Investors never like to see their money disappear into thin air. But this is what happens under the UK accounting treatment of goodwill. When a business is acquired for more than net asset value (as it usually is), the difference between the price paid and the book value of the assets acquired is typically written straight off the acquirer's balance sheet. Investors need to be aware of the consequences of such practices: shareholders' funds walk out of the door without ever passing through the profit and loss account. There is no ongoing record of what the acquirer has actually spent.
As Terry Smith points out in Grand Illusions (p 52), this makes it particularly difficult to monitor companies whose special skills are perceived to lie in the making and managing of acquisitions. The table on page 54 gives a more accurate guide to the returns achieved by the leading conglomerates, by adding back shareholders' funds that had vanished from the balance sheet. With the honourable exception of BTR, these restated results make unimpressive reading.
Under other accounting regimes, shareholders are able to track companies' investment in acquisitions more closely. Under some, goodwill is amortised so that the real costs are taken through the profit and loss account. Under others, goodwill is left on the balance sheet as a reminder of the true capital that an acquisition has consumed. As a step in the right direction, UK companies should be encouraged to record their capital-raising exercises - just as they record their dividend payouts - in the five-or 10-year performance summaries in their Report and Accounts. Funds raised to buy businesses at a premium to net assets may still have disappeared, but they will be less easily forgotten.