PracticeAccounting FirmsGoodwill hunting

Goodwill hunting

England's Rugby World Cup win was a strong reminder that all teams, whether in business or sport, require strenuous efforts from all members without exception. Equally, it was a good reminder that the intangible asset that we call goodwill can change swiftly in certain circumstances, and that representing it by a number in a balance sheet as a snapshot on a particular date can be misleading.

The understanding of that weakness in the longevity of the numbers appears to have led most accounting firms to dispense with any representation of a firm’s goodwill on their balance sheets.

That may be sensible, as it certainly has been questionable in the past whether a firm does have a value in excess of its net assets. And many firms rationalised that, if they didn’t ask incoming partners for goodwill payments, they would view a portion of their annual profits as being a payment for the increase in the firm’s value. As long as partners put aside this portion as an investment for their retirement (usually by means of mandatory pension payments), there would be no moral argument for further payments on retirement.

However, recent events have caused many firms to rethink this logic.

The consolidators’ actions hardened values of some of the larger small firms and gave a framework for valuation. The pension situation means that the excess profits invested now look poor in comparison to the potential capital receipt that partners believe their share to be worth. So will we see goodwill reappearing on more firms’ balance sheets?

If we are going to see more mergers and takeovers as the ageing population of partners retire, then the existence of goodwill on the balance sheets of merging firms – inevitably calculated on differing bases – is going to cause problems at the negotiating stage. Not least because payments of capital for goodwill may be more attractive to retiring partners who can claim taper relief than continuing partners wanting tax relief on annuity payments.

All these considerations appear to lead inexorably towards more firms seriously considering incorporation. I have always been fascinated by the distinction between the entrepreneurs we serve, whose every action is focused towards the goal of building their share value, and us, who as advisers vacillate between increasing current short-term profits and building lasting value in our firm. Could this be why we appear so slow at adapting to change?

Warren Gatland, the Kiwi who coached the Irish rugby team a few years ago, said to the senior players at his first coaching session: ‘This game is simple. See this funny shaped ball? You just pick it up and put it down over that line over there.’ Would that our business management focus was so sharp.

Clive Woodward has shown there are other ways of winning a rugby game than scoring tries, but his focus has remained as sharp. Perhaps the goodwill is something that, without clear thinking, blurs our focus.

Send in your questions for our adviser panel of experts on matters relating to small practices by emailing adviser@accountancyage.com.

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