Content area
Full text
Themed Issue on Intangible assets and the knowledge economy
Edited by Professor Robert Watson
Introduction
Despite the fact that the balance sheets produced for financial reporting purposes have never been constructed with the purpose of providing a current "fair value" of the company to an investor, advocates of greater intangible asset reporting frequently make the criticism that by not adequately reflecting the value of intangible assets, these balance sheets provide users - predominantly investors and analysts - with potentially misleading information concerning the "true" value of the company. This paper evaluates whether since the introduction of "fair value accounting" in respect of the treatment of acquired "goodwill" shown on consolidated balance sheets, these criticisms are well founded.
We also investigate the extent to which it can be confidently asserted that the recognition of acquired goodwill and the post-acquisition rules for recognizing any goodwill "impairment" has materially improved the information available to the users of financial statements and/or whether these developments have resulted largely in providing self-interested managers with greater opportunities to engage in earnings and balance sheet manipulations that are of doubtful value to users.
Changing accounting standards and the move to fair value
Accounting standards have changed considerably over the past decade, and this is particularly true with regard to the increasing emphasis placed on reporting assets at fair value (predominantly the current market price of an asset). Relative to the historic cost alternative, the reliability and relevance of fair value-based accounting numbers will be maximized when the assets concerned are being actively traded in liquid markets. Hence, fair value accounting is largely restricted to firms' holdings of "available-for-sale" and "trading" securities where current market prices are readily observable. The case for using fair values is greatly reduced in cases where the assets are rarely traded, are too complex and/or where they are difficult to separately identify. This is clearly, the situation in respect of post-acquisition goodwill. Whilst goodwill, which is the difference between the purchase price and the estimated fair value of the acquired assets, is relatively easy to observe at the time of the acquisition, post-acquisition changes in its value are not. Though increasing the value of goodwill post-acquisition is not allowed, the annual "impairment" test to determine whether its value...