Vodafone's goodwill write down sends shock waves through City

Vodafone’s announcement last week that it was slicing £28bn of goodwill from
its balance sheet relating to its mega acquisition of German telecoms provider
Mannesmann in 2000 left observers open-mouthed.

The FTSE 100 giant had already amortised goodwill at a rate of tens of
billions of pounds over the past few years, but the latest figure shocked
investors, leading to a share price slump from its Monday opening price of
116.5p to 112p by Friday (which then rose after the sale of its Japanese arm was
announced).

It is entirely possible that Vodafone would have amortised its goodwill at a
constant rate if it were not for the new accounting regime that has moved the
goalposts to where the standard setters think they should be.

International financial reporting standards seek to produce more transparent
accounts that are harmonised across the globe. In terms of goodwill, companies
like Vodafone now have to carry out regular impairment testing to make sure
their value is carried ‘fairly’ in the accounts, which led to the £28bn.

IFRS3 on business combinations, in particular, has led to a fundamental
change in the way that goodwill is recognised in a set of accounts.

IFRS3 defines fair value as: ‘The amount for which an asset could be
exchanged, or a liability settled, between knowledgeable, willing parties in an
arm’s length transaction.’

Testing introduces volatility into the accounts, which has analysts shifting
nervously in their seats. Vodafone’s announcement of a £28bn write down had been
predicted, but at the moment the City can only guess at the potential for
another massive write down next year.

A small mercy is that prior amortisation does not have to be restated.

Despite suggestions that IFRS has confused rather than cleared up the
presentation of accounts, the aim of standards like IFRS3 is ultimately to help
investors by presenting the markets with realistic and fair reflections of the
financial activities of a business.

PricewaterhouseCoopers partner Richard Winter believes the standards improve
the rigour of the acquisition decision-making process.

‘Businesses will not proceed with acquisitions without justification for what
they are buying in terms of how it will be reflected in the balance sheet.’

But analysts are more immediately concerned with the treatment of
acquisitions that have already occurred. Under the new standards, regular
impairment testing could reveal some nasty surprises in the next few weeks as
prelims and year-end results start to file through.

A senior telecoms analyst told Accountancy Age that the Vodafone
situation suggested the company had presented its takeover of Mannesmann too
optimistically in the past.

More crucially, Vodafone still sat under a cloud regarding its huge bill for
purchasing a 3G license from the government, a bill that was being amortised,
but had not undergone recent impairment testing.

‘New FD Andrew Halford has been thrown hospital passes on these subjects,’
the analyst commented.

But Vodafone, although handling an acquisition bigger than most, is not on
its own. Both these sets of tables represent a whole range of FTSE 350
companies, from utilities and energy businesses to publishing and broadcasting.
So any business involved in acquisitions will find their finance functions
presented with more work measuring the impact of purchases than before.

Take BAE Systems, for example. Its acquisitions led to a £546m write down in
2004, of which £480m related to business acquired in 1999 as part of a merger
with Marconi Electronic systems.

The disposal of some of these businesses to Finmeccanica led to the write
down.

Despite the concern for UK corporates, spare a thought for AOL Time Warner.
It recorded a $54bn (£30.8bn) write-down to reflect the lowered valuation of its
2001 merger. The charge was considered the largest asset impairment write-off in
corporate history.

Mannesmann takeover

Borne out of its £101bn takeover of German telecoms giant Mannesmann in 2000,
Vodafone has been counting the cost, taking tens of billions in amortisation and
impairment charges ever since. While the latest writedown, a whopping £28bn,
could be describes as an accounting treatment, the City is more likely to focus
on Vodafone’s acquisition strategy and what it means for future profits.