The Financial Accounting Standards Board (FASB) eliminated goodwill amortisation from 2002 and the International Accounting Standards Board (IASB) followed in 2005. Before that, goodwill, the capitalised value of the excess of purchase price over fair value of identifiable assets, required an annual charge to earnings for up to 40 years until the value of goodwill was eliminated. (Warren Buffett’s essay, “Goodwill and its Amortisation: The Rules and The Realities” in the appendix to his 1983 chairman’s letter, is an excellent discussion of goodwill amortisation). Since those accounting changes, goodwill is now subjected to impairment testing, which, unlike goodwill amortisation, is a real economic cost to the firm.
“Employee Stock Option Costs and Goodwill Amortisation, a NOPAT Adjustment”, Joseph Noko
Statement of Financial Accounting Standards (SFAS) 142 has implications for my calculation of invested capital. Accumulated goodwill amortisation, which sums up all the goodwill amortisation expensed throughout the life of the firm, is added back on my calculation of invested capital, for the pre-SFAS 142 era.
Pooling of interests is another long-defunct accounting method impacting goodwill. Prior to SFAS 141, which came into effect in 2002, when companies using this method merged, or acquired a business, the assets and liabilities of the company acquired or merged with were transferred at their book values, avoiding goodwill recognition and recording of the purchase price, eliminating the need for goodwill amortisation, and so, inflating GAAP earnings. In addition, because book values were typically lower than the purchase price, a firm’s balance sheet was more attractive, as were its returns. So, to ensure comparability between firms using the pooling of interests method and the purchase method of accounting for mergers and acquisitions, for companies using the pooling of interests method, I add the difference between what the firm paid for the business and the book value of assets, to invested capital.