Transparent goodwill

SFIO should take goodwill impairment seriously

Adidas, the German sportswear and shoe company, has informed the Serious Fraud Investigation Office (SFIO) that it suffered goodwill impairment of Rs 170 crore after it bought Reebok in a global deal in 2005, this newspaper reported a few days ago. This is part of the Rs 870-crore loss that the German sportswear maker says was caused by former employees Subhinder Singh Prem and Vishnu Bhagat. Another report indicated that this has raised doubts in SFIO’s mind over the allegations: losses caused by goodwill impairment are notional, and are not commonly shown, supposedly, by Indian companies in their financial statements. In reality, however, generally accepted accounting principles in India do provide for goodwill impairment. Whenever a company acquires another company, it normally pays a premium over the value of the assets on the company’s books — this premium is goodwill. In the West, assets include both the tangible variety (factories, land, inventories, etc) and the intangible ones (brand, distribution network, technology and so on), while in India only tangible assets are included in the calculation. Goodwill can be revalued, say a year after the acquisition, by comparing the value of the assets with discounted future cash flows. And goodwill can suffer impairment if the projected cash flows reduce. That could happen for a variety of reasons: for example, a deterioration in the economic environment or a loss of image.

In the West, goodwill impairment is a live issue, and companies there value goodwill regularly — any loss or gain reflects in their profit and loss statements. But in India companies seldom reassess its value. Some companies value their brands, but few undertake any exercise to regularly value the goodwill that accrued to them from an acquisition — though there have been exceptions like Dr Reddy’s Laboratories, which three years ago took a hit of Rs 1,400 crore on its bottom line from goodwill impairment of its German acquisition, Betapharm. In the current case, Adidas has said that it has suffered goodwill impairment, which could be a legitimate claim. There could be doubts over the number, but there is nothing wrong with the concept. It is possible that Adidas expects future cash flows to diminish, which could impair goodwill, thanks to the current round of controversy or perhaps if the actual stocks are less than what the books suggest. Adidas’ claim cannot be dismissed offhand. SFIO would do well to look into it.

This is also the time for some serious debate on the issue. Many Indian business leaders, once they get to know that there could be goodwill impairment and hence a dent in the profit (which, in turn, could trigger a fall in the share price), merge the acquired company into the acquirer company, and this effectively kills all notion of goodwill impairment. Some others adjust the impairment against the reserves. Bad acquisition decisions and incorrect business assumptions are thus effectively hidden from shareholders. While the shareholders’ rights on mergers and acquisitions cannot be tinkered with, the accounting principles governing such mergers can certainly be made tighter to ensure that the goodwill value of a company post-acquisition can be calculated in a transparent manner.