Impairment Data Hints at Problems Ahead

You gotta love goodwill. It seems like such a simple concept in financial reporting, yet somehow it can drive corporate accountants, compliance officers, auditors, senior executives, and financial analysts all crazy.

For the non-accountants out there (and we’ll explain why goodwill matters to you shortly), goodwill is the value a company assigns to the intangible qualities of an asset it owns. For example, if Software Company A has tangible assets worth $1 million (cash, equipment, receivables, etc.) and Software Company B buys the business for $10 million, a portion of that $9 million difference is reported as goodwill: the believed value of Company A’s patents, reputation, client relationships, employee talent, and so forth.

I say “believed value” because sometimes your estimate of goodwill might be proven wrong, and sometimes by quite a lot. Long-time customers leave, key employees quit, acquisition plans don’t meet expectations; then you need to disclose an impairment of goodwill on that asset you previously reported as so cool and valuable. Large impairments can be as unpopular as a stink bomb in church, with investor complaints, falling stock price, boardroom recriminations, and even shareholder litigation following close behind.

Goodwill is on my mind because I’ve been working with Calcbench, a financial data firm, examining goodwill and impairments over the last several years—and the data does not look good. Impairments are spiking by all sorts of metrics, and that could be a harbinger of difficult corporate compliance and financial reporting in the near future.

Let’s start with the numbers. Goodwill has been rising briskly since 2011, to a total of $3.408 trillion among all corporate filers in 2015. That’s no surprise given the M&A frenzy we’ve seen in the last several years. The bad news is that impairments have jumped from a low of $34.66 billion in 2013 to $83.02 billion last year. We are now at a five-year high for the total dollar value of impairments, impairments as a percentage of goodwill, average size of an impairment, and percentage of filers disclosing an impairment in any given year.

Filers Total goodwill Total impairment Impairment as % of goodwill Avg. impairment per co. % of filers reporting impairment
2011 8,516 $3.060 trill $67.23 bill 2.20 pct $141.5 mill 5.58 pct
2012* 8,192 $3.243 trill $71.86 bill 2.22 pct $149.4 mill 5.88pct
2013 7,893 $3.351 trill $34.66 bill 1.03 pct $90.27 mill 4.87 pct
2014** 7,334 $3.561 trill $48.65 bill 1.37 pct $118.9 mill 5.58 pct
2015 5,617 $3.408 trill $83.02 bill 2.44 pct $205.5 mill 7.19 pct

Why is goodwill impairment rising so much these days? Partly due to the crash in oil & gas prices—among the S&P 500 impairments last year, for example, seven of the largest nine impairment charges were reported by energy companies. The more sobering example, however, is Yahoo’s $4.4 billion impairment due to “a combination of factors, including a sustained decrease in our market capitalization in fourth quarter of 2015 and lower estimated projected revenue and profitability in the near term.”

Translation: Yahoo has been a strategic train wreck. Its growth plans and the acquisitions it made in recent years all flopped, finally forcing the company to write down $4.4 billion worth of assets.

Implications of Impairments

My fear is that we are going to see more Yahoo-type impairments in the near future. Many of those merger deals done amid cheap debt are now failing to meet expectations in our chronically sluggish economy, and senior executives can’t stall much longer before admitting their grand plans have fizzled. That will lead to some painful conversations in the boardroom and among compliance, audit, and operations executives.

wrongFirst is the choice to disclose an impairment. Under U.S. accounting rules, companies must assess the state of their goodwill assets annually in a two-step test, and then disclose any impairments they decide to take. That two-step test will soon be simplified to one step, but another issue remains: goodwill is a management estimate. In theory the audit firm should scrutinize that estimate like any other line item on the balance sheet; in practice, bringing the necessary skepticism is difficult, and audit firms don’t spend much time looking at goodwill since it isn’t considered a significant risk for financial fraud or the company’s ability to continue as a going concern. So we get these stink bombs of impairment that leave investors gagging at management.

Once that stink bomb wafts through the organization, the corporate culture and governance problems start. You may have spent months trying to integrate an acquired unit into your corporate culture (or integrating yours into theirs), only to telegraph to employees, “Oops, all that enthusiasm we talked up three quarters ago was just hype.” Odds are the employees already knew this, but it won’t make your efforts to build a strong culture any easier.

Investors, meanwhile, will start complaining that senior management should have known those assets weren’t worth the goodwill the company paid, or that the merger plans were too aggressive. Boardroom fights, shareholder proposals, litigation—it all comes out, especially because large goodwill impairments tend to get reported exactly when the company is struggling.

All this is exactly what we’ve seen in the turmoil at Yahoo, which should be the first search result you get when you enter “goodwill gone wrong.” I hope we don’t see more companies fall into the same predicament, but right now, the numbers aren’t reassuring.

*2012 excludes General Motors, which reported an outlier impairment of $27.14 billion. Including that number, total impairments for the year would be $99.0 billion, impairment as a percentage of goodwill would be 3.05 percent, and average impairment per company would be $205.4 million.
**2014 excludes Verizon subsidiary AOL, which reported an outlier impairment of $35.6 billion. Including that number, total impairments for the year would be $84.275 billion, impairment as a percentage of goodwill would be 2.37 percent, and average impairment per company would be $205.5 million.

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