I find it humorous that under their estimated $3.8B in utility plant assets they also list $324M "goodwill" assets. GAAP says that goodwill is an intangible asset, but it seems they're spending it rather aggressively...
Goodwill is basically a carrying error.
In supply-demand situations like houses, the seller can list a price they are okay with receiving. If it has more interested parties, they can make an offer higher than the asking price. When selling a company, there's similar practices of looking at the current annual income, project growth over a few years, and offer a price based on that. Explaining in terms that are logical, non-accountants can keep up. Making comments of "we value at $500, but paid 2x that for goodwill" just makes no sense
I would disagree. It’s not very logical to value software companies (for instance) at their book because a lot of their worth is in know-how, workforce and the products themselves. Unless you believe that’s worthless “goodwill” makes perfect sense. The issue is that these intangible assets are notoriously hard to value.
Of course if we’re talking about utility companies for instance it’s quite different.
> current annual income, project growth over a few years, and offer a price based on that
These are not a tangible assets. Future growth expectations are included in “goodwill”.
> Making comments of "we value at $500, but paid 2x that for goodwill"
Nobody does that, or should do it anyway. There is a lot of inefficiency in acquisitions that’s true but no company is going to just say “well we value it X but going to pay 2X”. In most cases there is no real way to calculate future growth without a very wide margins of error anyway..
Anyway there is no point in getting too worked up about this. The main purpose of goodwill is to prevent a massive decrease in company’s assets after they acquire another company. You can deduct depreciation in goodwill from your tax bill anyway. One of the few issues I can think of is this distorts GAAP earnings data for public companies. e.g. look at AMD it looks as if they have not been making any money for the past year or so, which is far from the truth. They just get to depreciate ~$2 billion in goodwill from the Xilinx acquisition depressing their reported net income.
Precisely. That practice is establishing the goodwill value of the company. This is another word for expected future cash flows.
If you've ever had a small company be acquired for more than it's asset value - you were the beneficiary of "goodwill".
Personally I downplay the concept of depreciation as much as I'm able. I don't analyze purchases in terms of cost depletion over some imagined life, expecting virtual savings/profit in the first year. Rather I think in terms of number of years/uses that will be required to break even on the initial purchase, after which it's all a bonus (and/or the new normal).
Having standard accounting customs probably makes more sense as you get further into the business world, with less unilateral decision making plus the general need for standardization. But it's not like overabstracted/overleveraged businesses have great societal effects either.
Most rational people will be willing to pay more than $10 (the book value of the box). The difference between what you pay for the box and the value of the materials of the box is recorded as "goodwill".
The goodwill is clearly an asset (it's the value ascribed to the future cash streams from the box). This analogy extends to companies if you think of them as a source of future cash streams and should give you some intuition for why the accounting is done this way
It starts out as essentially the amount spent to "buy the goodwill" of the owners and convince them to sell, not an estimate of how much the intangible assets are actually worth. That's the first concrete number usable for GAAP.
Afterwards, companies have to annually test goodwill for "impairment" and write down the value of its goodwill if it's impaired.
For example, if you acquire a restaurant chain with a bunch of retail locations but then announce that you're a racist, losing all the customers, you still own the retail locations but the premium that you paid for the constant restaurant revenue is now worthless. Assuming that restaurant revenue was more than you could make from leasing the retail space to someone else, there needs to be a way to represent that loss of book value.
> The accounting treatment for goodwill remains controversial, within both the accounting and financial industries, because it is, fundamentally, a workaround employed by accountants to compensate for the fact that businesses, when purchased, are valued based on estimates of future cash flows and prices negotiated by the buyer and seller, and not on the fair value of assets and liabilities to be transferred by the seller. This creates a mismatch between the reported assets and net incomes of companies that have grown without purchasing other companies, and those that have.
[0] https://en.wikipedia.org/wiki/Goodwill_(accounting)#Controve...
If you make an offer based on your projection, I'll turn it down. If you make a better offer (hoping to gain some efficiency by combining businesses together, for example) I might instead consider the offer worthwhile since it removes all of my risk, stress, and opens me up to start something different.
At the end of the day, you've paid for my goodwill. Nothing nefarious, I (owner being bought out) just happened to be stubborn.
The fact that we agreed on a price point that's not reflected in your accounting just means that an intangible value has been converted into dollars. Accountants and economists might not care for intangible value, but reality is more complicated than economic and financial models can describe.
And then in one year you'll need to take an impairment charge?
(And there's no need for the "Uhh??" tone, this isn't Reddit.)
Obviously the futher you get away from "my business is a factory that I own, my cash reserves, and a pile of materials that I can turn into product" and more into "my business is the smarts of a bunch of people who can leave with two weeks notice, a bunch of contracts that can be severed with 90 days notice, and an API that people love so much they don't want to go elsewhere" it gets very difficult to justify.
If you buy Coca-Cola Corporation you get tangible assets like the manufacturing plants and work in progress which can be valued fairly simply. But you also buy the Coca-Cola brand, which is intangible and difficult to value.
And yet it obviously has value - nobody thinks the value of Coca-Cola is entirely in its bottling plants.
So we just kinda say, "I guess it's worth what you just paid for it" and put it in the accounts as the difference between the purchase price and the value of the assets that can be valued.
My assumption is that I'm not understanding something important about it, but I can't figure out what that is from the explanations in these comments.
You decide to sell the business. You want to retire, you entertain offers. The winning offer is fifteen million dollars. The purchaser now has something they paid $15m for. The actual assets are only $10m. How you you account for that in double-ledger accounting? You put $5m down to goodwill.
That's the grossly simplified version. It's the difference between tangible, obvious assets (cash, property, stock, etc), and the intangibles that a buyer might pay a premium for.
At heart it's a reasonable enough convention. You can do all sorts of too-clever-for-our-own-good stuff with it but you know what, that's true of basically every accounting construct.
> The purchaser now has something they paid $15m for. The actual assets are only $10m. How you you account for that in double-ledger accounting? You put $5m down to goodwill.
This is the part I don't understand that makes it all seem shady. Surely, that $5M is a loss for the purchaser, and profit for the seller, no?
Why the weird "goodwill" accounting?
Because why would you buy a business for more than it is worth?
To be clear, we're talking about money spent over the value of the product/service. Value is obviously kind of an amorphous thing, in that depending on various market forces the value of a single thing can swing wildly. But assuming there is a known market value, and a purchaser chooses to pay over that market value, that should - in financial terms - be considered a waste, shouldn't it? If the government knew a contractor would take $50M for a contract, and paid them $100M anyway, just for the hell of it, that would be a waste, not goodwill.
I think to call it "goodwill" should imply charity, and thus be required to conform to the same rules and regulations of any charitable donation. Otherwise we should call it waste. This should make it clearer exactly what's being purchased and why. Shareholders might perk up their ears if they hear the company they invest in just wasted $50M.
e.g. we can agree that most software companies are worth more than the total value of the chairs, desks and laptops they own? Most of that value is intangible (know-how, employees, products themselves) after an acquisition this becomes goodwill. Obviously these things are notoriously hard to value but that does not mean that they are totally worthless as you keep implying for some reason…
Evaluating most businesses which spend a lot on R&D is hard, estimating future growth is hard to. Look at public companies, majority of the market cap of all(?) tech companies is made up of goodwill rather than backed by tangible assets
e.g. look at Apple it’s worth 46x it’s book value if someone somehow hypothetically acquired Apple at it’s current market price (it’s and oversimplification but more or less accurate) ~97% of what they paid for would be accounted as goodwill
The net assets are basically $15,000 worth of IT gear like a laptop and some servers. There is current month to month contracted revenue spread across a diverse base of users paying $5-100/mo each.
How much would you offer me for this company? How much would you take for this company if you currently owned it?
Something is worth what someone else is willing to pay for it. Obviously whatever the company sells for is worth exactly that amount at that moment in time. Valuing such a business at $15k would be absurd, just as valuing it at $15m would be.
Thus, the difference in asset value vs. what you paid is just called "goodwill" - perhaps the name hangs people up a lot.
If you then turn around and sell the same company later for a loss, you take a write down on that goodwill.
Certainly not perfect, but there aren't too many other ways you can express the present value of a company other than what it sells for.
That 100k/yr, though, is tangible and pricing it is straightforward. That's a very different situation that doesn't require making numbers up.
> Thus, the difference in asset value vs. what you paid is just called "goodwill" - perhaps the name hangs people up a lot.
The name absolutely doesn't help, but I don't think that's what I'm hung up on. I'm hung up on the idea of making up a monetary figure out of whole cloth and pretending it's real in some way.
This disconnect confuses me greatly, and the only way I can make it make sense in my head is in the sense of "creative accounting". Which just explains why I didn't choose a career in finance, and highlights why I view the financial world generally with tremendous skepticism.
You can absolutely assign a value to that stream. That's how you arrived at the purchase price in the first place! But that income hasn't been realized yet and it's not written in stone. The income could be higher or lower depending on what happens in the future.
I will say that while I don't think goodwill is sus in and of itself, your intuition that people doing things with the goodwill value can be sus. If I buy a company with $10m in assets and $5m in goodwill, and a year later announce I'm writing down the goodwill to $1m, something is definitely up! I may have mis-managed the company into the ground. It may be that the premium I paid was based on fraudulent assessment of the intangibles (e.g. a bunch of future sales that never existed), things like that.
I said in an earlier comment that I didn't think I was getting hung up on the name, but I had a thought that hints that maybe I am.
If it were called "slop" instead of "goodwill", I think I would be less bothered by it. don't get me wrong, it would still bother me -- and I wouldn't understand it any better -- but it would feel less like a term someone would use when trying to pull a fast one.
> It's just that accounting wants both sides of the ledger to balance
Yeah, you and a couple of other people keep saying that, but I don't really understand what that means. I mean, I know what having both sides of the ledger balance means, but this sort of example seems bizarre and extremely suspect to me. It just looks for all the world like people making stuff up.
That's OK. I can't understand everything, and this isn't something that's actually important for me to understand.
Before the purchase, I had some pile of assets worth $A. After the purchase, I still have some pile of assets worth $A. The purchase balances.
You don’t know that. In theory a company pay a premium because of future growth expectations. I don’t think land is a good example though because it’s relatively easier to value.
If you look at publicly traded companies most have a market cap higher or way higher than their book value (tangible/“real” assets). If another company ends up acquiring a public company that difference will simply be accounted as “goodwill” on their balance sheet
Sure I do. It's right there in the basic math.
> In theory a company pay a premium because of future growth expectations.
Yes, but until that growth happens, it doesn't exist. So it doesn't change the fact that, at the time of the sale, a loss was incurred.
To treat the expectations of future growth as a current asset is what seems shady to me. It's just making things up.
> current asset is what seems shady to me
Why? How? Do you believe all the things you don’t understand are somehow shady? Goodwill depreciates over time so you just incur the same loss just spread out over multiple years.
> at the time of the sale, a loss was incurred.
An asset is worth what a purchaser is willing to pay for it. There is no loss incurred until you sell it.
You wouldn’t value a software company based on how much the chairs and desk it’s employees sit at cost? It basically the premium a purchaser is willing to pay above the real/book value of a company.
The other half is incorrect, though: accounting value isn't based on 'projections'. Projections might affect the fair market value of the target (without accounting for post-acquisition synergies). But the accounting value is based solely on historical financial results.
In case anyone else was wondering what the provenance of this $325MM goodwill line item on CMP's balance sheet is, defer to the parent's (Avangrid) latest 10-K filing[3], buried under footnote 7 on p. 123:
> Goodwill for the Maine reporting unit is $325 million from the purchase of CMP by Energy East Corporation in 2000.
[1] https://s24.q4cdn.com/489945429/files/doc_downloads/2023/04/...
[2] https://s24.q4cdn.com/489945429/files/doc_financial/Suppleme...
[3] https://www.sec.gov/Archives/edgar/data/1634997/000163499723...