 80 percent of the total value of goodwill and 11 percent of
total assets, so it was clearly significant. (The charge of USD1,974.2 million equals 82.6 percent of
the USD2,390.2 million of goodwill at the beginning of the year and 11.3 percent of the
USD17,484.7 million total assets at the beginning of the year.) Rate Your Confidence

High
2. With reference to acquisition prices, what might this goodwill impairment indicate?

Hide Solution Medium

Solution: Low

The goodwill had originated from previous acquisitions. The impairment charge implies that the
acquired operations are now worth less than the price that was paid for their acquisition. Continue !

Category

Analyzing Balance Sheets

As presented in Exhibits 2 and 3, SAP’s 2017 balance sheet shows EUR21,274 million of goodwill, and
Apple’s 2017 balance sheet shows goodwill of USD5,717 million. Goodwill represents 50.1 percent of SAP’s r Related Questions:
total assets and only 1.5 percent of Apple’s total assets. An analyst may be concerned that goodwill Practice questions related to
represents such a high proportion of SAP’s total assets. this topic

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