RAROC and Goodwill Amortization/Depreciation

[Mkaim]

Hi David,

Just noticed that Crouhy, et al. mention that "Goodwill is also depreciated over time" on page 150. If I recall correctly, under FASB, Goodwill is not amortized but is tested for impairment and charged of appropriately if impairment exists. However, there seems to be an exception, based on an update released on 1/16/2014 for private businesses who can amortize goodwill over 10 years. Goodwill in the RAROC calculation is used in the RAROC denominator as a subset of strategic risk capital. My question is do you think they mean that you amortize it ONLY for calculating economic capital or are they making a general statement about how businesses treat Goodwill for accounting and economic capital purposes?



FASB release: http://www.fasb.org/cs/ContentServer?pagename=FASB/FASBContent_C/NewsPage&cid=1176163742955

 

[QuantMan2318]

Very Interesting, @Mkaim, Possibly Crouhy refers to the impairment of Goodwill "as being Depreciated over time" or he might be referring to the current discussions by our standard setters to re introduce Amortization of Goodwill.

It is interesting to note here that our Accounting standards prior to the IFRS convergence talk, talked about amortizing Goodwill arising in Business combinations over a period (it was 5 years in India). I think it was the same earlier in US GAAP as well as the regional standard setters in the EU. We all know about the difficulty in valuing Goodwill, these IFRS guys wanted to test it for impairment and changed the entire stuff, now after the crisis resulting in Goodwill being impaired after the market had done the same, they want to return to the "Old Fashioned Days" This is a significant reversal of policy in my opinion

I wonder, I was thinking that the Denominator for RAROC was the Economic Capital ( Credit Risk Capital + Market Risk Capital +Operational Risk Capital ) under Basel Norms. I thought it better to separate the GAAP concept of Capital from the Risk Concept of Capital

Anyway, if we are taking the Capital as Net Assets+Net Working Capital, then it makes sense to amortize Goodwill in the interests of conservatism

Hope this is correct and people over here may correct me if I am wrong

 

[Mkaim]

Very Interesting, @Mkaim, Possibly Crouhy refers to the impairment of Goodwill "as being Depreciated over time" or he might be referring to the current discussions by our standard setters to re introduce Amortization of Goodwill.

It is interesting to note here that our Accounting standards prior to the IFRS convergence talk, talked about amortizing Goodwill arising in Business combinations over a period (it was 5 years in India). I think it was the same earlier in US GAAP as well as the regional standard setters in the EU. We all know about the difficulty in valuing Goodwill, these IFRS guys wanted to test it for impairment and changed the entire stuff, now after the crisis resulting in Goodwill being impaired after the market had done the same, they want to return to the "Old Fashioned Days" This is a significant reversal of policy in my opinion

I wonder, I was thinking that the Denominator for RAROC was the Economic Capital ( Credit Risk Capital + Market Risk Capital +Operational Risk Capital ) under Basel Norms. I thought it better to separate the GAAP concept of Capital from the Risk Concept of Capital

Anyway, if we are taking the Capital as Net Assets+Net Working Capital, then it makes sense to amortize Goodwill in the interests of conservatism

Hope this is correct and people over here may correct me if I am wrong

Hey @QuantMan2318 ,

Thanks for the feedback and your perspective. The denominator that I'm looking at, pre systemic risk adjustment, includes what you mention above + strategic capital which is comprised of goodwill and burned-out-capital. I do agree with your points regarding the amortization. My concern was more of widening differences between accounting and economic reality given the treatment of goodwill for public companies; I can only imagine the difference increasing significantly for a public company that experiences significant growth inorganically. Thanks again.