A company is required to compute and report goodwill as part of its yearly balance sheet.
Up to 2001, U.S. law required goodwill to be amortized over a 40-year period. Since then, companies are required to calculate goodwill on an annual basis. However, as of 2015, they may choose to amortize goodwill over a 10-year period for ease of calculation.
How do you calculate goodwill in this context? The easiest method is by cash flow. Say a company’s annual cash flow is $1 million; its quantifiable assets (cash on hand, real property, etc.) are valued at $600,000. Therefore, its goodwill can be valued at $400,000.
Sometimes calculating goodwill requires computing impairment. Impairment can apply to many aspects of a company’s balance sheet. In the case of goodwill, it occurs when acquired assets deteriorate in their ability to generate cash flow, and the fair value of the goodwill dips below its book value.
Some things that can impair goodwill include damages caused by breach of contract or by impairment of business opportunity; bankruptcy and reorganization; and conversion from a C corporation to an S corporation.
One enormous goodwill impairment charge took place in 2002, when the merged AOL Time Warner took a charge for $98.7 billion. In 2000, at the peak of the dot-com boom, America Online (AOL) bought the media company Time Warner for $182 billion in stock and debt.
Unfortunately, a year later, just as the merger was complete, the market for internet stocks like AOL tumbled, and by 2002, investors were dumping the stock of the merged company, leading to the huge write-off. The merger has been described as the least successful in history.
This is a multi-part feature adapted from a story in the July/August 2020 issue of Produce Blueprints.