We sometimes have occasion to wonder if newspaper editors still edit beyond maintaining the necessary ratio of editorial content to advertising space. We used to wonder if staff writers ever utilized the wonderful asset formerly referred to as the "morgue," a complete collection of past editions maintained by every news publisher. We sincerely doubt that the research efforts of today's media staffers go back beyond yesterday's newspaper, magazine or television reports.
An article describing WorldCom's write down of almost $80 billion of goodwill and other intangible assets was published in the New York Times on March 14, 2003. The facts concerning the write down accurately tracked the company's March 13th press release. The comment regarding many ". . . areas of the company's vast telecommunications network [being acknowledged as] essentially worthless" is a vast understatement. WorldCom has written off the entire net value of property and equipment as shown on its last reported balance sheet dated March 31, 2002. This amount of course would have included all or a majority of the $3.8 billion allegedly moved from the earnings statement to the balance sheet in the accounting fraud reported immediately following the company's Chapter 11 filing. Also included would have been amounts subsequently reported by the company which brought the total to more than $8 billion.
Our concern is the write off of the entire amount of the company's March 31, 2002 goodwill. The WorldCom press release indicated that this write off was occasioned as the result of "a preliminary review of its goodwill and other intangible assets and property and equipment (PP&E) accounts." In our opinion, prior to the issuance of the Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 142 a great many of our auditing firms had forgotten, or chose to ignore some of the basic principals regarding goodwill.
In the l950s, during what might be referred to as the "Genesis" period of GAAP, goodwill was quite uncomplicated. Unlike physical assets like buildings and machinery, it was an intangible asset underpinned nevertheless by strict rules. Goodwill could be created by favorable location; a reputation for fair dealing in both buying and selling; by good management; by efficiency in production; by special privileges; and similar "benefits" that summed up as "greater earning power." There was ongoing discussion among technicians about whether goodwill, once purchased, should be carried on the books indefinitely and at about that time it was ultimately agreed that goodwill might be written off even if there were no evidence of loss of its value. The period of amortization was arbitrarily agreed upon as not greater than 40 years.
One very consistent rule about goodwill is that it must be bought and paid for. It may not be established by valuation or other means. Calculation of goodwill, particularly when arising from purchase of a business, is one of the simpler arithmetic applications in use by accountants. Goodwill represents the excess of that amount paid for all or a defined majority of a business, less the net asset value of the assets acquired. In addition to the establishment of goodwill for value paid, purchase accounting calls for a buyer to examine all of the acquired assets and book them at their fair market value. When the purchase price has been allocated as much as possible to tangible assets, the remaining value is attributable to goodwill.
We have always strongly advocated well-planned, strategic acquisitions. We have always believed that purchase price variation between "good times" and "bad times" should not stop management from using acquisitions for corporate growth. Further, we have always advised clients that variations resulting from economic swings will not negatively impact the overall values achieved at higher price levels and may result in some beneficial opportunities at the other end of the spectrum. Neither we, nor any of the professionals with whom we are acquainted have ever seen prices as excessive as those almost routinely paid during recent years. And therein lies the problem.
The fallacy, and in our opinion, extremely valid justification for SFAS 142 is a market situation such as that faced during the just completed corporate feeding frenzy of the past 10 or so years. With a high enough purchase price, there is only so much reasonable valuation to be allocated to hard assets. This problem is compounded when recently purchased, developed, or created seller assets are transferred to a new buyer, as opposed to those that have been in service and therefore depreciated or amortized over a number of years.
We are seeing the results and, unfortunately, will continue seeing them for some time. Excessively high purchase prices, allocated as much as possible to minimally depreciated assets have resulted in unrealistically high levels of goodwill. Huge amounts of over capacity in the telecommunication and other, similar "hot" sectors, coupled with very high hard asset values can present many problems for prudent management. When added to a beneficial change in GAAP such as SFAS 142, the results can only be what we have seen.
One of the analysts quoted in the Times article referred to ". . .network assets in reality worth a fraction of their past value." Change that that statement to read "a fraction of their outrageously overstated past value, be realistic and prepare for more write downs -- and maybe even larger ones -- and let's get back to business!