Accounting Considerations for Automotive Dealerships: Getting Your Arms Around Goodwill
February 24, 2015Download
Goodwill — also known as “blue sky” — is an intangible asset, a commodity that isn’t easily quantified. Goodwill typically appears on a balance sheet following a merger or acquisition when one company acquires another company for a price higher than the fair value of its assets. With so many dealers consolidating their businesses over the last year, now is a good time to revisit the nature and accounting treatment of goodwill.
What is “goodwill”?
Think of goodwill as the “it factor” that differentiates you from other dealers. It comes from years of cultivating relationships with repeat buyers and a reputation for offering fair prices and reliable, friendly customer service. You can’t touch goodwill, but it’s potentially valuable.
Accountants have a more formal definition, of course. The Financial Accounting Standards Board (FASB) defines goodwill as “an asset representing the future economic benefits arising from other assets acquired in a business combination […] that are not individually identified and separately recognized.”
How do you account for it?
Generally Accepted Accounting Principles (GAAP) require buyers of a business to allocate the purchase price of assets acquired and liabilities assumed based on their fair values. It’s straightforward for most working capital and debt accounts. You simply transfer book value from the seller’s balance sheet to the buyer’s balance sheet. But other assets — such as used vehicle inventory, customer lists and franchise agreements — may require outside appraisals.
Any purchase price that’s not assigned to identifiable assets and liabilities is booked as goodwill. GAAP requires goodwill to be tested for impairment after the deal closes at least annually (or more frequently if certain conditions exist).
Goodwill impairment happens when the fair value of the company or reporting unit falls below its book value. If goodwill is determined to be impaired, its book value is reduced on the balance sheet and an impairment loss is reported on the income statement. This could, theoretically, send up a red flag with investors and lenders.
What about privately held dealerships?
FASB’s Accounting Standards Update (ASU) No. 2014-02, Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill, offers privately held companies an alternative goodwill measurement method. That’s because — after soliciting feedback from private company lenders, owners and accountants — FASB learned that many stakeholders disregard goodwill and impairment losses when assessing operating performance.
Private dealers now have the option to amortize existing and newly acquired goodwill on a straight-line basis over a 10-year period (or less, if you can justify a shorter useful life). By electing to use the alternative method, you’ll lower the carrying value of the goodwill, which makes taking an impairment loss less likely. Also, you’ll no longer be required to perform impairment testing annually.
When might impairment take place?
Goodwill impairment is more likely to happen under certain conditions. So FASB does require private dealerships to test for impairment when “triggering events” take place. Examples of triggering events include:
- Unanticipated competition,
- The loss of a key person, and
- The issuance of a new regulation that has a significant adverse effect on auto dealerships.
Goodwill impairment equals the excess of the carrying amount of the entity over its fair value. This measurement standard is simpler than GAAP for nonprivate entities, because private businesses aren’t required to hypothetically reallocate fair value to all of the entity’s identifiable assets and liabilities.
In addition, private companies can measure impairment at the entity level. So, if you have multiple franchises that are doing well overall but an acquired franchise is underperforming, the modified rules give you extra time to turn things around before reporting an impairment loss.
Who can help?
Dealerships today are able to spend less time and money on goodwill testing than in past years, because of the 2014 accounting changes mentioned above. If you have questions about goodwill and goodwill impairment, contact your CPA — he or she can help you better understand these complex factors as you prepare to buy or sell a dealership.