The recent recession and decline in equity markets is forcing many companies to write down the value of their goodwill, an esoteric asset account that is very popular on the balance sheets of corporate America.

What Is It?
Goodwill has always been a tough item for investors to get their arms around. The official definition of goodwill is that it represents the difference between the price a company pays for an asset and its book value. Since the book value is usually recorded at cost, a company will typically pay much more than book value for an asset. (Learn more in Can You Count On Goodwill?)

This difference is placed on the asset side of the balance sheet, and the company is required to test it annually for impairment, according to FAS 142. If it is impaired, a non-cash write-down of the asset is required.

Recent Significant Company Write-Downs
Dick's Sporting Goods (NYSE:DKS) just reported its fourth quarter of fiscal 2009, and the company recorded a $193.4 million impairment of assets. The charge was pretax and decreased net income by $161.7 million or $1.44 diluted earnings per share. The charges related to the company's purchase of the Golf Galaxy chain in 2007.

Flextronics International (Nasdaq:FLEX) is another company that took a significant write-down of goodwill in its recent Q3 results. It actually took it one step further and wrote off its entire goodwill account of $5.9 billion. Flextronics attributed this write-down to "declines in the stock market and adverse macroeconomic conditions that contributed to an overall reduction in demand for the company's offerings".

Ann Taylor Stores (NYSE:ANN) also reported a pretax goodwill impairment charge of $286.6 million in Q4. This large non-cash charge resulted in a GAAP loss of $5.82 for the full year. Apparel maker Jones Apparel Group (NYSE:JNY) wrote off $838 million in goodwill. The company had spent the last few years buying smaller companies to fill out its product line. Its GAAP loss for 2008 was $9.24 per share compared to an income of 45 cents per share in 2007.

Point/Counterpoint
One problem with goodwill is that when a company finds that it is impaired and must be written off, the result is usually a large GAAP loss. This headline number will usually dominate the news reports and provide an inaccurate picture of the company's finances. (For more, see Financial Statements: Who's In Charge?)

Some investors say that a goodwill write-down shouldn't be ignored, because it implies that a company overpaid for a purchase and the charge is accounting reality catching up to real life. It also provides a more current value of assets on the balance sheet, which is always a better thing.

What It Means To Investors
Investors generally have mixed feelings about goodwill due to its non-cash nature, and they sometimes ignore the issue entirely. However, the write-off does have implications regarding the wisdom of management in possibly overpaying for assets that it should have examined more carefully before purchasing.

Asset performance shows how what a company owes and owns affects its investment quality. Learn more in Testing Balance Sheet Strength.

Related Articles
  1. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  2. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  3. Stock Analysis

    How to Find Quality Stocks Amid the Wreckage

    Finding companies with good earnings and hitting on all cylinders in this environment, although possible, is not easy.
  4. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  5. Stock Analysis

    Are U.S. Stocks Still the Place To Be in 2016?

    Understand why U.S. stocks are absolutely the place to be in 2016, even though the year has gotten off to an awful start for the market.
  6. Investing News

    U.S. Recession Without a Yield Curve Warning?

    The inverted yield curve has correctly predicted past recessions in the U.S. economy. However, that prediction model may fail in the current scenario.
  7. Investing

    Retirees: 7 Lessons from 2008 for the Next Crisis

    When the last big market crisis hit, many retirees ran to the sidelines. Next time, there are better ways to manage your portfolio.
  8. Economics

    Industries That Thrive On Recession

    Recessions are not equally hard on everyone. In fact, there are some industries that even flourish amid the adversity.
  9. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  10. Fundamental Analysis

    Is a U.S. Industrial Recession on the Horizon in 2016?

    Find out why the industrial economy may be teetering on an industrial recession and what could prevent it from going over the cliff.
RELATED FAQS
  1. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  2. Do interest rates increase during a recession?

    Interest rates rarely increase during a recession. Actually, the opposite tends to happen; as the economy contracts, interest ... Read Full Answer >>
  3. What are the risks of annuities in a recession?

    Annuities come in several forms, the two most common being fixed annuities and variable annuities. During a recession, variable ... Read Full Answer >>
  4. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  5. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  6. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center