This divide in opinion is perhaps most noticeable between North America and Europe with the latter’s reluctance to embrace full-blown impairment charges arguably delaying the point at which the bottom of the valuations market could be reached. The grey areas surrounding valuations and impairment have never been greyer — as Marc Castedello of KPMG’s Advisory practice explains.
Announcements of goodwill impairments have been a common feature of recent months. Yet I feel confident in saying that the period of goodwill impairments is far from over. In fact, I believe that the situation could actually worsen still further during the remainder of 2009.
Working in Europe, this seems quite a straightforward claim for me to make. However, I also acknowledge that my counterparts across the Atlantic might take somewhat of a different view. That’s because a significant divide is opening up in the way many companies are approaching goodwill write-downs.
Essentially, there are two possible approaches currently in play for those businesses that know that an impairment charge is looming. Some take it all in one go, getting the bad news out into the open and dealing with the consequences in one fell swoop. Others prefer to take a series of small charges, arguing that accepting one sizable impairment charge would not reflect the true value of their company in anything other than the exceptional economic circumstances we currently find ourselves.
Those that ascribe to the latter approach are effectively banking on the market returning to health before they have to take their full course of impairment charges. To date, North American businesses appear to be taking the ‘single hit’ approach whereas European businesses appear to favor the more conservative ‘small steps’ approach.
To see what this means in practice, according to a recent study by KPMG in the U.S., goodwill impairment in 2008 more than doubled to US$339.6 billion, with the median charge going up ten-fold. The number of companies in the U.S. study that had impairment in 2008 increased to nearly 20 percent; up almost three-fold from the previous year.
The North American approach may in some way be due to the pressure exerted by agencies like the SEC which claimed that it expects to see more goodwill impairment charges due to the state of the stock market. The message seems clear – the regulators are watching and will want a good explanation for why impairment charges may appear smaller than expected.
The question now is whether European regulators will take a similar tack. I believe that they probably will sharpen their focus on this issue, demanding more in-depth explanations around the impairment testing process. The problem they will run into is the problem affecting everyone else currently involved in this area — i.e. that valuation is not an exact science and that it has never been more difficult than it is now to ascribe a value to an entity.
Let’s be quite clear though; there is no suggestion of any wrong-doing here. Rather, there are grey areas on top of grey areas; making life difficult. As one example, self-generated goodwill (arising from things such as synergies across business units) can be used to compensate for the impairment of goodwill arising from an acquisition, depending on the level of impairment testing. How can the extent to which one compensates for the other be gauged? Similarly, business forecasts comprise a significant portion of the valuation process and while these may sometimes be over-optimistic, it can be very difficult to actually prove that this is the case.
I think many people accept that prices have to decline. After all, the low cost of debt in a time of seemingly unlimited liquidity was a key factor behind some inflated corporate valuations before the credit crisis. Now that the cost of refinancing is far higher and a higher degree of uncertainty continues to affect the market, there should be a natural correction with values declining. What is happening at present is a disagreement over the pace at which these values should be declining. With not all businesses taking the fast track, it could be argued that the point at which we can call the bottom of the market, with valuations having fallen as far as they can, is still some way off.
Businesses which argue most vociferously against impairment appear to treat impairment and worsening economic conditions as two separate issues. I would argue that they are not. What is impairment if not an accounting consequence of worsening economic conditions? I find it somewhat disingenuous for some companies to report that they are being adversely affected by the economic downturn but not translating that into an impairment charge.
As mentioned before though, this is where businesses can quickly get into the grey area of interpreting the guidance around goodwill. Some regulators, like the SEC, appear to have already nailed their colors to the mast in terms of what they expect to see happening around goodwill. European businesses may soon find that their own regulators will gear up to take a similar stance. Until then, our trans-Atlantic difference of opinion may continue unabated.
— Marc Castedello is a Valuations partner with KPMG in Germany.
Simon Griffiths (Global Advisory Corporate Communications, KPMG in the U.K.)
Tel.: +44 121 232 3760
e-mail:
simon.m.griffiths@kpmg.co.uk.
