Study with the several resources on Docsity
Earn points by helping other students or get them with a premium plan
Prepare for your exams
Study with the several resources on Docsity
Earn points to download
Earn points by helping other students or get them with a premium plan
Community
Ask the community for help and clear up your study doubts
Discover the best universities in your country according to Docsity users
Free resources
Download our free guides on studying techniques, anxiety management strategies, and thesis advice from Docsity tutors
An in-depth analysis of the historical research on goodwill, focusing on the debates surrounding its measurement and the various views on its underlying components. the shift from amortization to impairment methods, the hidden assets view, and the objective reality of goodwill. It also discusses the importance of goodwill in financial statements and the challenges investors face in understanding its meaning.
Typology: Summaries
1 / 123
This page cannot be seen from the preview
Don't miss anything!
MASTER THESIS WITHIN: Accounting NUMBER OF CREDITS: 30 ECTS PROGRAMME OF STUDY: Civilekonom AUTHOR: Simon Burman & Gabriel Demirel TUTOR: Andreas Jansson JÖNKÖPING May 2021
i
This master thesis marks the end of a four-year-long pursuit of knowledge and insight. The following is an attempt to express gratitude towards everyone who has been a part of this final composition. We would first like to thank our families for providing us with the general support and encouragement to complete this concluding project. We would also like to thank our fellow colleagues – we who have shared the same journey. To you, we say thank you for your support during this last time together. Our gratitude goes also to the interviewees of this study, as this thesis would not exist without your participation. But if it was not for our tutor, Andreas Jansson, this thesis would never have seen anything close to its final shape and for that, we are extremely grateful for your support, enlightenment and never-ending encouragement. It is with these last words we would like to devote our final gratitude to Jönköping University, for providing us with the opportunity, inspiration, and conditions of which in the end has provided us knowledge and experiences that will never be forgotten. Therefore, where the beginning of this four-year-long journey saw a warm welcome shall its final parting see nothing less than a warm farewell comprised of our deepest gratitude. Jönköping International Business School May 2021 Simon Burman Gabriel Demirel
iii ultimately represents a comprehensive understanding of the current accounting item goodwill in financial statements based on the perceptions of acquirers. The findings of this study can be used to bring clarity to the users of financial statements when interpreting goodwill and therefore potentially increase its perceived relevance. Foremost can this study’s holistic model be used as a guideline for future research to further elaborate on the understanding of goodwill and generate improvements to its current accounting design.
iv
AT Agency theory CEO Chief executive officer CFO Chief financial officer DCF Discounted cash flows EBIT Earnings before interest and taxes EBITDA Earnings before interest, taxes, depreciation and amortization EMH The efficient market hypothesis FASB Financial accounting standards board GT Grounded theory IAS International accounting standard IASB International accounting standards board IFRS International financial reporting standard PAT Positive accounting theory PPA Purchase price allocation PPE Plant, property and equipment
This chapter introduces the reader to the accounting item goodwill by first presenting a general background that presents its complexity. This is then followed by a problematization that motivates why there is a need to bring clarity to the accounting item goodwill.
Financial accounting is a highly detailed, thorough and meticulously formulated reporting system that provides guidelines for how business entities shall disclose financial information (IASB, 2018a). This system achieved international harmonization in the early 2000s which ultimately enabled official comparisons of entities’ financial information (IASB, 2018a; IASB, 2018b; Wagenhofer, 2009). One can therefore proclaim that financial accounting today resembles a global language. The purpose of this language is to achieve standardization of relevant and faithful narrations of entities’ financial events (IASB, 2018a). This is achieved through the application of a regulatory dictionary that centers around final narrative forms of concepts attached to numbers, called line items of financial statements (IASB, 2001). Inventory, accounts receivables and PPE are all examples of such concepts, where their attached values are obtained through systematic calculations (IASB, 2001). In the end, thanks to this reporting language’s regulatory legitimacy can these items be considered reliable and therefore effectively act as a foundation for decisions made by entities’ different stakeholders (IASB, 2018a). However, among the many and well-established line items within the accounting dictionary exists one item whose narration has always been complex – goodwill (Wen & Moehrle, 2016). Goodwill in financial accounting acts as the official concept for benefits obtained during the creation of a business combination and has done so for a very long time (e.g., Dicksee, 1897; Leake, 1914). Its current international definition is “An asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized”
(IASB, 2008, p. A210). Put in other words, goodwill is therefore any value of a company that is assumed to exist but not narrated by any other financial statement item and recognized only during the transfer of ownership to another entity (Courtis, 1983; IASB, 2008; FASB, 2014). Goodwill therefore practically acts as the accounting language’s narration of a residual difference between the price paid for obtaining the ownership of another entity and the value of the entity’s other identifiable line items (Chauvin & Hirschey, 1994). Goodwill is therefore strongly linked to corporate ownership transactions. As the world has experienced a continuously growing global economy since the post- war era, businesses have grown into sizes larger than ever before (e.g., Davis, 1992; Wen & Moehrle, 2016). Entailed to this growth, corporations have increased in their merger and acquisition activities (Wen & Moehrle, 2016). Since the 70s has this implied an almost proportional growth rate of goodwill values on balance sheets, seeing a compound annual growth rate of almost 18% in the US (Davis, 1992; Chauvin & Hirschey, 1994). This means that in recent years has goodwill become a substantial line item on financial statements, as sometimes up to 50% of the price paid in corporate ownership transactions has seen its allocation to goodwill (Boennen & Glaum, 2014). Goodwill has therefore seen a substantial increase in its relative weight against other items within the accounting dictionary. Consequently, goodwill has become a hotter topic among academics in more recent years, having induced debates around its different underlying aspects (Wen & Moehrle, 2016). When looking deeper into the international dictionary, one of the first notable issues is that goodwill is only allowed to appear as an item on balance sheets in sequence to a business combination (IASB, 2008 ; IASB, 2004a). Consequentially, this implies that goodwill is not considered an asset if internally generated (IASB, 2004b). This perspective on goodwill can be referred to as the recognition issue of goodwill in accounting and is one of the less discordant research topics on goodwill (e.g., Malmqvist, 2017 ). Opponents to this view argue however that as the two essential characteristics when recognizing intangible assets are possession and severability (IASB, 2004b), it can be questioned whether if goodwill really meets these requirements and thus is considered an economic asset (Chambers, 1966; Sands, 1963).
officially generates narration of something that is unclear. The question of what the goodwill item actually seeks to narrate has attracted academic curiosity for a very long time (Canning, 1929; Gynther, 1969; Chauvin & Hirschey, 1994; Drefeldt, 2009; Malmqvist, 2016; Nilsson, 2017; Malmqvist, 2017). One belief has been that goodwill represents a compilation of several underlying components such as brand names, customer loyalty, special skills and knowledge, management’s competence, good name and reputation, established clientele, favorable situation among else (Chauvin & Hirschey, 1994; Davis, 1992; Falk & Gordon, 1977; Nelson, 1953; Duvall et al, 1992; Tearney, 1973; Gynther, 1969). Still, goodwill has not yet managed to be elaborated in this spectrum, as its definition lingers on an elusive interpretation of goodwill only being benefits from other unrecognized assets (IASB, 2008). The accounting item goodwill is therefore currently one of the more complex items within the accounting dictionary. It demands not only from its audience an understanding of what impairments are and how a business combination is accomplished but also imagination of what the concept of goodwill is fundamentally referring to. Had goodwill only possessed an insignificant claim on balance sheets would these demands seem neglectable. But as goodwill has only kept establishing itself in the exact opposite direction of being a marginal item on balance sheets, these demands can only be stated to have seen a proportional increase in their importance (Boennen & Glaum, 2014). It is therefore to this background it becomes apparent, that the current state of the accounting item goodwill can be questioned.
Among the many different concepts within the accounting language’s dictionary can goodwill be perceived as one of the most complex in terms of what is required by a user to fully understand it. And as the accounting language’s ultimate narrative form is the line items of financial statements, the question becomes therefore what perception is actually to be made from the final designation of the accounting item goodwill? What does an entity that includes goodwill in their balance sheet seek to disclose with the word goodwill and its attached value? What information is sought to be communicated to the entity’s stakeholders through this item? In its current state in financial statements, the accounting item goodwill cannot be stated to have a clear answer to these questions. Instead, the status quo of goodwill in the language of accounting rather nurtures different problems for its audience that ultimately overwhelms its relevance as an accounting item. As line items of financial statements consist of two components – a concept and an attached value – it can be perceived as namely two central messages are sent by each individual item. Considering the concept in the line item goodwill, the early premise is that it represents an economic asset for an entity and deserves thus a position on the balance sheet (IASB, 2001; IASB, 2004a; IASB, 2008). But what this concept suggests being its underlying objective reality that generates economic benefits has long been addressed by researchers to be highly difficult to define (e.g., Sands, 1963; Chambers, 1966). For example, in comparison to the concept “real estate”, it is instantly clear that a building of some sort is referred to as the general underlying objective reality. But for goodwill, there exists no such clear connotation for its underlying objective reality correspondingly. Therefore, when a user of financial statements is presented with the concept of goodwill, he or she would find it difficult to assess what the entity specifically intends to say with the concept of goodwill. The user could seek further information in the attached notes, as these aim to bring further explanation required to gain an understanding of the financial statement’s line items (IASB, 2001). But even here might the information be limited for goodwill, as prior studies have found that most notes attached to goodwill are more bland than contributive (e.g., Rahm et al, 2016). The concept of goodwill is therefore a big question mark regarding what its
impairments were not anticipated and therefore not reflected in the stock price, indicating that the market couldn’t access or comprehend the information. Therefore, findings on the current relevance of goodwill as perceived by investors indicate that the goodwill item is not completely understood. This can be due to many other reasons than just the unclarity of the item, however. For example, investors might naturally be more interested in other financial metrics than the values of goodwill. However, the implication that the goodwill item might not be perceived as relevant or completely understood by investors remains. Goodwill can therefore be stated to be an unclear and bland line item that ultimately results in it having a lower perceived relevance in financial statements. Whether this outcome is due to its inherent complexity or simply not including valuable information enough for its users, it is still questionable why it is not better understood, considering its substantial claim on balance sheets (Boennen & Glaum, 2014). However, where the problem of the accounting item goodwill’s low relevance becomes most obvious is in consideration to the very purpose of its existence. The purpose of the language of accounting through its meticulously and thoroughly designed dictionary is to ultimately generate faithful and relevant information about reporting entities’ financial positions (IASB, 2018a). The financial statements represent this reporting language’s definitive shape which means that the inherent line items act as the final narrations for achieving this purpose (IASB, 2001). The legitimacy of the language of accounting relies therefore largely on these line items’ ability to generate relevant and faithful narrations about the financial position of entities. But as the line item of goodwill is currently unclear and bland rather than contributing to users of financial statements, this item can therefore be stated as failing to live up to this purpose. Goodwill, being one of the most historically discussed and problematic concepts in accounting (Wen & Moehrle, 2016), represents therefore an ultimate shortcoming of the accounting language. The purpose of this study is therefore to respond to this failure, by bringing clarity to the accounting item goodwill and hopefully contribute to an increase in its current relevance.
The question becomes therefore how this unclarity of the accounting item goodwill can be treated for the ultimate improvement of its relevance. As goodwill is one of the most historically covered topics within accounting research, this question has been asked in a wide collection of previous research (e.g., Dicksee, 1897; Canning, 1929; Falk & Gordon, 1977; Gynter, 1969; Drefeldt, 2009). The academic debates have still managed to constantly remain in discordance, as debates of goodwill’s inherent issues continue to generate little to no outcomes (e.g., Drefeldt, 2009; Nilsson, 2017; Wen & Moehrle, 2016; Jennings et al, 2001; FASB, 2014). Thus, due to the current state of goodwill in accounting, prior research has yet not succeeded in generating substantial clarity. This signals that goodwill is indeed a complex phenomenon, but it also raises the question of why prior research has not been more contributive? One reason could be that prior goodwill studies have mostly focused on the different aspects that constitute the complete item goodwill. For example, some studies have been particularly directed towards the subsequential measurement aspect, some towards the recognition aspect and others on the asset definition of goodwill (e.g., Jennings et al, 2001; Falk & Gordon, 1977, Davis 1992; Bradley et al, 1988). Hence, these studies’ concentration on elaborating specific issues related to the complete item goodwill might have omitted understandings of a holistic perspective of goodwill. It could be argued that clarification of individual aspects of goodwill, in summary, should contribute to such a complete understanding of goodwill. But by only focusing on individual aspects, integrations between these or interrelating consequences might be overlooked. Further, due to the vast spectrum of research on individual aspects of goodwill (Wen & Moehrle, 2016; Chambers & Finger, 2011; Duvall et al, 199 2 ; Gynther, 1969), it becomes difficult to argue that conducting similar approaches would generate a substantial contribution to the vast research field of goodwill. As such, this study will therefore attempt to address a more complete and synthesizing understanding of the accounting item goodwill to generate a comprehensive description of its current narration and thus, potentially contribute to an increased relevance. Another potential reason behind the lack of debate-changing results might be due to the type of research methods applied by earlier goodwill studies. Most prior studies have focused on studying annual reports, share prices, press releases, balance sheets, notes or
therefore ultimately contribute to an increase in its relevance as perceived by the users of financial statements. Further, by clarifying the line item goodwill, this study might hopefully introduce a path of enlightenment for today’s standard setters that in the end might generate a change in the current usage and application of goodwill. In the hopes of ultimately generating clarity to the meaning of the accounting item goodwill, it could imply that future methods of measuring and interpreting goodwill might become more accurate and representative of its actual meaning as an asset.
Based on the acquirers’ perceptions, what is the meaning of the accounting item goodwill?
The purpose of this study is to clarify the financial statement line item goodwill by generating a holistic understanding. This will be approached by examining what the concept of goodwill and its attached value really mean. By bringing an increased understanding of the accounting item goodwill, it could help increase its current perceived relevance among users of financial statements. An increased relevance would also help contribute to the purpose of accounting by generating relevant and faithful information to entities’ stakeholders. Lastly, as the topic of goodwill is one of the most historical and complex issues in accounting research, a clarification of its current state in balance sheets might provide guidelines for future research in the pursuit of ultimately improving the accounting of goodwill.
This study aims to bring clarity to the financial statement line item goodwill. This means that the study assumes foremost goodwill from the perspective of the definitions obtained by its current accounting standards. Specifically, these resemble the global dictionary of goodwill as assumed provided by IASB. As such, this study does not look at goodwill from a general business perspective but from the assumptions defined by the language of accounting. Furthermore, this study intends to examine goodwill through its
recognition from the business combinations phenomena, where the perception of acquirers has been stated as the main empirical focus. This means that this study assumes foremost corporate acquisitions as the main method for generating business combinations, meaning that mergers and other methods to obtain a business combination are not highlighted in this study.
Accounting dictionary = in this study, a parable for the regulatory accounting standards in financial accounting. For goodwill, the accounting dictionary is assumed to be the IASB standards of IFRS 3, IAS 36, IAS 38 and IASB conceptual framework. Accounting item = financial statement line item, consisting of a concept and an attached value of this concept’s underlying objective reality. Amortization (intangible assets) = in financial accounting, a method of measuring an intangible asset’s subsequential value. Amortizations are systematic pre-determined deductions of an asset’s carrying amount. Business combination = a transaction that results in one entity acquiring the control of one or several other entities. In this study, business combinations are foremost assumed implemented through corporate acquisitions. Discounted cash flows (DCF) = in this study, the primary economic calculation that is conducted to generate the present value of future cash flows. Fair value = the value of an asset as reflected by its market participants. Thus, the price received if the asset would be sold at a market at any current date. Goodwill = a residual that arise during business combinations as the purchase price exceeds the sum of the acquired company’s fair value of total identifiable assets and debt. Impairment = in financial accounting, a subsequential measurement method for assets based on continuous evaluations. An asset’s carrying value is compared against its recoverable amount. If the recoverable amount is lower than the current carrying value, then the asset’s carrying value is reduced to this level through an impairment. Intangible asset = economic benefits owned by an entity that lacks physical substance. Manager discretion = freedom for a manager to decide what to be done in a particular situation.
