A goodwill teaching moment…
For anyone who teaches M&A material in their classes, this is a great article just written by Jonathan Weil. Bank of American paid a lot for Countrywide. There was a massive amount of goodwill in that transaction. However, while everything else is in the dumps, the goodwill still lingers in an untouched state. Wow, this is a great one for class.
PAT HOPKINS emailed me and provided additional insight, and said that i could share his thoughts with everybody..
Pat says … actually, it’s not surprising at all… It all has to do with allocation to reporting units… I imagine the reporting unit to which it was allocated is pretty huge, with Countrywide being an insignificant (even immaterial?) component.
As far as the decision to suspend the Countrywide brand, this has nothing to do with Goodwill. Companies are required to assign fair value to brands as a separate intangible. This fair value is completely independent of the company’s intention to use the brand (or not). I suspect that the scandal destroyed most of the value of the Countywide brand before the company was acquired. Again, even if the brand wasn’t already impaired (prior to acquisition), I also suspect that the Countrywide brand wasn’t worth that much when compared to the size of BoA.
For most (material and valuable) brands, the acquirer’s decision to shelve the brand should result in future impairments as the brand withers from non-use. Of course, the impairment test for brands is the ridiculous two-step test for noncurrent assets. The undiscounted cash-flow test is a pretty significant hurdle to clear…
Great issue for class discussion, though!
You learn something everyday. (And by “you”, I mean “me”.)
Thanks, Lisa (and Pat!).
Surprising or not, does it seem odd that accounting allows the recording of unidentifiable items (Goodwill) as assets on financial statements.
Perhaps, it would be better if the concept of assets were limited to items that had an independent existence separate and apart from the entity.
Coincidentally, I gave this article to my Advanced Accounting course this morning.
Rick
Rick,
The goodwill is recorded only when acquisitions occur. If we used available for sale accounting when acquiring 51% interest in another company, the investment would be recorded at market value. That market value consists of the fair value of identifiable assets in place plus any other synergy/growth opportunity. So AFS accounting implicitly records goodwill as an asset. What do you suggest we record when the 51% acquisition is accounted for as a consolidated sub? Should we end up with fewer assets under one accounting than the other at the end of day 1?
Admittedly, this article is about day 2 (subsequent to acquisition) accounting. But I think your comment focuses more on day 1 accounting.
That is an interesting question regarding the AFS securities. I see potential inconsistency regarding the measurement of these two purchases, but I think there is a fundamental distinction between a passive investment in a security and an acquisition of a business, which would justify differences in the accounting treatment.
I think the question comes down to whether synergy/growth opportunities should be recorded as assets on the balance sheet. I don’t think they would qualify under classical measurement theory, which serves as the foundation for the CF, because they arise only in the valuation process, after individual assets have been recognized and valued. I wonder under what accounting theory would growth opportunities or future sales be recorded as assets. Oh yes, that would be the matching concept.
The most interesting sentence to me in the above referenced article is: “It [BAC] might as well be telling the public not to believe any of the numbers on its financial statements.” Regardless of whether the accounting in question is in accordance with GAAP or not I doubt it makes sense to investors.
Rick
What an interesting article. A couple of thoughts I had based on my experiences:
- I accept the theory behind the initial accounting as an asset but I think the reality is sometimes companies get caught up in expansion and overpay. In theory though, the impairment analysis should correct that issue but this demonstrates that isn’t always the case.
- I think some of the issue is in segment identification. BoA had only 3 segments and thus 3 RU’s at that time. The CW goodwill was allocated to a consumer segment that encompassed deposits, credit card services, and loans. That segment had $40B of existing goodwill and would seem to be a diversified offering of financial service products. I’ve had a few experiences where we’d let a company assert only one segment and then they handed us an impairment analysis at the company level. They followed 142 but the analysis was blatantly at way too high a level because they probably had more operating segments than they asserted.
- In 2009, BoA did restructure their segments and thus restructured their goodwill reporting units from 3 to 6. Correct me if I’m wrong but I believe the accounting for reporting unit restructurings seems to dictate an allocation of existing goodwill to the new reporting units based on relative fair value of each unit. The original consumer reporting unit is now broken up into deposits, card services, and home loans so the CW goodwill would likely have been spread out amongst those three. One would assume that the home loan unit had a very low fair value relative to these others so they likely only were allocated a small portion of the existing goodwill. Thus, the CW goodwill impairment is likely no longer even contingent upon the performance of the home-loan division.
I know this is a long time back, but I thought the statement below by Walter P. Schuetze from a speech he gave to the FAR section at the 1998 AAA annual meeting. It seems like it is a pretty good response to Robert’s question regarding the purchase of goodwill
“There is no doubt, and I agree, that the owner of an investment in net assets, or an interest in net assets, controls that investment. If the financial statements are to show the investment, which investment implicitly includes the lump [goodwill], and the results of holding that investment, then the balance sheet will show a one-line item representing the investment, perhaps at cost or perhaps at fair value, and the income statement will show dividends flowing from the investment and perhaps changes in the fair value of the investment. That is the way an investment, and the results of holding an investment, are shown in the financial statements of an investment company. In the financial statements of an operating company, however, the investment is not portrayed; instead the individual operating assets such as marketable securities, loans, inventory, land, plant, equipment, mines, and patents, and the results of using or holding those individual operating assets, are portrayed, for it is those individual operating assets that generate cash inflow, and only those operating assets. It is in the balance sheet of an operating company that the lump [goodwill] does not, in my opinion, satisfy the control criterion even though that criterion would be met in the balance sheet of an investment company as to the investment itself.”
Rick