How to Interpret Writedowns

Over time, Alpha will be required to amortize the goodwill balance into expense. This takes a long period of time and is the proper course of action if the acquisition works as planned. However, from time to time a company can make a mistake when they make an acquisition.

Recently, eBay (EBAY Quote) reported its quarterly results. When doing so, eBay took an impairment to write down the value of its Skype acquisition (now eBay's "communications" segment, or unit). According to eBay's Form 10-Q:

We conducted our annual impairment test of goodwill as of August 31, 2007 in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets." As a result of this test, we concluded that the carrying amount of our Communications reporting unit exceeded its fair value and recorded an impairment loss of approximately $1.4 billion during the quarter ended September 30, 2007. The impairment charge includes the impact of the earn out settlement payment described below and was determined by comparing the carrying value of goodwill in our Communications reporting unit with the implied fair value of the goodwill. We determined the fair value of the Communications reporting unit using the income approach, which requires estimates of future operating results and cash flows discounted using an estimated discount rate. Our estimates resulted from an updated long-term financial outlook developed as part of our strategic planning cycle conducted annually during our third quarter. Our estimates of future operating results for our Communications reporting unit are for an early stage business with limited financial history, as well as developing revenue models. These factors increase the risk of differences between projected and actual performance that could impact future estimates of fair value of the Communications reporting unit.

Asset Revaluation

From time to time, a company will recognize that certain assets on their balance sheet are not worth their "carrying" value and decide to revalue (or reprice) these assets.

If a company discovers that it holds an asset that is worth more than it once was, then that is good news. The company may choose to continue to carry that asset at its "adjusted" cost (initial cost minus depreciation ) or realize the appreciation by selling the asset at its market value .

However, if an asset is worth less than its carrying value, then a company may decide to take an impairment and write down the value of the assets. For example, let's say a company has old inventory that it can no longer sell because it has rolled out a new product. The company might write down the inventory to recognize its reduced valuation.