This article from today's Boston Globe on write-down of goodwill is pretty good, although they confusingly throw in some unrelated (but I suppose now obligatory) Enron stuff.
boston.com
Biotech firms wrestle with new rules
Accounting for goodwill puts Curis, others to test
By Jeffrey Krasner, Globe Staff, 8/21/2002
When Creative Biomolecules Inc., Ontogeny Inc., and Reprogenesis Inc. merged in July 2000 to form Curis Inc., there was a little-noticed result: Curis booked $122.3 million of goodwill on its balance sheet.
The accounting entry represented the price paid by Creative Biomolecules' shareholders for Ontogeny and Reprogenesis over and above the value of the two firms' hard assets, like factories and cash. The goodwill became an asset on Curis's balance sheet, adding to the company's total net worth, to be amortized, or written off, over its expected life. On Dec. 31, $106 million of that amount remained on the firm's balance sheet.
Then the rules changed.
The Financial Accounting Standards Board, or FASB, last year changed the way companies have to account for goodwill. Beginning in January, companies had to periodically test to see if goodwill had lost value, or as the accountants say, had become ''impaired.''
As Curis's share price dropped precipitously from $2 in April to about $1 in May, the company analyzed the goodwill to see if it was impaired. The company found $64 million of goodwill had evaporated. After deducting amortization, a mere $9 million of goodwill was left on the balance sheet, according to the firm's quarterly report.
More companies are going to be forced to take similar write-offs as they implement the new rules, and many of them are likely to be in the biotechnology industry, accounting experts said. ''Biotechnology will have more of these impairments, because the firms make high-risk bets,'' said S.P. Kothari, professor of accounting and finance at the MIT Sloan School of Management.
But in an era of heightened concern about corporate accounting, such goodwill write-offs are no longer an esoteric item of import only to analysts and accountants. Such write-offs can have a profound impact on a firm's financial results and the performance of its stock.
''Nowadays, CEOs and chief financial officers are going to be extremely conservative in their financial statements so they can't be accused after the fact of being too aggressive,'' said Paul Danos, professor of business administration and dean of the Tuck School of Business at Dartmouth College. ''If you're conservative in an extreme way, the shareholders can be hurt because the stock price is depressed.''
Write-offs of goodwill can also affect companies by triggering technical defaults of loan covenants, said Danos. Conversely, the evaporation of goodwill could potentially mislead investors by seemingly improving a company's performance: When earnings are spread over a smaller asset base, the firm's return on assets will increase, he said, making the company seem more efficient.
Curis officials declined to comment on the goodwill write-down, saying the company is in a quiet period, or a regulatory ban on public statements prior to the announcement of a material event.
Goodwill write-offs can also affect the bottom line. BioTransplant Inc. of Charlestown Monday reported a loss of $24 million, or $1.08 a share, in part due to an $18 million loss from the write-down of goodwill and other intangible assets from its acquisition of Elegix Inc. last year. Management reevaluated the goodwill on its balance sheets after it found Elegix cell-separation systems weren't selling as well as expected, and after the company initiated two layoffs, the firm said. ''We believe ... these non-cash assets, as reduced by this charge, are now consistent with current product revenue expectations,'' said Donald B. Hawthorne, president and chief executive, in a statement.
Goodwill is an accounting creation that has assumed a central role in modern corporate bookkeeping. Formally, according to FASB, which codifies accounting rules for US companies, any amount paid for an acquisition above the value of hard assets like a warehouse full of inventory is deemed goodwill. That loose definition has made goodwill a convenient catchall to justify the price paid above book value for any acquisition.
Now, after a string of corporate accounting scandals, such bookkeeping entries are receiving greater scrutiny from regulators. The Enron collapse was triggered in part by special partnerships that kept liabilities off the balance sheet. WorldCom recently disclosed that the company had improperly booked $7 billion in regular business expenses as assets, to be capitalized and written off over time, instead of charged against current revenues. The two companies are just the most egregious examples of corporate accounting abuses that have sensitized investors to management efforts to use accounting to manipulate financial results.
FASB actually changed the goodwill rules in June 2001, long before the Enron scandal surfaced. In two new rules, the accounting board made it more likely that companies would have to take periodic goodwill write-offs. The first rule eliminates the so-called pooling-of-interests method of accounting for an acquisition. As a result, accounting experts say, almost all acquisitions are likely to create some goodwill, and other intangible assets, which must be recorded on a company's balance sheet.
The second rule changes the way companies handle that goodwill. Previously, goodwill was an asset that was amortized over a set period representing its ''useful life,'' often 20 years. Under such an arrangement, one-twentieth of the value of the goodwill would be charged against earnings in each year. Ultimately, the carrying value of the goodwill would be completely eliminated, and the asset would disappear from the balance sheet.
Under the new rule, goodwill can sit indefinitely on the balance sheet, but it must receive a periodic checkup to ensure that its assigned value is still accurate. If warning signs occur - such as a loss of a key manager, or a downturn in the business climate - a company is required to perform an immediate check for a reduction in value.
That is what Curis said happened this spring. ''Because the company's market capitalization continued to decline during the three-month period ending June 30, the company concluded that the decline in market value served as an indication that the carrying value of its goodwill asset may be impaired,'' the company said in its quarterly report to the Securities and Exchange Commission. An analysis showed that Curis's technology was worth less than the numbers indicated. Curis is developing a variety of regenerative therapeutics, including its OP-1 protein, which is approved for sale to treat certain types of bone fractures. But the company had to suspend several of its drug development programs and lay off a quarter of its work force this spring to slow its spending.
To be sure, not all companies are being hurt by the change in goodwill accounting. Some have benefited. Those firms that carried goodwill and wrote off a portion each year now no longer have to take that annual charge against revenues. Invitrogen Corp. of Carlsbad, Calif., told shareholders in its most recent report that the rules change is helping it save money. ''We expect that the elimination of amortization of goodwill and indefinite-lived intangible assets will have a positive impact on reported net income for the year ended Dec. 31, 2002 of approximately $179.2 million, net of tax,'' the company said in its quarterly report to regulators.
''We are seeing a lot of favorable year-over-year comparisons,'' said Sheryl L. Thompson, a spokeswoman for FASB. ''This is the first year they don't have to arbitrarily write down goodwill.''
Kothari, the MIT professor, said there is one group that will undoubtably gain from the new rule: accountants. ''This is a bonanza for accountants,'' he said. ''Every quarter, they will have to perform one more impairment test. They are not going to be unhappy about it.''
Jeffrey Krasner can be reached at krasner@globe.com.
This story ran on page C1 of the Boston Globe on 8/21/2002.
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