Question

(RTTNews) - Japanese electronics conglomerate Toshiba Corp. (TOSYY.PK, TOSBF.PK) said Tuesday that it expects to record goodwill impairment charge of several billion dollars related to an acquisition of U.S. nuclear power operations.

The goodwill is related to the purchase of U.S. engineering company CB&I Stone & Webster Inc.'s nuclear construction and integrated services business by Toshiba's U.S. subsidiary, Westinghouse Electric Co. LLC. Westinghouse's acquisition of 100 percent of the shares of CB&I Stone & Webster or S&W from Chicago Bridge & Iron Company N.V. or CB&I closed in December 2015. At that time, Toshiba said the amount of goodwill would be finalized by December 31, 2016, in accordance with U.S. GAAP procedures. But the company had made a preliminary estimate that the goodwill resulting from the transaction will be about $87 million and subject to change.

As the deadline for the finalization of the procedure is nearing, Toshiba said it has found that the goodwill will reach a level of several hundred billion yen, or several billion dollars, resulting in a negative impact on the company's financial results. Westinghouse has been engaged in purchase accounting and studying the actual status based on materials provided by S&W and others after the transaction completion. The company is evaluating the cost to complete the AP1000 contracts to measure the fair value of acquired assets and liabilities.

Westinghouse has found that the cost to complete the U.S. projects will far exceed the original estimate, mainly due to increases in key project parameters, resulting in far lower asset value that originally determined. Thus, goodwill recognized will possibly far exceed the original December 2015 estimate of $87 million, Toshiba noted. Both Toshiba and Westinghouse will initiate impairment testing for the goodwill toward the third-quarter of fiscal 2016 business results. Toshiba will announce its revised forecast for fiscal 2016 after determining the impact of the possible Westinghouse loss on its own financial results. On the Tokyo stock exchange, Toshiba's shares fell 51.50 yen or 11.62 percent to close at 391.60 yen.

Required:

1. Based on this Toshiba case and other reference materials available from the internet, please discuss the possible reasons that goodwill is not amortized like other intangible assets, but is tested for impairment on a periodic basis.

2. Assume that you were a financial analyst. Please explain to your client the reasons that impairment losses lead to lower stock price.

*Hint: Please note that you first need to figure out the factors and financial ratios that are negatively affected by the goodwill impairment losses. After that, you need to further build up a link between those factors and the lower stock price.

3. Assume that you were a financial analyst, and you focus on the e-commerce industry. You recently notice that the goodwill level in Jingdong fluctuates a lot over the last eight years. What are the possible reasons for this fluctuation? As a financial analyst, would you consider this as a positive sign or a negative sign?

Answer 1

1) Reasons why Goodwill is not amortised but tested for impairment on a periodic basis-

a) It is very difficult to value the benefits that would be generated by goodwill over a time period which does not link amortisation charge with the economic benefits rendered during an accounting period.

b) IAS 36 specifically stated that intangible assets with indefinite life should not be amortised, rather they need to tested periodically for impairment losses. If it is amortised, it will become very difficult to assign a life span to it because a goodwill provides economic benefits to an entity for an indefinite period.

c) Amortisation of goodwill would lead to adoption of different approaches and rates by various companies, which makes it difficult to compare the financial statements of different entities.

2) Factors resulting in impairment losses-

External factors:

a) Considerable fall in the asset's market price

b) Rise in the market interest rates

c) Company's net assets are more than its market capitalization

d) Adverse changes in markets, economy, technology etc.

Internal factors:

a) Physical damage or obsolescence of asset

b) Poor economic performance than expected

c) If the asset is idle or held for disposal

The negative impact of impairment losses will be on ratios like net profit margin and debt-equity ratio. The reason is that after recognition of impairment losses in the income statement, profits will indicate a one-time dip, which consequently affects the book value of equity in a negative way and ultimately the market value of the company as a whole. This would lead to negative impact on the stock price of the company in the market.

3) Reasons for fluctuating goodwill

a) Fluctuations in the amount of profit earned during the period

b) Management efficiency

c) Nature of business

d) Level of competition in the operating industry

e) Time factor

f) Economic policy of the government

g) Situation of the money market

If there has been too much fluctuations in the level of goodwill, it will be considered a negative sign because it suggests that the entity's standing in the market is very volatile which gets affected very easily with any change in the above mentioned factors.