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Goodwill has always struck me as a very suspect accounting practice. I'm honestly surprised it's legal.

CamelCaseName 3y ago
Why? What about it is suspect?
jerf 3y ago
It's a perfectly sensible practice. It is, perhaps, an unfortunate name, since as a term of art it makes sense but the plain English implies an awful lot of value judgments for what is really just a "a recognized and intentional mismatch resulting in a fudge factor".
civilitty 3y ago
"Goodwill" is just the premium the acquirer had to pay for the company above the net fair market value of its tangible assets. It starts out as essentially the amount spent to "buy the goodwill" of the owners and convince them to sell, not an estimate of how much the intangible assets are actually worth. That's the first concrete number usable for GAAP. Afterwards, companies have to annually test goodwill for "impairment" and write down the value of its goodwill if it's impaired.
- djoldman 3y ago
  Wow, just read up on goodwill impairment testing... seems sketchy AF.
  - civilitty 3y ago
    What part seems sketchy? Like HWR_ said, it's mainly used to balance the books. The tax basis of goodwill is zero and an impairment generally isn't tax deductible. Its main purpose is to track the health of the company. For example, if you acquire a restaurant chain with a bunch of retail locations but then announce that you're a racist, losing all the customers, you still own the retail locations but the premium that you paid for the constant restaurant revenue is now worthless. Assuming that restaurant revenue was more than you could make from leasing the retail space to someone else, there needs to be a way to represent that loss of book value.
    - TechBro8615 3y ago
      The "controversy" section [0] of its Wikipedia entry summarizes it better than I could: > The accounting treatment for goodwill remains controversial, within both the accounting and financial industries, because it is, fundamentally, a workaround employed by accountants to compensate for the fact that businesses, when purchased, are valued based on estimates of future cash flows and prices negotiated by the buyer and seller, and not on the fair value of assets and liabilities to be transferred by the seller. This creates a mismatch between the reported assets and net incomes of companies that have grown without purchasing other companies, and those that have. [0] https://en.wikipedia.org/wiki/Goodwill_(accounting)#Controversy https://en.wikipedia.org/wiki/Goodwill_(accounting)#Controve...
      - zdragnar 3y ago
        I run a startup. You think it could be worth $x based on $y projection. I disagree, optimistically believing I will double your projection. If you make an offer based on your projection, I'll turn it down. If you make a better offer (hoping to gain some efficiency by combining businesses together, for example) I might instead consider the offer worthwhile since it removes all of my risk, stress, and opens me up to start something different. At the end of the day, you've paid for my goodwill. Nothing nefarious, I (owner being bought out) just happened to be stubborn. The fact that we agreed on a price point that's not reflected in your accounting just means that an intangible value has been converted into dollars. Accountants and economists might not care for intangible value, but reality is more complicated than economic and financial models can describe.
        TechBro8615 3y ago
        Yeah, that's all well and good. But then after I acquire your company, I get to use that goodwill cost to offset other, unrelated losses. It seems counterintuitive, because I could overpay for your company, and then hide my existing losses by covering them with the "goodwill" premium I paid to you. In that situation I'm running a bad business: I was losing money, and I overpaid for an acquisition. But the goodwill makes it look on paper as if I've increased my total assets when really I'm just burning cash.
rodgerd 3y ago
At heart it's simple enough, as I learned in sixth form accounting: you need something in your ledger to account for the difference between the asset value of your business and the price someone will pay to buy it from you. Obviously the futher you get away from "my business is a factory that I own, my cash reserves, and a pile of materials that I can turn into product" and more into "my business is the smarts of a bunch of people who can leave with two weeks notice, a bunch of contracts that can be severed with 90 days notice, and an API that people love so much they don't want to go elsewhere" it gets very difficult to justify.
michaelt 3y ago
The way goodwill was explained to me is: If you buy Coca-Cola Corporation you get tangible assets like the manufacturing plants and work in progress which can be valued fairly simply. But you also buy the Coca-Cola brand, which is intangible and difficult to value. And yet it obviously has value - nobody thinks the value of Coca-Cola is entirely in its bottling plants. So we just kinda say, "I guess it's worth what you just paid for it" and put it in the accounts as the difference between the purchase price and the value of the assets that can be valued.

Why? What about it is suspect?

jerf 3y ago

It's a perfectly sensible practice. It is, perhaps, an unfortunate name, since as a term of art it makes sense but the plain English implies an awful lot of value judgments for what is really just a "a recognized and intentional mismatch resulting in a fudge factor".

civilitty 3y ago

"Goodwill" is just the premium the acquirer had to pay for the company above the net fair market value of its tangible assets. It starts out as essentially the amount spent to "buy the goodwill" of the owners and convince them to sell, not an estimate of how much the intangible assets are actually worth. That's the first concrete number usable for GAAP. Afterwards, companies have to annually test goodwill for "impairment" and write down the value of its goodwill if it's impaired.

djoldman 3y ago
Wow, just read up on goodwill impairment testing... seems sketchy AF.
- civilitty 3y ago
  What part seems sketchy? Like HWR_ said, it's mainly used to balance the books. The tax basis of goodwill is zero and an impairment generally isn't tax deductible. Its main purpose is to track the health of the company. For example, if you acquire a restaurant chain with a bunch of retail locations but then announce that you're a racist, losing all the customers, you still own the retail locations but the premium that you paid for the constant restaurant revenue is now worthless. Assuming that restaurant revenue was more than you could make from leasing the retail space to someone else, there needs to be a way to represent that loss of book value.
  - TechBro8615 3y ago
    The "controversy" section [0] of its Wikipedia entry summarizes it better than I could: > The accounting treatment for goodwill remains controversial, within both the accounting and financial industries, because it is, fundamentally, a workaround employed by accountants to compensate for the fact that businesses, when purchased, are valued based on estimates of future cash flows and prices negotiated by the buyer and seller, and not on the fair value of assets and liabilities to be transferred by the seller. This creates a mismatch between the reported assets and net incomes of companies that have grown without purchasing other companies, and those that have. [0] https://en.wikipedia.org/wiki/Goodwill_(accounting)#Controversy https://en.wikipedia.org/wiki/Goodwill_(accounting)#Controve...
    - zdragnar 3y ago
      I run a startup. You think it could be worth $x based on $y projection. I disagree, optimistically believing I will double your projection. If you make an offer based on your projection, I'll turn it down. If you make a better offer (hoping to gain some efficiency by combining businesses together, for example) I might instead consider the offer worthwhile since it removes all of my risk, stress, and opens me up to start something different. At the end of the day, you've paid for my goodwill. Nothing nefarious, I (owner being bought out) just happened to be stubborn. The fact that we agreed on a price point that's not reflected in your accounting just means that an intangible value has been converted into dollars. Accountants and economists might not care for intangible value, but reality is more complicated than economic and financial models can describe.
      - TechBro8615 3y ago
        Yeah, that's all well and good. But then after I acquire your company, I get to use that goodwill cost to offset other, unrelated losses. It seems counterintuitive, because I could overpay for your company, and then hide my existing losses by covering them with the "goodwill" premium I paid to you. In that situation I'm running a bad business: I was losing money, and I overpaid for an acquisition. But the goodwill makes it look on paper as if I've increased my total assets when really I'm just burning cash.

rodgerd 3y ago

At heart it's simple enough, as I learned in sixth form accounting: you need something in your ledger to account for the difference between the asset value of your business and the price someone will pay to buy it from you. Obviously the futher you get away from "my business is a factory that I own, my cash reserves, and a pile of materials that I can turn into product" and more into "my business is the smarts of a bunch of people who can leave with two weeks notice, a bunch of contracts that can be severed with 90 days notice, and an API that people love so much they don't want to go elsewhere" it gets very difficult to justify.

michaelt 3y ago

The way goodwill was explained to me is: If you buy Coca-Cola Corporation you get tangible assets like the manufacturing plants and work in progress which can be valued fairly simply. But you also buy the Coca-Cola brand, which is intangible and difficult to value. And yet it obviously has value - nobody thinks the value of Coca-Cola is entirely in its bottling plants. So we just kinda say, "I guess it's worth what you just paid for it" and put it in the accounts as the difference between the purchase price and the value of the assets that can be valued.