The goodwill number from an acquisition is the difference between the price paid for the acquisition and the estimated fair values of net tangible assets and the identified intangible assets acquired. The acquired tangible assets are then depreciated or amortized against future earnings, as are the definite-lived intangible assets. Goodwill and indefinite-lived intangibles are not amortized. Rather, they are impaired when their carrying value is deemed to be higher than the value they are expected to deliver.
This accounting opens an opportunity to “fiddle with the numbers.” As depreciation and amortization result in lower future profits, acquirers have an incentive to understate the fair value component that is subject to depreciation and amortization. That makes the acquisition look more profitable subsequently. Consequently, goodwill and the value of indefinite-lived intangibles are overstated and thus more likely for impairment. Empirical research lends support to this behavior.
