4 ms·

Goodwill only ever shows up as the result of an acquisition. If a company with a book value of $1B gets acquired for $10B, the balance sheet of the acquirer wil

Goodwill only ever shows up as the result of an acquisition. If a company with a book value of $1B gets acquired for $10B, the balance sheet of the acquirer will see its goodwill increase by $9B after the acquisition closes. Nobody's doing a bottom up estimate of brand value to come up with that $9B, it's just the fudge factor double entry accounting needs in order to make the Equity = Assests - Liabilities equation continue to hold.

zeusk 5y ago
Why not just pare down the assets by $9B to reflect the expenditure of acquisition?
- rmah 5y ago
  I don't know the details, but I'm pretty sure it's tax related. I'll bet companies would love to be able to do that. Because then that company could deduct that capital loss from their income to lower or eliminate their tax burden.
- scott00 5y ago
  In double entry accounting, the $9B has to go somewhere, or you defeat the primary objective, which is to make it harder to forget transactions by maintaining a number of invariants. The two relevant ones here are [Equity]_t = [Assests]_t - [Liabilities]_t, and [Equity]_t = [Equity]_t-1 + [Profit]_t + [net cash from stock issuance/buybacks]_t - [dividends]_t The method that GAAP chooses is to move the $9B from cash to goodwill (assuming a cash transaction), which is a transfer from one type of asset to another. The alternative that I think you're suggesting is to move it from cash to expenses for the period in question. There's not necessarily a right answer to this question, accounting conventions are subjective, but I think most people think that the market premium you pay in an acquisition is more like acquiring an asset that will yield future business profits than an expense which, now that you've paid it, will have no future utility to the business. And it's easy enough to look at it the other way if you care to: the goodwill is reported in the balance sheet, and the cash flow statement shows the huge outlay of cash.
long_time_gone 5y ago
This is true from a pure accounting perspective. In reality, if a company only has discounted cash flows to imply a $1b valuation but sells for $10b, there must be something to explain that difference. In accounting, it's just an equation to make things balance. However, for the firm who decided to offer $10b, there is clearly some additional value they are applying to the $1b book.

zeusk 5y ago

Why not just pare down the assets by $9B to reflect the expenditure of acquisition?

rmah 5y ago
I don't know the details, but I'm pretty sure it's tax related. I'll bet companies would love to be able to do that. Because then that company could deduct that capital loss from their income to lower or eliminate their tax burden.
scott00 5y ago
In double entry accounting, the $9B has to go somewhere, or you defeat the primary objective, which is to make it harder to forget transactions by maintaining a number of invariants. The two relevant ones here are [Equity]_t = [Assests]_t - [Liabilities]_t, and [Equity]_t = [Equity]_t-1 + [Profit]_t + [net cash from stock issuance/buybacks]_t - [dividends]_t The method that GAAP chooses is to move the $9B from cash to goodwill (assuming a cash transaction), which is a transfer from one type of asset to another. The alternative that I think you're suggesting is to move it from cash to expenses for the period in question. There's not necessarily a right answer to this question, accounting conventions are subjective, but I think most people think that the market premium you pay in an acquisition is more like acquiring an asset that will yield future business profits than an expense which, now that you've paid it, will have no future utility to the business. And it's easy enough to look at it the other way if you care to: the goodwill is reported in the balance sheet, and the cash flow statement shows the huge outlay of cash.

long_time_gone 5y ago

This is true from a pure accounting perspective. In reality, if a company only has discounted cash flows to imply a $1b valuation but sells for $10b, there must be something to explain that difference. In accounting, it's just an equation to make things balance. However, for the firm who decided to offer $10b, there is clearly some additional value they are applying to the $1b book.