Goodwill and Intangible Assets

Many of today's most valuable companies are built on things you cannot touch: software, brands, patents, customer relationships and data. On the balance sheet, these show up partly as intangible assets and partly as goodwill. Understanding how they are recorded helps investors judge the quality of a company's book value, spot acquisitions that went wrong and understand why some businesses appear to have little in tangible assets yet earn enormous profits.

Intangible assets#

Intangible assets are identifiable non physical assets with value:

Under US GAAP, most internally developed intangibles, such as brands built through advertising or research spending, are expensed and never appear on the balance sheet. Intangibles mainly appear when they are acquired. Finite life intangibles are amortised over their useful life; indefinite life intangibles, such as some trademarks, are tested for impairment instead.

Goodwill#

Goodwill is created when a company buys another for more than the fair value of its identifiable net assets.

goodwill = purchase price - fair value of identifiable net assets

Impairments#

Goodwill is not amortised under US GAAP or IFRS. Instead, companies test it at least annually for impairment. If the acquired business is worth less than its carrying value, the company writes down goodwill, taking a non cash charge that reduces net income and equity.

Large impairments often signal that an acquisition did not deliver. Examples include AOL Time Warner's write down of about $99 billion in 2002, then the largest ever, and Kraft Heinz's $15 billion write down of brand values and goodwill in 2019.

How investors use this information#

The intangible economy problem#

Because internally created intangibles are expensed, companies that invest heavily in research, software and brands can show low book values and depressed earnings during heavy investment phases. Some researchers argue this makes traditional value measures such as price to book less useful today, and that capitalising research and development gives a truer picture. See Value Factor.

Red flags#

• Goodwill larger than total equity: book value may be largely acquisition premiums.
• Serial acquirers with rising goodwill and weak organic growth.
• Delayed impairments while a business clearly deteriorates.
• Aggressive capitalisation of software or development costs. See Earnings Quality and Cash Conversion.

Frequently asked questions#

What is goodwill on a balance sheet?#

The amount a company paid for an acquisition above the fair value of the acquired business's identifiable net assets.

What is a goodwill impairment?#

A write down of goodwill when an acquired business is worth less than its carrying value, reducing net income and equity.

Why don't internally built brands appear on the balance sheet?#

Because accounting rules require most internally generated intangibles, such as advertising and research spending, to be expensed rather than capitalised.

Next, learn what shareholders own in Debt, Cash and Shareholders' Equity.