Goodwill Impairments Spiked Last Year

More companies are finding that they probably paid too much for their past acquisitions.

Charges to reflect business purchases gone south jumped to $51 billion last year, driven by a handful of major calamities with acquired companies and a growing number of smaller ones.

Goodwill impairments appear on corporate balance sheets primarily when companies true up the carrying value of a business they acquired because it's value hasn't held up to the purchase price. In accounting parlance, that means the fair value of a reporting unit, or the business acquired, has fallen below the carrying value at which it is held on the books.

A recent study shows 235 public companies took such markdowns in 2012 to the tune of $51 billion, up 76 percent from 2011, when 227 companies recorded impairments totaling $29 billion. The study comes from investment bank Duff & Phelps and Financial Executives Research Foundation. It shows 43 percent of U.S. public companies carried some goodwill on their balance sheets in 2012, and 10.5 percent of those companies wrote down the value.

Duff & Phelps says nearly half of the total impairment figure can be attributed to three specific events. In 2012, Hewlett-Packard took a charge of $13.7 billion related to its acquisition of British software company Autonomy, leading to bitter allegations and fervent denials of wrongdoing. In the same year, Microsoft recorded a $6.2 billion impairment to write down its acquisition of aQuantive, and Boston Scientific wrote down $4.35 billion in value related to its transaction involving Guidant. The study did not take into account, however, a $27 billion impairment charge by General Motors because it resulted more from the application of fresh-start accounting in 2009 as the company emerged from bankruptcy.

When Duff & Phelps began its study in 2008, the financial crisis had drained $188.4 billion in goodwill out of capital markets that year. The dollar figure dropped dramatically the next year to $26.4 billion, then crept to $29.7 billion and $29.1 billion in 2010 and 2011. Chris Wright, managing director at consulting firm Protiviti, says he sees the goodwill impairment trends over the past several years as an indication that markets are normalizing and turbulence can no longer be blamed for fluctuations in values.

“To some extent, we are seeing the aftermath of the preceding downturn,” he says. For a time when markets are in turmoil, companies can perhaps assert any apparent impairment is the result of turmoil and should not be regarded as permanent. “When the market is in turbulence, it's easy to say this is turbulence and we don't have an impairment. When we don't have turbulence, you stand alone.”

In terms of industry sectors, impairment charges were biggest in technology (with H-P and Microsoft in the lead), healthcare, and industrials. That comes as no surprise to Scott Lehman, partner in charge of accounting at Crowe Horwath. “In some respects, business combinations are a bit of a gamble,” he says. “You're typically paying a premium on the expectation that it is going to pan out.” That's especially true in IT, he says. “Oftentimes you're banking on products that are going to be superstars. When that doesn't pan out, you see huge impairments.”

“To some extent, we are seeing the aftermath of the preceding downturn. When the market is in turbulence, it's easy to say this is turbulence and we don't have an impairment. When we don't have turbulence, you stand alone.”

—Chris Wright,

Managing Director,

Protiviti

Keeping It Old School

The study also revealed companies have not eagerly jumped into using a new method provided under accounting rules that was intended to make it easier to identify when an impairment charge might be warranted. The Financial Accounting Standards Board established a qualitative test companies can use to help them determine if they might have a goodwill impairment to record to spare them the more detailed calculations that can lead to a full fair-value analysis. The accounting standard was adopted in late 2011, making the optional test new for the 2012 reporting year.

The study data says only 16 percent of public companies opted to apply the new test while 45 percent said they preferred the quantitative test and decided to stick with it; 13 percent said they considered the qualitative test but decided it wouldn't be cost effective, and an equal number said they considered it but wanted more guidance. Gary Roland, managing director at Duff & Phelps, says some recent guidance on goodwill impairment from the American Institute of Certified Public Accountants should fill that demand.

GOODWILL IMPAIRMENT TRENDS

The charts below, from Duff & Phelps, compare trends in goodwill impairments for private vs. public companies with results from their recent poll.

The proportion of public companies recognizing an impairment in 2012/2013 (37%) is similar to that in last year's survey (36%). However, private companies showed a notable decline from the 34% observed in last year's survey to the 23% in this year's survey.

Macroeconomic and industry conditions appear to have improved relative to the 2012 Survey. The proportion of respondents citing factors specific to the reporting unit as the reason for taking an impairment has increased from the prior year's survey, nearing 60% of companies in the 2013 Survey.

Source: Duff & Phelps.

Companies were enthusiastic about the new test at first because one of the stated goals was to reduce the cost and complexity of the standard impairment test, says Brian Marshall, a partner with McGladrey. That enthusiasm waned as the reality of the requirements around the qualitative test sunk in. “There's actually a lot of documentation required to support an assertion on a qualitative basis that you've passed,”   he says. “There are no numbers, so it's judgmental.” When starting that conversation with companies over whether to begin with the qualitative test or proceed to the more detailed quantitative test, one of the top questions is how much cushion the company has the prior year. “If you didn't pass by much, in a lot of cases you're not going to get a lot of benefit out of doing the qualitative test.”

Some companies opted not to use the qualitative test simply because they didn't want to face the added scrutiny, or worse, end up performing the more detailed test after placing hope in the qualitative test, says Peter Bible, a partner with audit firm EisnerAmper. “It's the path of least resistance,” he says. “It's math, so you can calculate it. That means there's less judgment. People find it easier to do that.”

The decision around which test to apply is very much based on a given company's circumstances, says Deloitte & Touche Partner Robert Morris. “It's largely driven by how much cushion each of their reporting units is likely to have,” he says. “It's judgmental. Sometimes they just feel more comfortable going to step one,” or the first step in the quantitative analysis. “They've been performing it the last number of years, they have processes and controls around it, they're comfortable with it, and it gives a more certain answer.”

In some cases, smaller public companies with only a single reporting unit might also find it easier to apply the quantitative test rather than the new qualitative one, says Adam Brown, a partner with BDO USA. “Your public stock price is going to be a strong and reliable indicator of what the fair value is compared to the book value,” he says. “When you have that, you already have some pretty strong evidence for the quantitative test. It could be more efficient.”