There has been a recent
spate of writedowns
as a result of
market problems. While the enormity of these numbers may be staggering, writedowns are common occurrences in the business world. However, the magnitude and causes of writedowns vary. This installment of The Finance Professor will look at writedowns, from both economic and the accounting perspectives.
For starters, it's important to understand that companies will take a writedown (the downward
) for a variety of reasons. Here are the most frequent rationales:
- Goodwill impairment
- Asset revaluation
- Discontinued operations
When one company
another company, accounting rules state that the acquired company be consolidated into the
of the acquiring company. In particular, it is the
that needs to be consolidated.
Consolidation accounting is very complex and is typically studied by accounting students in advance courses. However, I can boil down the implications of consolidating acquisition into one simple implication: goodwill. Goodwill represents the excess of the purchase price
of a company. For example, say that "Alpha Corp." acquires "Beta Corp." for $5 billion. The book value of Beta Corp. is $4 billion
the companies are combined. Thus, Alpha will consolidate the
of Beta onto its
but is missing $1 billion of value in the process. Accounting rules then require Alpha to record $1 billion of goodwill as a "non-current" asset.