GM's $30B Goodwill Write-up Explained

[SuperFly03]

OK, someone posted a link to an article which ridiculed GM for manufacturing a $30B asset. I thought I would give the forum a little perspective because I know many of you may be considering investing in GM when it goes public.

This is not meant to start a debate of GM vs. Ford vs. Chrysler vs. Nissan or whatever other crap that might come up. This is simply an explanation for how the accounting works because I have the knowledge to explain it.
Keep it clean.

Quoted Original Article (Link below):

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?

That’s the amount GM said its goodwill was worth on the June 30 balance sheet it filed last month as part of the registration statement for its planned initial public offering. 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. The amount is about eight times the $3.5 billion GM is paying to buy AmeriCredit Corp., the subprime auto lender. Another twist: GM said its goodwill would have been worth less had its creditworthiness been better. Talk about a head- scratcher. (More on this later.)

Not Normal

This isn’t the way goodwill normally works. Usually it comes about when one company buys another company. The acquirer records the other company’s net assets on its books at their fair market value. It then records the difference between the purchase price and the net assets it bought as goodwill.

The origins of GM’s goodwill are more convoluted. Shortly after it filed for bankruptcy last year, GM applied what’s known as “fresh-start” financial reporting, used by companies in Chapter 11. Through its reorganization, GM initially slashed its liabilities by about $93.4 billion, or 44 percent. Under fresh- start reporting, though, GM’s assets rose by $34.6 billion, or 33 percent, mainly because of the increase to goodwill.

GM’s explanation? 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.

Funky Numbers

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.

On the liabilities side, for example, GM said the fair values were lower than the carrying amounts on its balance sheet because it used higher discount rates to calculate the fair value figures. The higher discount rates took GM’s own risk of default into account, which drove the fair values lower.
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.

Unexpected Outcome

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.

There’s a broader storyline here. Normally when companies go public, they’re supposed to be prepared from a business and financial-reporting standpoint to take on the responsibilities of public ownership. GM’s IPO, of course, is a much different animal. Taxpayers already own most of the company. Now the government is trying to unload its 61 percent stake
back onto the investing public, though it may take years before the government can sell it completely.
Fluffy 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.

This much is certain: The next time GM wants to create $30 billion out of nothing, it won’t be so easy.

This guy clearly isn’t a CPA, he is an analyst who is getting all hot and bothered by GM. This kind of stuff happens when company’s exit bankruptcy and want to reflect their financial position with more accuracy.

http://www.bloomberg.com/news/2010-0...than-weil.html

Originally Posted by Deloitte

Recording the emergence from bankruptcy is one of the most complex and demanding accounting challenges an organization may face. It places significant demands on an organization’s management team to deal with the equivalent of a year-end close upon emergence, account for restructuring of legal entities, adopt the requirements of ASC 852 (formerly SOP 90-7) and establish the opening balance sheet of the successor organization.

Originally Posted by Deloitte

Understanding the bankruptcy process and the related technical accounting requirements, obtaining a valuation of all the assets and liabilities of a business enterprise, and pushing the results down to every legal entity can be an enormous burden on financial, operational and systems management and their supporting teams. Completing the process as quickly as possible will allow management to move forward and focus on the operations of the newly reorganized business.
The Fresh Start process necessitates two significant accounting events

1. Recording the effects of a Plan of Reorganization
2. The revaluation of both assets and liabilities for debtors and non-debtors alike

http://www.deloitte.com/view/en_US/u...42f00aRCRD.htm

ASC stands for the Accounting Standards Codification. It basically is our accounting rule book. It is where every standard for the treatment of transactions and events for financial reporting hides. There are other statements issued by the SEC but that isn’t what is being dealt with here.

The basic issue at hand is that GM went into bankrutpcy with $X in assets, $X in liabilities and the remainder was shareholder’s equity. When they exited bankruptcy, as a part of their restructuring, they were allowed to revalue everything.

Let’s also back up and revisit some facts. As a part of bankruptcy reorganization GM (the original) became Motors Liquidation Co. (“Old GM") and GM (“New GM”) was reborn using the same name. As a part of that legal reorganization all of the equity in Old GM got wiped out because the entity went defunct. Meaning that your basic accounting equation (Assets = Liabilities + Shareholder’s Equity) is now out of whack because the equity side got chopped but the asset side didn’t budget.

On that same day, as a part of this reorganization New GM revalued the assets and liabilites sides of the equation as well. So now you have all three parts moving at once.

Equity, we can nail that number down. New GM knows what the company received when they issued stock to the current owners of New GM (Treasury, UAW, Canada, etc.).

The liability numbers, in general, are determinable for most companies. The problem New GM has is the insane pension liabilities related to the union workers. Given GM’s horrid credit quality they had to use very high discount rate (a.k.a. interest rate to determine the present value of a future liability). So now you’ve got your liabilities moving down.

At this point you have GM’s equity going from a deficiet (e.g. negative equity) of $109.4B to a positive of $19.2B for a swing of $128.6B. Liabilities have gone from $213.7B to $121B or a decrease of $92.7B. Mathematically the right side of the accounting equation has now increased by $35.9B which means, regardless of what the value of the assets are before the switch they will increase by $35.9B because the equation must balance.

Related to the assets there were 2 major changes: Property, Plant and Equipment and Intangible Assets.



As you can see from the summary above the biggest changes were in buildings, machinery and special tools. None of these should really be a surprise to anyone. GM was a very bloated organization with nearly a dozen brands and the factory capacity to match. When the economy went south and GM decided to spin off brands they couldn’t sell everything. GM was left with some brands which they didn’t want and couldn’t sell. So what was the result? Just stop making the cars.

As the economy struggles to rebound it is nearly impossible for GM to sell the specialized tools, plants and even the property. In accounting when you revalue an asset like this you have to bring it to the value you would expect to sell it for in a normal orderly transaction (a.k.a. not a fire sale).

I would expect buildings, highly specialized assembly plants, real estate, etc. to take a huge hit. Housing market has busted, no one is laying out cash for things like full assembly plants, commercial real estate is in the toilet, contractors are defaulting on loans left and right. A decrease of 50% seems reasonable because when the assets were put in place their value was spread out over the course of their estimated life which probably extended another 10-15 years and accordingly their depreciation didn’t track with the value of the assets as they stand today. It’s one of those best guess games that we accountants have to play.

The other change was an $15.9B increase to intangible assets. Intangible assets include things like patents, copyrights, customer relationships, dealer networks, non-compete agreements with former executives, etc. All of these things have value. From an accounting perspective things that are created internally (i.e. Pontiac logo, Chevy logo if they weren’t purchased) can only be capitalized (i.e. put on the balance sheet) at the cost that it took to create them. You are not allowed to put the value of them on the balance sheet unless you can measure them at fair value which is what bankruptcy allowed GM to do and hence the significant increase in intangibles.

So now we’ve basically got a wash here. Fixed assets are down by $17.7B and intangibles are up by $15.9B for a net change of $1.8B. There were other minor adjustments to the assets but the largest two (excluding Goodwill) washed out. So the right side has gone up by almost $36B but the left side has remained flat. Mathematically it has to balance so the accounting rules say shove the value into this thing called “Goodwill”.

As noted by other members, Goodwill typically arises when a company pays more for a company than the net assets are worth (assets minus liabilities). It is possible to have negative goodwill but that’s for another day. However this is an oddball circumstance whereby a company can write on an asset which really doesn’t have a basis other than making the math work

Now, going forward you will see this Goodwill be written off. Annually, GM will have to evaluate the discounted cash flows and compare them to their public float (equity + debt). If the discounted cash flows are less than the float then you will see what is called a Goodwill impairment charge which is a fancy term for bringing down the value of Goodwill so that discounted cash flows exceed their public float.

It is a non-cash charge that has no impact on anything. It’s all on paper. No analyst cares about it, no investor should care about it. There are some theoretical implications based on the impairment charge but the bottom line is it will not affect the entity’s ability to make money or their associated cash flows normally.

So let’s all just chill out and take a deep breath.

Numbers sources:
http://www.sec.gov/Archives/edgar/da...htm#rom45833_7
http://www.sec.gov/Archives/edgar/da...tm#toc85733_13

[Hylton]

A guy walks into an accounting firm looking for a new accountant for his business. He goes to the first firm and meets with the senior partner and says "I've got one question for you - how much is 1 + 1?" The partner looks back at him oddly and says "2". The potential customer gets up and walks out the door.

He goes to another firm and asks the same thing - "How much is 1 +1?" The guy stares at him in disbelief and after a few seconds of silence, says "2". Again the business man shakes his head and walks out.

Finally he walks into the last accounting firm and demands to see the most senior partner. He is brought up to mahogany row and is presented to the senior partner. The business man sits down opposite the senior partner and says "I am having a really hard time finding a firm that I can have complete confidence in with respect to my business. I only have one simple question for you. How much is 1 + 1?" The senior partner gives him a real solid stare, gets up from the table and closes the door. He then returns to the businessman and says "How much do you want it to be?"

[SuperFly03]

Originally Posted by Hylton

A guy walks into an accounting firm looking for a new accountant for his business. He goes to the first firm and meets with the senior partner and says "I've got one question for you - how much is 1 + 1?" The partner looks back at him oddly and says "2". The potential customer gets up and walks out the door.

He goes to another firm and asks the same thing - "How much is 1 +1?" The guy stares at him in disbelief and after a few seconds of silence, says "2". Again the business man shakes his head and walks out.

Finally he walks into the last accounting firm and demands to see the most senior partner. He is brought up to mahogany row and is presented to the senior partner. The business man sits down opposite the senior partner and says "I am having a really hard time finding a firm that I can have complete confidence in with respect to my business. I only have one simple question for you. How much is 1 + 1?" The senior partner gives him a real solid stare, gets up from the table and closes the door. He then returns to the businessman and says "How much do you want it to be?"

[Hylton]

I thought you'ld like that. Most of my close friends are accountants for some strange reason.

[a_Username]

Nice explanation.

[SuperFly03]

Originally Posted by a_Username

Nice explanation.

Thank you.

Tried to keep it simple and straight forward for those looking at investing in GM.

Note: This isn't investment advice... just making sense of the jargon.

(CYA baby.... CYA).

[mickss]

I remember this guy (Jonathan Weil) from another forum I use to belong to. The discussion at the time (last year) in that forum was bank failure`s and the FDIC and someone posted an article by him, which at the time didn`t seem to jive with my understanding of the FDIC, then another member posted this rebuttal to that argument. http://curiouscapitalist.blogs.time....ding-the-fdic/

It would seem that Jonathan Weil not only isn`t a CPA, he also dosn`t understand how the FDIC is run.

[Mr. Wyndham]

Thank you for taking the time to write that out, SuperFly.

There are a few terms up there that I don't fully understand (not an accountant, remember...). But it was very informative, and cleared up a lot of misinformation.

Thanks, again!!

[SuperFly03]

Originally Posted by Dragoneye

Thank you for taking the time to write that out, SuperFly.

There are a few terms up there that I don't fully understand (not an accountant, remember...). But it was very informative, and cleared up a lot of misinformation.

Thanks, again!!

You're welcome.

If you need additional clarification please let me know. I'd be more than happy to expand the discussion.

[HeHasReturned]

I don't know enough about accounting to fully understand whether you're right or not, so I'll take your word for it until I hear a good counter-argument. Until then, let's hypothetically say you're definitely right, even then why would somebody then want to invest in GM?

[FenwickHockey65]

:troll:

[SuperFly03]

Originally Posted by FenwickHockey65

:troll:

[DGthe3]

Originally Posted by HeHasReturned

I don't know enough about accounting to fully understand whether you're right or not, so I'll take your word for it until I hear a good counter-argument. Until then, let's hypothetically say you're definitely right, even then why would somebody then want to invest in GM?

I'm not an accountant either, but I'm going to assume that its for the same set of reasons for why anyone ever invests in anything ...

[HeHasReturned]

Originally Posted by SuperFly03

Haha, you're hilarious, I'm a troll for asking you to follow up on your post? Great response