Accounting rule targets goodwill

Companies that got caught up in the takeover frenzy at the end of the bull market could be about to get a hard lesson in 'fessing up.

AOL Time Warner, which last week earned the dubious distinction of reporting the biggest annual loss ever for a company, is an extreme example of how an obscure accounting rule could soon hammer scores of other companies.

Companies with the most goodwill


Goodwill (in billions)
Percent of total assets
AOL Time Warner
Altria (former Philip Morris)
France Telecom
Kraft Foods
Vivendi Universal
Qwest Communications
Tyco International

Source: Multex, using most recently available data

The rule, known as FASB 142, forces companies to admit once a year if the premiums they paid for acquisitions, called goodwill, were a waste of money. For firms that paid inflated prices during the bubble years, that could erase billions of dollars of value from their balance sheets. The stakes are huge: Standard & Poor's 500 companies have $1.3 trillion in goodwill on their books, says Zacks Investment Research.

Truth-telling season is about to begin, because the rule requires most companies to test their goodwill for “impairment” at the end of 2002. Past acquisitions that aren't throwing off as much cash as expected must be written down.

“Companies doing acquisitions during the last few years when the market was hot may soon need to write down (the goodwill) because they paid inflated prices,” says Brett Trueman, professor of accounting at the University of California at Berkeley.

In AOL's case, the company wrote off $46 billion in the fourth quarter — contributing nearly half its $99 billion 2002 loss — because its $106 billion merger with Time Warner in 2001 fell short of expectations. That type of write-off falls into the category of “one-time” charges that have become so popular with companies. But it can indicate deeper problems that have a lasting impact on shareholders. AOL stock, which closed at $10.51 Wednesday, is 63% below its 52-week high.

Analysts are hesitant to predict which other companies might soon find themselves in a similar predicament. USA TODAY and Multex teamed to identify which companies had the most goodwill entering the fourth quarter. AOL was No. 1.

Just because a company has paid for acquisitions — and carries a large amount of goodwill doesn't mean it will have to write it down, says Zoe-Vonna Palmrose, professor of accounting at the University of Southern California.

But the list of the 10 companies with the most goodwill has several others that, like AOL, made high-priced acquisitions during the boom and have since fallen on hard times: WorldCom, Vivendi, Qwest and Tyco. Among goodwill-laden companies:

  • WorldCom. The struggling telecom firm, which went on a buying spree, including long-distance provider MCI, looks like the next big victim of Rule 142. The company had the third-largest balance of goodwill as of its most recently reported quarterly report.

And that goodwill is about to vanish. The company warned investors last Wednesday that it will likely have to write off substantially all its goodwill, resulting in a charge of about $50 billion.

  • Tyco. The troubled conglomerate is still loaded with goodwill from the acquisition binge by its former CEO, who has been indicted. The company already wrote off $4.5 billion in goodwill in June 2002, to reflect the decline in worth of its ill-fated acquisition of its finance unit called CIT Group. But even after that write-down, the company still has $26.2 billion in goodwill left on its balance sheet. To put that in perspective, it means that 40% of company assets are goodwill, largely from deals done by its former CEO.
  • Qwest. The telecom, burdened with $34.4 billion in goodwill, warned in October that $24 billion of it would be written off. It didn't rule out further reductions of its goodwill, citing sour industry conditions and its own falling market value.
  • Viacom. The media giant still has $57.5 billion of goodwill, even after writing off $1.5 billion in 2002 from its Blockbuster unit. The company, though, says its other large acquisitions, such as CBS and Outdoor Systems, are performing well and haven't resulted in any goodwill write-downs.

If the economic downturn and stock market malaise continue, though, experts see trouble.

“We are expecting to see a fair amount of these; we will see more,” says Robert Willens, tax expert at Lehman Bros.

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