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It’s time to reassess how we evaluate goodwill

Are we underselling the unidentifiable?

To make their businesses more attractive to investors, it’s important for Australian companies to know if there’s a better way to account for goodwill in financial reporting.

“We need to use a common language of reporting so that the way accounts and goodwill are reported in Australia is the same as in China, the US, the UK, and Germany,” said Dr Yousef Shahwan, lecturer of accounting at the Tasmanian School of Business and Economics.

“They need to be reported in a way that can be understood by foreign investors. It’s the same for any kind of principle or disclosure that applies to accounts.”

Putting a price on the ‘unidentifiable’

Dr Shahwan believes that acquired goodwill – also referred to as ‘unidentifiable intangibles’ (e.g. reputation, commercial locations, and brand) – is one of the most problematic and controversial accounting issues.

In accounting, goodwill is the amount recorded on the books after a company acquires assets and liabilities and pays a price in excess of their identifiable value. The difference between the amounts is calculated as the goodwill.

“I began looking at this area about 20 years ago, when I found that the way goodwill is being amortised [written off as an expense, similar to depreciation for a tangible asset] would not be the most appropriate way of accounting, because research at that time had shown that goodwill will never decline in value as an asset,” said Dr Shahwan.

He felt that goodwill has previously been undervalued or under-considered – but not everywhere.

Dr Shahwan followed up on research published in 1995 by two prominent American scholars, Professor McCarthy and Schneider, who initiated a revision of goodwill accounting. The research had an impact all over the world.

Those results, and later studies by Dr Shahwan (PDF 167KB), found that the market perceives goodwill as an asset, and incorporates the information in the valuation of a firm.

In Australia, International Financial Reporting Standards (IFRS) were applied in 2005 to regulate accounting including goodwill practice. 

Time to test if the standard is appropriate

Now that goodwill has been subject to annual impairment review testing for more than 10 years, Dr Shahwan said it’s a good time to investigate what effect they’ve had in promoting uniformity of practice in Australian accounting.

So far, Dr Shahwan’s work with financial statements analysis has concluded that the current regulations provide uniformity, but not as expected, and further developments are still required.

“This is a very relevant area to research, because the way goodwill is being treated in books and in financial statements has a very strong impact on the decisions of creditors, stakeholders and investors,” he said.

“All of those potential creditors and investors, they wanted to look at a statement that has been prepared to a set of standards and an international language that they can also understand.”

To cope with the current era, business reports need to be globalised in order to attract foreign direct investments and reduce the cost of capital.

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