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When goodwill isn't so good

Nigel Morris-Co...

This newspaper has long argued that items such as goodwill and brand values should be excluded from balance sheets as they are nebulous, cannot be accurately calculated and give a false value to companies. So, we argue, does valuing companies on "revenue" and artificial straight line depreciation saying that fixed assets and profit are the only true measures of a company's value to shareholders. Once again, it is reported by a market regulator, a company is "writing down" goodwill. It's time for a radical rethink on how companies, especially listed companies, are valued.

It is here argued that any value which is based on opinion is unsuited to form the basis of a company's accounts. Understanding the accounts of businesses should not be subject to the same vagaries of assessment as ice dancing or diving.

Goodwill is, at its heart, the value a purchaser is prepared to pay for continuing business and, decades ago, there was a broad agreement that that price equalled five times turnover or nine times profit. Goodwill presumes that customers are loyal or that the company has something to sell that has few, if any, competitors.

Today's reality is that markets are global, competition is defined not by whether customers walk down the street to a nearby supplier but whether they can get goods or services quicker, cheaper and with less effort using the internet. When shopping around doesn't involve actually going to shops, price and convenience are significant factors, as is the ease of finding competing products or services.

As the dot com bubble proved, "eyeballs" do not equate to financial success; as Enron and many others showed, "revenue" is meaningless when costs exceed profit; as the technology industry collapse demonstrated, straight line depreciation has no place when there is a fire-sale because tech is worth, maybe, 10% of its purchase price almost as soon as it's installed and therefore can never be a high-value asset in a company's books and certainly does not have a straight line depreciation over, say, five years.

All of the above problems arise out of accounting fictions, created by international accounting bodies, driven by their members, who form "standards." The fact is that they are almost always lies.

The situation is compounded by audit standards and by the fact that auditors routinely evade responsibility by claiming that the accounts are based upon statements made by directors. The last accounts of Satyam, right before it failed so spectacularly, included just such a statement. Yes, the auditors were disciplined but the penalty was not even close to proportionate to the harm caused.

It's time for a radical, wholesale review of the presentation of the accounting in companies. Tax authorities will dislike some changes but like others.

1. Tax authorities like depreciation because assets don't his profits in one go. But the cost of those assets hits companies in one go. The delay in claiming tax relief on them is an interest-free loan to governments. But, in a world where there are constant calls for "transparency" the obscuring of a company's financial position by fictitiously overstating the value of assets, to please the tax man as much as to boost balance sheets, has no place. Purchases should be set against profit in the year of purchase. If the order is placed earlier, that should show as a liability.

2. Goodwill and brand values should not appear in accounts. They may appear as an item on sale but not as part of the routine assets of the company. They are nothing more than opinion and, where that is based on "revenue" not profit are never going to be accurate. Worse, they assume that there is strong brand or product loyalty. That is, increasingly, not the case - which explains the desperate advertising of brands to try to maintain market share.

3. "Revenue" should not be regarded as a measure of value. The only acceptable measures of value should be demonstrable profit and real asset values.

4. Audit should be abolished. Within 90 days, management accounts should be filed with markets or companies' regulators. The management accounts should be signed off by the board which should have personal responsibility.

Why? Australian public company Pro-Pack Packaging has today restated its accounts to write down its goodwill figure in one division, by AUD149 million, for the second half of 2018 - after regulator ASIC questioned the goodwill figure in the previous half-year's accounts.

It's not the first and it won't be the last. In the early days of the global financial crisis, companies rushed to restate their accounts for a wide range of reasons. It's still going on, all around the world, but it's no longer news. It should be. The reputation of markets depends on it.

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