Goodwill equal to half of enterprise value in acquisitions

BVWireIssue #78-4
March 25, 2008

On average, clearly identified intangible assets (such as brands) represented just 23% of enterprise value, while 47% of enterprise value in recent corporate transactions was ascribed to “goodwill,” a new survey from Ernst & Young found. The report, Acquisitions accounting–What’s next for you? A survey of price purchase allocation practices, examines the allocation of transaction values for 709 companies across 21 countries.

By ascribing a high proportion of enterprise value to goodwill, many companies are at risk of impairment under current volatile economic conditions. Jim Eales, global head of Valuation & Business Modeling Services at Ernst & Young, explains, “The accounting consequences of these acquisitions need to be carefully considered by acquisitions teams. For each transaction, International Financial Reporting Standards require companies to fair value the tangible and intangible assets acquired. Tangible and amortizable intangible asset values will depreciate as per their life expectancy, affecting future earnings. In the current difficult economic conditions, the goodwill element becomes more susceptible to volatility and write-downs, which can have a significant impact on investor confidence and on the company’s financial health.”

Of the areas identified, the consumer products sector had the highest average allocation of enterprise value to goodwill, with 65% attributed to it. The technology sector was next with 60% allocated to goodwill. Tangible assets represented only 9% of enterprise value in the consumer products sector. Among the intangible assets recognized by the buyers, customer relationships and contracts were cited in 44% of deals surveyed. These assets are particularly important in the insurance and telecommunications industry, where transactions are often motivated by the purchase of a client portfolio. Brand (31% of transactions) and technology (20% of transactions) are the other most often identified intangible assets.

Upcoming revised standards issued by the International Accounting Standards Board call for fair value measurements and give rise to new challenges for the valuers. Eales explains: “There is a danger the consequences, from an accounting perspective, of these changes will be overlooked until it is too late. One example is contingent consideration. As subsequent changes in contingent consideration will no longer effect goodwill, getting the fair value right at the date of acquisition is critical.”

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