Goodwill – A Controversial Accounting Issue in “the New Economy”.

Diploma

ABSTRACT  

The New Economy is a new arena in business life where IT (Information Technology) companies act. The IT sector in Sweden grew immensely during the end of the 1990s. That growth was possible through numerous acquisitions. The market’s valuations of the new prosperous enterprises in this young sector were extremely high.

 

Through a row of highly priced acquisitions, huge goodwill items emerged in most IT companies. Profitability was not a core issue and the future seemed bright to most actors. Share prices fell dramatically during 2000 and IT companies had to write down goodwill in a drastic way in the annual reports. 

 

In this thesis different aspects of accounting for goodwill in the annual reports covering the year 2000 for 29 Swedish IT and Internet companies are presented. A close-up on two companies, HiQ and TietoEnator, provides a deeper insight in our study. Different concepts of goodwill are looked into. Accounting rules and regulations dealing with goodwill in specific and with intangibles in general are presented both from a national and an international outlook. 


Background

 

What is the IT sector?

 

The rapid development and change in the IT (Information Technology) sector and the growing number of services connected to IT are factors that make it difficult to clearly define the IT sector. One of the more frequently used definitions of the IT sector is that it consists of partly the industrial sectors that manufacture computers and telecom equipment, and partly the service sectors working with software, support, consulting, sales and so forth concerning computers and IT solutions.

 

In September 1998 the OECD Committee for Information, Computer and Communication Policy established a definition of what the IT sector should include. The sectors included according to the OECD definition can be divided in two main categories, namely the production of hardware and the production of IT services.

 

Information technology and its fast spread are regarded by many as a key factor in the development of what is called the New Economy. This expression, “the New Economy”, can be regarded both as a name for the IT sector and as a description of the type of development on a macroeconomic level which is characterised by economic growth, increasing employment and low inflation.The perhaps controversial expression “the New Economy” is discussed further in a separate part of our thesis.

 

The IT Sector in Sweden – a Remarkable Development.

 

Sweden today is considered to be one of the leading IT (Information Technology) countries in the world. In February 2001, the analysis company IDC, ranked Sweden as the world’s leading IT country, (considering the age of IT,) for the second year in a row, closely followed by countries like Norway, Finland, the United States and Denmark. Sweden has a relatively well developed IT infrastructure and there is a high level of profficiency in IT at user level. Many Swedish companies are in the forefront in the age of information technology.

 

During the period 1993-1999 the IT sector represented roughly 25 % of the total GNP growth in Sweden. In 1999 the export from the IT sector amounted to 19 % of the total Swedish export. The gross export from the Swedish IT sector was by then e.g. higher than the export from the total Swedish forest industry.

 

Share prices for many Swedish IT companies reached an all time high. In one article published in the Swedish business paper “Dagens Industri” in August 1999 a financial analyst from Swedbank presented his opinions about the high share prices in the Internet sector and if he considered the Internet companies to be overvalued. He meant that no facts really supported the high price level. The investor’s valuation base for a number of companies was expectations about a persistent high yield and growth. Risks considering an emerging competition were often neglected.  

 

Organic Growth Versus Acquisition Strategy

 

One significant factor in the very fast growing IT sector was the speed with which many IT companies grew through a number of acquisitions. It was considered a great advantage to build sizeable companies through acquisitions rather than growing by the companies´own operative business. The market had total confidence in the potential of companies that had acquisitions strategies. The base for valuation of the acquired companies was market price (or share price), which in many cases resulted in enormous goodwill items in the accounts of the acquiring companies. A majority of the acquisitions were made when share prices were eight or nine times as high as they were at the end of year  2000. For a number of the acquiring companies, one crucial condition of making growth possible, was to pay for the acquisitions by issuing new shares in their own highly valued companies.