Homework 7 - Goodwill

Yes, I am returning to our class discussion of Goodwill and remind you that there, I argued that Goodwill is not really an Asset,..., but we were unable to take that argument and agree as a class how to account for this. When Goodwill remains on the balance sheet for a long period of time, it is even more problematic, in my opinion.

There will never be a cash inflow (or outflow) from Goodwill and that is one reason I feel it cannot qualify as an Asset, given the Concepts definition of Asset. The cash flows related to an acquisition arise from the cash flows of assets and liabilities that are acquired.

But Goodwill is no longer amortized. It can remain on the balance sheet indefinitely and is one of the few things that can remain as such. This makes it more of an oddity from my point of view.

Let's consider the Concept from the point of view of the assets and liabilities acquired in an acquisition. In some cases these items eventually evaporate as the acquired business ceases to operate - it matures and ends. Most businesses end. But even in long horizons for good businesses such as the auto companies, the asset one might acquire eventually are replaced in order to keep the business operating. General Motors today is very different from the various car companies purchased to become old General Motors.

With this I put forward an alternative accounting theory for GOODWILL.

The problem with Goodwill is NOT that it is presented as an asset. The breakdown in accounting theory is more that assets are not unchanging and permanent. What is missing is the allocation of the costs represented over time to Earnings as a Charge that Offsets the earnings on an acquired business. Therefore the Concept I propose that Goodwill (and in the bargain, no asset or liability) can have an indefinite life. In lieu of an indefinite life my theory proposal is that Goodwill should be amortized on a basis and over a horizon that management feels is appropriate. (This might mean straight line over 40 years, which used to be the US GAAP accounting policy.)

Here is the question:

What are the Strengths and Weaknesses of this proposal to require amortize of Goodwill?

Homework 8

We have discussed a number of anomalies concerning the expensing of Employee Stock Options, and the principal one that stands out from my point of view is that the income claimed by the employee who exercises a stock option, the intrinsic value, is charged to APIC rather than expensed to Earnings.

What is charged to earnings currently is the TIME VALUE of the Stock Option. In accounting, a well known theory coming from the AICPA is that we can make this expression:

The fair value of any option = TIME VALUE + INTRINSIC VALUE Equation NO. 1

Please accept that equation. If the company were to charge the entire cost of the option to Earnings, it should in my opinion, charge both time value (the value now charged) and the intrinsic value as determined on the date of exercise. Accounting is complete only if 100% of costs are eventually expensed.

Here is the question:

As a matter of theory, should the intrinsic value on stock options that employees consider compensation be charged to Earnings as part of the way Compensation Costs are expensed?