What is Goodwill? Essay

Question 1

What is Goodwill?

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            The Accounting Principles Board’s Opinion No. 17, which was superseded by Statement of Financial Accounting Standards No. 142, defined goodwill as “[the] excess of the cost of an acquired company over the sum of identifiable net assets” and added that it “is the most common unidentifiable intangible asset” (Paragraph 1). Furthermore, Paragraph 87 of the APB Opinion No. 16 said that “the excess of the cost of the acquired company over the sum of the amounts assigned to identifiable assets acquired less liabilities assumed should be recorded as goodwill.”

            Financial Accounting Standards No. 141, on the other hand, defined intangible asset as “an asset apart from goodwill if it arises from contractual or other legal rights” (Paragraph 39). The same standard defined goodwill as “[the] excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed” (Paragraph 43). This definition is the same as the goodwill definition in Paragraph 87 of APB Opinion No. 16. FASB Statement No. 142 differs with APB No. 17 only in how goodwill is “accounted for subsequent to [its] initial recognition.”

Why does GAAP have a specific definition for goodwill beyond its economic concept?

            Admittedly, the Goodwill related to a company is that intangible asset that can’t be identified to a specific asset. This intangible asset has an ability to improve upon the company’s financial condition.  This includes both the present as well as the future value of the firm.  Therefore, from an economic standpoint, goodwill serves to assist the firm in providing products and or services from operations and provides value in its ability to increase the firm’s ability to generate profits.

            The GAAP definition serves to guide companies in valuing, summarizing, and reporting Goodwill in their financial statements. This definition then makes its easier for financial statement users to compare financial statements of companies whether these companies have reported Goodwill.

Question 2

What conclusion can one make about a company if a company has no goodwill on its books?

            Of hand, there are three possible conclusions that can be derived if a company has no goodwill on its books. The first conclusion is that the company didn’t purchase or acquire another company. In this case, no matter what accounting pronouncement era the company is in, there is no acquisition to account for which might lead to the recognition of goodwill.

            The second conclusion is that the company purchased or acquired a company, and subsequently recorded the acquisition in accordance with APB Opinion No. 16 / 17 which required that companies record acquisitions by using the pooling of interest method which allowed some primarily stock-based acquisitions to be recorded at book value, rather than at fair value. In this case, no goodwill will be recognized since the acquisition is recorded at book value rather than the fair value of the ownership acquired.

            The third conclusion is that the company purchased or acquired a company, and recorded goodwill in its books, but the said recognized goodwill has been fully amortized or impaired. The first scenario is the company acquired a company while SFAS No. 141 was still in effect. This standard required that all acquisitions be recorded at fair value which effectively eliminated the pooling of interest method suggested by prior to this standard. Furthermore, with the recognition of acquisition at fair value, companies now recognize goodwill. With this recognition comes its amortization which as stated in SFAS No. 141 is over the shorter of its estimated useful life or 40 years whichever is shorter. The second scenario under this conclusion is that the goodwill has been impaired. The testing of the impairment of goodwill is suggested by SFAS No. 142 which superseded SFAS No. 141.

Question 3

a.       Amount of goodwill associated with the Rockwell Aerospace and Defense Business acquisition

               “On December 6, 1996, the Company acquired Rockwell’s aerospace and defense business by issuing 9.2 million shares of common stock valued at $875 and assuming debt valued at $2,180.  This transaction has been accounted for under the purchase method.  The assets and liabilities have been recorded at fair value based on preliminary valuations, with excess purchase price recorded as goodwill.  Goodwill is amortized on a straight-line basis over 30 years.  The fair value of the net liabilities acquired was $1,610 and goodwill was valued at $2,485” (1996 Annual Report Boeing).
Since this Goodwill has a useful life of 30 years, the related amortization expenses are computed by dividing the value of the Good will by the useful life:
Year
Amortization
Accumulated
1996 (for one month only)
$6.90
$6.90
1997
82.83
89.73
1998
82.83
172.56
1999
82.83
255.39
The above figures, specifically under the accumulated Good will amortization for the years 1997, 1998 and 1999, are almost equal to the figures reported on the company’s Annual Reports for 1998 and 1999. These figures are:
Year
Accumulated
1997
91
1998
174
1999
257
Sources: 1998 and 1999 Annual Reports of Boeing Corporation.
And I am thinking that the differences in my computed figures and the reported figures are due to rounding off.
b.      Useful life of that goodwill

Boeing’s financial statements for the year 1996 stated that goodwill is amortized over 30 years, hence the goodwill associated to the acquisition of Rockwell Aerospace and Defense Business has a useful life of 30 years. Specifically the company’s 1996 Annual Report says:

“Goodwill, representing the excess of acquisition costs over the fair value of net assets of businesses purchased, is being amortized by the straight-line method over 30 years.  Goodwill is included in the respective industry segments’ identifiable assets and the goodwill amortization is charged against the respective industry segments’ operating profit.  Recoverability of the unamortized goodwill balance is based upon assessment of related operational cash flows.”
This choice of a shorter amortization period than what was allowed in APB Opinion No. 17, which allowed for a maximum of 40 year amortization, says something about how Boeing understands the portion of Goodwill that may be indefinite in life versus the portion with a finite life. This means that Boeing assumed that the premium it paid for Rockwell Aerospace and Defense is Good will with finite life. Or that if it has a portion with infinite life, the effort to perform an impairment approach on that portion is too much; hence a cost benefit analysis resulted to recording all of the Goodwill as a finite asset.

c.       Fair value of McDonnell Douglas

               “On December 14, 1996,  McDonnell  Douglas and The Boeing  Company  (Boeing)
entered into a definitive agreement whereby a wholly-owned  subsidiary of Boeing will  merge into  McDonnell  Douglas  in  a  stock-for-stock  transaction  with McDonnell  Douglas  surviving  as  a  wholly-owned  subsidiary  of  Boeing” (1996 Annual Report McDonnell Douglas).

               According to Boeing’s 1997 Annual Report, “Effective August 1, 1997, McDonnell Douglas Corporation merged with the Company through a stock-for-stock exchange in which 1.3 shares of Company stock were issued for each share of McDonnell Douglas stock outstanding. The Company issued 277.3 million shares in connection with the merger.” And the merger was accounted for using the pooling of interest method which means it was accounted for at book value. With this information, I can say that the total number of stocks of McDonnell Douglas was 213.3 million which I got by dividing the total stocks issued for the acquisition with the stock-for-stock exchange ratio.
Item
Amount
McDonnell Douglas shares
213.3 million
Fair market price (per share) before goodwill
$52
Fair market value of the acquisition
$11.092 billion
Book value of McDonnell Douglas*
$3.085 billion
Source: 1996 Quarterly Report (June), McDonnell Douglas Corporation.
Yes, I think there is Good will involved in the acquisition. There is a significant difference between the book value of the company which was computed by deducting total liabilities from total assets reported as of June 30, 1996.
d.      Special charge

It is only this year, 1997, that Boeing completed its assessment of the financial impact of its merger with McDonnell Douglas. As a result of this assessment the company recorded a pretax charge of $1.4 billion (1997 Annual Report Boeing Corporation) which is related to inventory valuation. Although this adjustment is still not equal to the difference between the fair and book values of McDonnell Douglas at the time of acquisition, it is still significant.

As such, this special charge will decrease the fair value computation I have made in the previous question. And this will also effectively decrease the unrecorded goodwill in the McDonnell Douglas acquisition. The pooling of interest accounting method used for the merger shielded McDonnell Douglas from recognizing goodwill impairment up to the portion of goodwill not identifiable to specific assets. In this instance – the recording of special charge – the ‘impairment of goodwill’ is specifically attributed to the inventory of McDonnell Douglas.

e.       Hughes Electronics Corporation

               As a result of the adoption of SFAS No. 141 and 141, Boeing adjusted the goodwill attributed to the Hughes Electronics Corporation purchase (2001 Annual Report Boeing Corporation). “On October 6, 2000, the Company acquired the Hughes Electronics Corporation (Hughes) space and communications and related businesses. The acquisition was accounted for under the purchase method, by which the purchase price was allocated to the net assets acquired based on preliminary estimates of their fair values. The original purchase price was $3,849, initial goodwill was valued at $740 and the other intangible assets were valued at $631” (2001 Annual Report Boeing Corporation). This amount was increased to $2,166 after the company finished its assessment of the net assets acquired. This must be so because of the differences of the amounts assigned to identifiable assets right after the acquisition and after its post assessment period. To wit,
The Accounting Principles Board’s Opinion No. 17, which was superseded by Statement of Financial Accounting Standards No. 142, defined goodwill as “[the] excess of the cost of an acquired company over the sum of identifiable net assets” and added that it “is the most common unidentifiable intangible asset” (Paragraph 1). Furthermore, Paragraph 87 of the APB Opinion No. 16 said that “the excess of the cost of the acquired company over the sum of the amounts assigned to identifiable assets acquired less liabilities assumed should be recorded as goodwill.”

Question 4

a.       Transitional impairment and impairment

The transitional impairment reported is $2,410 ($1,827 net of tax), and charged during the first quarter of 2002. This transitional impairment is reported as a cumulative effect of accounting change (2002 Annual Report Boeing Corporation). While the amount attributable to the impairment of goodwill, in its real sense as stated in SFAS No. 141 and 142 is reported as part of other losses and income.

These different classifications of provide a clearer communication to financial statement readers because the transitional impairment is really the effect of the adoption of the new accounting standards instead of as a result of the ‘real’ impairment of the company’s goodwill.

b.      Impairment charges in 2002 and 2003

The 2002 and 2003 impairment charges occurred as a result of the company’s adaptation of the new accounting standards specifically SFAS Nos. 141 and 142. If these standards were not enacted, then the said impairment charges would not have been recorded in the books of the company (2002 and 2003 Annual Report Boeing Corporation).

As specified, the transitional impairment charges relate to the company’s segments in space and communications, commercial airplanes, and other segments. Since the Hughes Electronics Corporation (Hughes) space and communications and related businesses was purchased in 2001, then it is probable that the transitional impairment is related to this purchase.

c.       Reportable segments

               In the company’s 2003 Annual Report, Boeing recognized a $913 million in goodwill charges as a result of a goodwill impairment analysis triggered by the reorganization of its Military Aircraft and Missile Systems and Space and Communications segments into IDS – $572 million recorded at IDS and $341 million recorded at the Commercial Airplanes segment. This impairment is not only attributable to the year 2003, but also attributable to the years before that. This is so because the impairment was due to the decision of the company to reorganize several of its segments.
Since goodwill can be identified to a specific segment of a company, the reorganization of that segment will also affect the value of its related goodwill.

References

1996 Annual Report (10-K). Boeing Corporation. Accessed on July 8, 2007, Available from http://www.sec.gov/Archives/edgar/data/12927/0000012927-97-000020.txt.

1996 Quarterly Report (June 10-K). McDonnell Douglas Corporation. Accessed on July 8, 2007, Available from http://www.sec.gov/Archives/edgar/data/63917/0000063917-96-000025.txt.

1996 Annual Report (10-K). McDonnell Douglas Corporation. Accessed on July 8, 2007, Available from http://www.sec.gov/Archives/edgar/data/63917/0000063917-97-000005.txt.

1997 Annual Report (10-K). Boeing Corporation. Accessed on July 8, 2007, Available from http://www.sec.gov/Archives/edgar/data/12927/0000012927-98-000007.txt.

1998 Annual Report (10-K). Boeing Corporation. Accessed on July 8, 2007, Available from http://www.sec.gov/Archives/edgar/data/12927/0000012927-00-000002.txt.

1999 Annual Report (10-K). Boeing Corporation. Accessed on July 8, 2007, Available from. http://www.sec.gov/Archives/edgar/data/12927/0000012927-99-000010.txt.

2001 Annual Report (10-K). Boeing Corporation. Accessed on July 8, 2007, Available from http://www.sec.gov/Archives/edgar/data/12927/000001292702000005/0000012927-02-000005.txt.

2002 Annual Report (10-K). Boeing Corporation. Accessed on July 8, 2007, Available from http://www.sec.gov/Archives/edgar/data/12927/000001292703000005/0000012927-03-000005.txt.

2003 Annual Report (10-K). Boeing Corporation. Accessed on July 8, 2007, Available from http://www.sec.gov/Archives/edgar/data/12927/000119312504034751/0001193125-04-034751.txt.

APB No. 17. Business Combinations.

APB No. 17. Intangible Assets.

FASB Statement No. 141. Business Combinations.

FASB Statement No. 142. Goodwill and Other Intangible Assets