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.
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.