Why are so many companies taking massive goodwill charges?

Billions of pounds are being written off every week as chief executives reassess the value of their extravagant investments in the New Economy.

Billions of pounds are being written off every week as chief executives reassess the value of their extravagant investments in the New Economy.

Under new accounting rules, these revisions are producing a series of ugly "goodwill write-downs" relating to the value of acquisitions made during the late-Nineties technology boom.

When one company buys another, the purchase price tends to be a lot higher than the value of the hard assets – the buildings, the office equipment and stocks – that it acquires. Goodwill is the name given to the gap between the two values. The precise nature of goodwill is keenly disputed. One view is that it is an intangible asset, such as the value of a having an entrenched customer base, or of a widely recognised brand name.

In the case of fast-growing telecoms companies, goodwill has often been taken to represent the strategic value of the increased market share that comes with an acquisition.

Accounting regulators, however, are not especially worried about what goodwill happens to be. Their main concern is that its value should remain clearly visible to investors.

At the centre of the present accounting regime covering goodwill is the belief that company chiefs must be held accountable for their acquisitions, and the price they paid, long after the event. For that reason, companies have to show the value of acquired goodwill on their balance sheet, just as if it were an asset. The figure itself will be an estimate of the future revenues the asset is seen generating. It could also be seen as the price the acquired business might fetch in today's market.

Like any asset, the value of goodwill almost always will depreciate over time. To recognise this, goodwill is often automatically written off in stages – via "amortisation" – over the period it is expected to generate revenues. This is also a way of letting companies spread the cost of an acquisition – and its impact of that cost on profits – over the course of its revenue-generating life.

The recent spate of write-downs has more to do with annual "impairment reviews" under which many companies recalculate the value of acquired goodwill according to the present market conditions.

That so many of these impairment reviews have led to massive write-downs is an admission that chief executives hugely overpaid for acquisitions in the technology boom. These executives are sending a message that they no longer expect their acquisitions to generate the gushing cashflows that were expected when they struck the deal.

And it is not hard to see why. Take-up of technology has been much slower and the legacy of massive investment has been an overcapacity that is still working its way out of the system.