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I'm researching a restaurant company and was reading it's Goodwill section in its 10-K report. I noticed
that this company's goodwill has been holding study at $24 million for years.
I questioned their goodwill impairment practices because over time, there restaurants will loose a little value and should be impaired.
I read the Goodwill section:
"Goodwill represents the excess of cost over the fair value of assets of the businesses acquired. Goodwill is not amortized, but is subject to impairment tests at least annually. The Company performs tests to assess potential impairments on the first day of the fourth quarter or during the year if an event or other circumstance indicates that goodwill may be impaired. The first step of the goodwill quantitative impairment test compares the implied estimated fair value of the reporting unit to the carrying amount, including goodwill. The Company considers all of its stores in total as one reporting unit.If the estimated fair value of the reporting unit is less than the carrying amount, then it is more likely than not that a goodwill impairment exits and a second step must be completed in order to determine the amount of the goodwill impairment. In the second step, the implied fair value of the goodwill is determined by allocating fair value to all of its assets and liabilities, other than goodwill, in a manner similar to a purchase price allocation. If the resulting implied fair value of the goodwill that results from the application of this second step is less than the carrying amount of the goodwill, an impairment charge is recorded for the difference. No goodwill impairment charges were recognized during 2018, 2017, or 2016."
This companies correct that Goodwill is required to be checked for impairment at least once every year, but I've never heard of a restaurant company that considers (all) of its stores as one reporting unit?
Take a look at another great restaurant company's Goodwill section in there 10-K and notice the difference:
"Goodwill is tested annually for impairment, and is tested more frequently if events and circumstances indicate that the asset might be impaired. We have assigned goodwill to our reporting units, which we consider to be the individual restaurant level. An impairment loss is recognized to the extent that the carrying amount exceeds the implied fair value of goodwill. The determination of impairment consists of two steps. First, we determine the fair value of the reporting unit and compare it to its carrying amount. The fair value of the reporting unit may be based on several valuation approaches including capitalization of earnings, discounted cash flows, comparable public company market multiples and comparable acquisition market multiples. Second, if the carrying amount of the reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of the goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit, in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill"
The difference is that the second company reports on an individual restaurant level and does not consider the company itself as one unit. According the rules of accounting set by the FASB, companies should report and test impairment on an individual unit level. Like the second company is doing. But the first does not? Why would the first company test impairment differently, if they are allowed to do that in the first place?
First thing to do would be to look up other restaurants and see if their disclosures say something similar. I don't know offhand where restaurants commonly use, but if similar restaurants are all disclosing differently, then that's your first tell.
It still may be a be a valid difference, but it will be good to understand what and why.
It's possible to game goodwill by playing with the reporting units. If I buy companies A, B and C....maybe I want to shut down C eventually and take care of them with companies A and B. If I shut down A on its own, its goodwill would be impaired. However, if I move the customers and capacity over to the other locations I could make an argument that really the combined goodwill of A, B and C are all now interrelated and it makes more sense to use the aggregate as Division D. This could make a great deal of sense, or it could be an accounting game from middle management that doesn't want an inherited big balance sheet hit to ruin their Christmas bonus.
Overall goodwill is a necessary, but stupid asset. If you ever find a bank willing to loan on goodwill, or someone interested in buying goodwill, please pm me. I've got the best selection of goodwill this side of the Mississippi.
No @thatsright19, I'm a full time investor, and this was confusing to me so I thought one or more of you could help.
I've looked up other public restaurants and read their Goodwill section in their 10-K. This is the only company that evaluates Goodwill like this. Also, I believe the GAAP rule says you have to evaluate it on an individual level.
They might be using this form of valuation to inflate their Goodwill, which inflates assets. Or this might be a completely valid form of valuation.
UPDATE: I also found this sentence in the shareholder letter:
"Net income in fiscal year 2018 included a $12.3 million ($9.4 million net of tax) non-cash loss related to an impairment of assets at six restaurants."
In most restaurants, the company will acquire one or more of their franchises, which usually increases or decreases goodwill. I don't believe that this company does franchising though? Either way, shouldn't this loss in impairment decrease goodwill?
This impairment charge is something else, because they said that there was no goodwill impairment in 2018. So this impairment was on something else?
When you say “non cash loss related to an impairment of assets at 6 restaurants”, that could mean fixed asset impairments not related to goodwill at all. For example, maybe they’ve slated 6 of those restaurants to close in 6 months, and so they start taking accelerated depreciation for book purposes to write down the assets. Or some of the assets are simply written down now because they won’t have alternative use in the business and they don’t think the assets can be realistically sold. Or maybe they’re scrapping out seating that wasn’t fully depreciated with new seating. Those would be noncash losses since they didn’t actually sell them in the real world.
Impairment isn’t exclusive to good will.
Also, there are easily searchable accounting guides on the internet for goodwill units and the different methodologies. I saw one for BDO but I’m not digging thru it to find your answer.
Also, in your original post you mentioned the goodwill stays the same and a little bit should be lost overtime. That’s false. That’s not how it works.
Last edited by Thatsright19; 01-12-2020 at 11:33 AM..
I'm researching a restaurant company and was reading it's Goodwill section in its 10-K report. I noticed
that this company's goodwill has been holding study at $24 million for years.
I questioned their goodwill impairment practices because over time, there restaurants will loose a little value and should be impaired.
I read the Goodwill section:
"Goodwill represents the excess of cost over the fair value of assets of the businesses acquired. Goodwill is not amortized, but is subject to impairment tests at least annually. The Company performs tests to assess potential impairments on the first day of the fourth quarter or during the year if an event or other circumstance indicates that goodwill may be impaired. The first step of the goodwill quantitative impairment test compares the implied estimated fair value of the reporting unit to the carrying amount, including goodwill. The Company considers all of its stores in total as one reporting unit.If the estimated fair value of the reporting unit is less than the carrying amount, then it is more likely than not that a goodwill impairment exits and a second step must be completed in order to determine the amount of the goodwill impairment. In the second step, the implied fair value of the goodwill is determined by allocating fair value to all of its assets and liabilities, other than goodwill, in a manner similar to a purchase price allocation. If the resulting implied fair value of the goodwill that results from the application of this second step is less than the carrying amount of the goodwill, an impairment charge is recorded for the difference. No goodwill impairment charges were recognized during 2018, 2017, or 2016."
This companies correct that Goodwill is required to be checked for impairment at least once every year, but I've never heard of a restaurant company that considers (all) of its stores as one reporting unit?
Take a look at another great restaurant company's Goodwill section in there 10-K and notice the difference:
"Goodwill is tested annually for impairment, and is tested more frequently if events and circumstances indicate that the asset might be impaired. We have assigned goodwill to our reporting units, which we consider to be the individual restaurant level. An impairment loss is recognized to the extent that the carrying amount exceeds the implied fair value of goodwill. The determination of impairment consists of two steps. First, we determine the fair value of the reporting unit and compare it to its carrying amount. The fair value of the reporting unit may be based on several valuation approaches including capitalization of earnings, discounted cash flows, comparable public company market multiples and comparable acquisition market multiples. Second, if the carrying amount of the reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of the goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit, in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill"
The difference is that the second company reports on an individual restaurant level and does not consider the company itself as one unit. According the rules of accounting set by the FASB, companies should report and test impairment on an individual unit level. Like the second company is doing. But the first does not? Why would the first company test impairment differently, if they are allowed to do that in the first place?
Any input on this would be great!
Ok, my husband who is a high level accountant for a Fortune 500 company says that the explanation is very complicated but as long as they have audited financial statements, there is nothing to suggest that there is anything inappropriate here.
Ok, my husband who is a high level accountant for a Fortune 500 company says that the explanation is very complicated but as long as they have audited financial statements, there is nothing to suggest that there is anything inappropriate here.
Great, although sometimes even if the company gets an audit, it can be inappropriate. There has been many publicly traded companies that were frauds, like Allied Capital, who got audited on a yearly basis.
Did your husband say why they might report this way, as one reporting unit instead of the individual restaurant level?
Also, they do not have any franchises, so they can't acquire any restaurants to add to Goodwill. They also don't have any subsidiaries. So, what's their $24 million in goodwill represent? If it's intangible assets, they're valuing them at a very high premium! If it's their total restaurants, they should have lost value over the years.
Did your husband say why they might report this way, as one reporting unit instead of the individual restaurant level?
Also, they do not have any franchises, so they can't acquire any restaurants to add to Goodwill. They also don't have any subsidiaries. So, what's their $24 million in goodwill represent? If it's intangible assets, they're valuing them at a very high premium! If it's their total restaurants, they should have lost value over the years.
Thanks!
If they don't have franchises then it would make more sense as one reporting unit, since there is a lot more control over the restaurants and little to no risk of a franchisee leaving, etc, thus damaging the goodwill.
And why would they lose goodwill over time if sales, reputation, etc, remain consistent or improve?
We used to amortize goodwill. Goodwill is the plug. Rather than let it be gamed, just know this will be a headwind going forward. I miss that approach. It was easy and consistent. People considered it smoothing, but honestly it makes sense. If you buy Apple, sure you have goodwill. Apple is worth more than the historical cost of her assets. She has a great engineering team for one, but in 5 years all of her products will be different.
Conversely some would say, well look if you bought Coke, that goodwill is worth something...and sure it is. For awhile. It may take longer than 5 years, but at somepoint you will have changed out every production line and facility and capitalized all of that...and still have this goodwill there. You can even separate out the brand....but that needs refreshing even if it's the same thing.
But now it's optional to take the hit, and what management team is ever going to want to take a hit? They're going to put a lot more concentration on how to not take this hit than is necessary, because we've gone and made it necessary. And this is where accounting has gone and gotten a little too gimmicky.
There is a small reprieve out a few years back that allows you to get away from the annual consulting stamp of approval for very small amounts of goodwill. You can return to simply amortizing it over 5 years, but only for small amounts.
From an investor standpoint, just look at that goodwill amount as a giant anvil sitting over your own head.
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