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What is goodwill anyway?

On financial statement balance sheets, there sometimes is a line item for goodwill. What does this mean to an accountant? Goodwill is a finance term that makes obvious how differently accounting rules treat marketing and advertising investments versus physical investments, such as facilities.

THE ACCOUNTING RULES

Agribusinesses invest in long-term assets by building capacity to create products to sell for many accounting periods in the future.

Financial statements are prepared annually; however, which means there is disconnect between the one-year accounting period and the many years of useful life of the additional production capacity.

Accountants use depreciation to allocate the cost of the investment over many accounting periods. The government sets the depreciation rules for tax purposes.

Initially, accountants place the full value of the production capacity on the balance sheet. They then expense this cost over time as depreciation on the income statement while also reducing the value of the capacity on the balance sheet.

Eventually, the entire value of the capacity is depreciated and the balance sheet will no longer exhibit an accounting value for that asset--even if the capacity is still productive.

This is very different from how investments in brand-building are accounted for. Marketing and advertising should establish brand value that will generate revenue for many accounting periods into the future--just like physical capacity. But brand expenditures are allocated on the income statement in the same year in which they occur.

Accountants can almost never place the value of the investments onto the balance sheet.

How does all of this relate to goodwill? Accountants calculate goodwill when a transaction occurs such that investments in strong brands must be treated the same as investments in production capacity. For example, consider Tyson Foods' acquisition of Hillshire Brands in 2014.

TYSON'S ACQUISITION OF HILLSHIRE BRANDS

Prior to the acquisition, Hillshire Brands invested in long-term assets (meat processing facilities) and in a portfolio of strong brands.

When Tyson acquired Hillshire, the balance sheet asset balance reflected the book or accounting value to be about $2.4 billion. Over the life of the firm, the total expenditures on long-term assets, such as the plant, property and equipment, amounted to just over $2 billion.

Accumulated depreciation over the entire life of the firm totaled more than $1.1 billion. This meant the accountants viewed the value of those long-term assets as just $0.8 billion. The remaining were mostly current assets: cash, accounts receivable and inventories.

Hillshire also had invested in its portfolio of brands. The accountants expensed investments in marketing and advertising each year. In its last year of operations, Hillshire spent more on media advertising and promotion ($174 million) than it did on capital expenditures ($139 million).

Presumably, the $174 million aided in creating brand awareness and loyalty and had a long-term impact on sales. The accountants did not reflect this as an investment, though. Instead, they expensed the entire cost on the 2013 income statement.

Tyson paid about $8 billion in market value to acquire Hillshire. This far exceeded the small book value of the equity on the balance sheet. Thus, the goodwill and intangibles account on Tyson's balance sheet increased by the entire amount of the transaction.

Shareholders care just as much or more about how well Tyson management does with the brands it acquired as part of Hillshire as they do about the physical assets.

Understanding the relationship between the accounting values and market values is an important part of the discussions we have with participants in the Agribusiness Finance for the Non-Finance Manager program.

Join us on the Purdue campus Aug. 11-14 to explore this and other finance relationships. AM

Mike Gunderson is an Associate Professorat Purdue University and Associate Director of the Center for Food and Agricultural Business. You can reach him at mgunders@purdue.edu.

Upcoming Agribusiness SEMINARS

Agribusiness Finance for Non-Finance Managers August 11-14, 2015

Executive Agri-Marketing August 31-September 2, 2015

Midwest Food and Agribusiness Executive Seminar

September 22-24, 2015

National Conference for Agribusiness

November 10-11, 2015

Learn more at www.agribusiness.purdue.edu
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Title Annotation:Insights from Purdue University
Author:Gunderson, Mike
Publication:Agri Marketing
Date:Jun 1, 2015
Words:671
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