Outlook: No easy way to value goodwill

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The Independent Online
Another of those gloriously complicated Financial Reporting Standards (FRSs) was rolled out of Sir David Tweedie's accounting workshop yesterday. This is FRS number 10, and like previous models, it is mindnumbingly technical. It tells companies how to account for "goodwill and intangible assets". According to Sir David, it is one of the Accounting Standard Board's longest-running projects - "a major problem for the ASB and its predecessor, the Accounting Standards Committee".

It is not hard to see why. After all those years of work, the ASB has failed to come up with a meaningful solution to the problem of accounting for goodwill. The whole point of the ASB and its Financial Reporting Standards is to introduce transparency and comparability into company accounts after the accounting scandals of the 1980s. Unfortunately, FRS 10, while well intentioned enough, seems likely to fail almost completely in this task.

The ASB's starting point is reasonable enough. When companies acquire each other they generally do so at a value considerably in excess of the book value of the assets. The problem then arises of how to account for this excess, or "goodwill value". In most cases, the goodwill is immediately written off against reserves. This approach is open to criticism for two reasons.

First, it causes the acquirer's net worth to be depleted or even eliminated. This in turn has encouraged companies to reduce the amounts attributed to purchased goodwill by separately valuing brands and other intangible assets in the balance sheet, resulting in some bizarre distortions. For instance, Burger King is listed as an asset on the balance sheet because it was bought by Grand Metropolitan, while McDonald's, as an internally- generated asset, has no value on its balance sheet whatsoever.

The second criticism is that it allows the acquirer to overstate the rates of return achieved on the acquired assets. A new and much lower base line is established which unduly flatters subsequent performance. That's why these techniques were so commonly used in the 1980s.

The solution proposed by the ASB is to capitalise the goodwill as an asset on the balance sheet. Simple enough, so where's the problem? Unfortunately that's just the start. Most goodwill and intangible assets will be presumed to have a life of 20 years and will be written off over that period. But some assets will have a more limited life and will be written off over a shorter period of time. And in yet other cases a longer or indefinite life may be assigned, but only if the durability of the asset can be demonstrated. A whole separate FRS is to be produced on what criteria are to be used to determine the life of an asset.

What on earth is all this mumbo jumbo about and who is it meant to help? As the description implies, an intangible asset - such as a brand or a particularly talented employee - is, well, an intangible asset and any attempt to value it is bound to be a wholly subjective thing. It is not something that can or should be attempted in company accounts. The whole business of determining how much a company is or is not worth should be left where it belongs - with the judgement of investors.

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