A worker guides down a sign showing the name of liquidated British construction and outsourcing group Carillion after it was taken down off a construction crane on a building site in the City of London on January 23, 2017. British construction and outsourcing firm Carillion, which has a variety of private and public service contracts in Britain and employs 43,000 staff worldwide, announced its immediate liquidation on January 15 after the heavily-indebted company failed to secure a last-minute financial rescue by the government and banks. / AFP PHOTO / Daniel SORABJIDANIEL SORABJI/AFP/Getty Images
© Daniel Sorabji/AFP

Jonathan Ford is right to highlight goodwill impairment — or the lack of it in the face of deteriorating performance at acquired businesses — as one of the litmus tests of credible accounting and rigorous auditing (“ Fog of goodwill”, The Big Read, June 19). The problem is not so much that accounting standards have weakened, but the perennial one highlighted by Carillion’s collapse: managements hate to admit they have overpaid for a business and failed to run it as well as they claimed they would. So they stick with optimistic forecasts when feeding their impairment models.

Clearly, auditors should be alive to this and their reports to shareholders often mention impairment as a key area for potential mis-statements. The spotlight now shining on the profession should sharpen the urge to challenge.

The answer is not to revert to an accounting method that writes off all goodwill at the time of acquisition. That suppresses the value of assets that had been (often expensively) paid for and flatters “return on equity” or “return on capital employed” numbers. It makes sense to leave on the balance sheet the amount paid for assets with an indefinite life (those with a finite life are amortised over the relevant period).

Another issue with accounting for acquisitions lies with those who are supposed to make use of the information — analysts and fund managers. They too easily go along with management’s tendency to adjust profit numbers by leaving out amortisation costs associated with acquisitions. It is possible that keeping assets on the balance sheet at inflated valuations might lull boards and investors into thinking that capacity to pay dividend payments is adequate. There is a case for more transparency on “distributable reserves”, but users of accounts do have plenty of other information on cash flows and balance sheet strength to help them judge the sustainability of the payout.

As stewards of the assets, directors of acquisitive companies should not be given a free pass either via a total writedown of goodwill or via questionable justifications for carrying values that reflect over-optimistic management forecasts.

Jane Fuller
Ripley, Surrey, UK

The writer is a member of the Audit and Assurance Council of the Financial Reporting Council. The views expressed are her own

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