Question

Why do you think goodwill is important for a company? What might be the problem if goodwill exceeds the market value of the firm? What do goodwill write-offs indicate about leadership decisions?

Answer 1

Goodwill arises on mergers or acquisitions. It is an intangible asset changed hands when a company is merged into another. It is the price paid by the acquirer to the promoters of the target company in consideration of the intangible value like market reputation, which are not specifically identified. In other words, Goodwill, in the books of accounts of the acquirer is the price paid in excess of the fair market value of the net assets.

If the Goodwill is in excess of the market value of the firm, more specifically the market capitalization, it means that the value assigned to the tangible assets and other identifiable non-physical assets is negative. This is a matter of concern. Because, valuation of goodwill is very much subjective in nature and the value assigned and accounted is susceptible to substantial variations. Another concern is the likelihood of faster write offs. Since any write off will result in erosion of profit, it can affect the profitability of the company.

There is no need for mandatory amortization of Goodwill. However, US GAAP and the International Financial Reporting Standards (IFRS) make it necessary to test the Goodwill for impairment, if any, periodically. Any impairment has to be written off. In case Goodwill is written off in the books, it indicates the Management’s perception of impairment in the value.