Nate Clark's Musings

This is a little dated, but I found it too funny not to post about. My most popular post to date discusses financial statements and how engineers can make sense of them. There’s a short section on “goodwill” there:

One interesting side note is that when Company A buys Company B, Company A must pay the market price (at least) for B. When Company B shows up on A’s balance sheet though those non-balance sheet assets need to be accounted for to make everything balance out. The non-balance-sheet assets will show up on A’s balance sheet under a row called “goodwill,” which is just the delta between what Company A paid and Company B’s book value.

When you see goodwill on a balance sheet, just know that it’s the totally made-up number A decided that B’s intangibles are worth. GAAP requires that A revisit the goodwill number annually to see if it passes muster for credibility, and if you see it decrease significantly, it’s a sign that something bad happened to B’s business after A acquired it or that A overpaid.

Back in November, the SEC actually fined UPS for messing up their goodwill!

UPS determined in 2019 that UPS Freight, a business unit that transported less-than-truckload shipments, was likely to sell for no more than about $650 million. GAAP required UPS to use the price it would receive to sell Freight in calculating whether it needed to write-down the value of the goodwill it had assigned to the business unit on its balance sheet. UPS’s own analysis indicated that nearly $500 million of goodwill it had associated with Freight was impaired. Rather than use that analysis, however, UPS relied on an outside consultant’s valuation of Freight without giving the consultant information necessary to conduct a fair valuation of the business. Using assumptions approved by UPS, which were clearly not ones a prospective buyer of Freight would make, the consultant estimated Freight was worth about $2 billion – three times as much as UPS had determined. On that basis, UPS did not record a goodwill impairment in 2019. Had UPS properly valued Freight, its earnings and other reported items would have been materially lower.

Amazing stuff! I wish I knew the UPS analyst who put together that valuation, and got to see the look on their face when they were told it would be part of an SEC enforcement action 😂

But in all fairness, you could see how something like this might happen. The people looking to sell Freight work in M&A, where the people putting together the financial statements (and who used the above-mentioned consultant) are in the accounting department. They probably don’t talk to each other and they definitely don’t have the same incentives. This could all just be an honest mistake – depends on what info was withheld from that consultant.

Hopefully this anecdote 1) amuses you as much as I, and 2) helps reinforce the point from the prior post about what goodwill actually is.