GM Creates $30 Billion – Like a Genie!

By Kevin Meyer

Traditional accounting does have its wackiness, and now our beloved GM is taking full advantage.  One of the crazier concepts and a toughie to get your head around as you transition from the real world to running a business beholdened to band-aid after band-aid of accounting and tax regulations, is the concept of "goodwill."  Here's the Wikipedia definiton:

Goodwill in financial statements arises when a company is purchased for more than the fair value of the identifiable assets of the company. The difference between the purchase price and the sum of the fair value of the net assets is by definition the value of the "goodwill" of the purchased company. The acquiring company must recognize goodwill as an asset in its financial statements and present it as a separate line item on the balance sheet, according to the current purchase accounting method. In this sense, goodwill serves as the balancing sum that allows one firm to provide accounting information regarding its purchase of another firm for a price substantially different from its book value.

At face value most people can see the logic.  A company like Coca Cola is worth more than just projected profits and assets like bottling plants.  There's value in people saying "I'll have a Coke" – real value from the perspective of the customer.  But trying to wrap quantitative accounting around subjective concepts then leads to lots of fun convolutions.  Perhaps you could call it value from the perspective of accountants.

GM is doing just that, and Jonathan Weil at Bloomberg calls them on their distortions – and the difficulty it may create in the future.

It will be a long time before General Motors Co. can shake the stigma of being called Government Motors. Here’s another nickname for the bailed-out automaker: Goodwill Motors.

Sometimes the wackiest accounting results are the ones driven by the accounting rules themselves. Consider this: How could it be that one of GM’s most valuable assets, listed at $30.2 billion, is the intangible asset known as goodwill, when it’s been only a little more than a year since the company emerged from Chapter 11 bankruptcy protection?

Now think about the impact of that supposed $30B in goodwill on the real and perceived value of the company.

By comparison, GM said its total equity was $23.9 billion. So without the goodwill, which isn’t saleable, the company’s equity would be negative. This is hardly a sign of robust financial strength.

GM listed its goodwill at zero a year earlier. It’s as if a $30.2 billion asset suddenly materialized out of thin air. In the upside-down world that is GM’s balance sheet, that’s exactly what happened.

Indeed, the company’s goodwill supposedly is worth more than its property, plant and equipment, which GM listed at $18.1 billion. Another twist: GM said its goodwill would have been worth less had its creditworthiness been better. Talk about a head- scratcher.

That last statement is what could create big problems in the future.  Here's the brief summary of GM's calculation – go to the article to dive into more detail.

The company said it wouldn’t have registered any goodwill under fresh-start reporting if it had booked all its identifiable assets and liabilities at their fair market values. However, GM recorded some of its liabilities at amounts that exceeded fair value, primarily related to employee benefits. The company said the decision was in accordance with U.S. accounting standards on the subject. The difference between those liabilities’ carrying amounts and fair values gave rise to goodwill. The bigger the difference, the more goodwill GM booked. In other instances, GM said it recorded certain tax assets at less than their fair value, which also resulted in goodwill.

Ahhh… if only all of us could do that!  So the danger?

Here’s where it gets really funky. If GM’s creditworthiness improves, this would reduce the difference between the liabilities’ fair values and carrying amounts. Put another way, GM said, the goodwill balance implied by that spread would decline. That could make GM’s goodwill vulnerable to writedowns in future periods, which would reduce earnings.

A similar effect would ensue on the asset side if GM’s long-term profit forecasts improved. Under that scenario, GM could recognize higher tax assets and bring their carrying amount closer to fair value, narrowing the spread between them.

So, to sum up, the stronger and more creditworthy GM becomes, the less its goodwill assets may be worth in the future. An intuitive outcome, this is not.

And not exactly the original intent of having goodwill on a balance sheet.

At this point, GM’s balance sheet remains loaded with fluff, as the goodwill illustrates. GM said its August deliveries were down 25 percent from a year earlier, so it’s not as if business is booming. Moreover, GM disclosed that it still has material weaknesses in its internal controls, which is a fancy way of saying it doesn’t have the necessary systems in place to ensure its financial reporting is accurate.

This being the political season, the Obama administration has made clear that it wants GM to complete the IPO this year, so the president can claim a policy success. It’s bad enough GM needed a taxpayer bailout. What would be worse is taking the company public again prematurely.

The real world conflicting with political expediency?  Really?