"INSTANTANEOUS" WIPEOUT OF VALUE
Because the value of many assets is so subjective, balance sheets are prone to sudden, arbitrary revisions. To cite one dramatic example, on July 27, 2001, JDS Uniphase, a manufacturer of components for telecommunications networks, reduced the value of its goodwill by $44.8 billion.
It was the largest write-off in corporate history up to that time.This drastic decline in economic value did not occur in one day. Several months earlier, JDS had warned investors to exp ect a big write-off arising from declining prospects at businesses that the company had acquired during the telecommunications euphoria of the late 1990s.4 If investors had relied entirely on JDS’s balance sheet, however, they would have perceived the loss of value as a sudden event.
Shortly before JDS Uniphase’s action, Nortel Networks took a $12.3 billion goodwill write-off and several major companies in such areas as Internet software and optical fiber quickly followed suit. High-tech companies had no monopoly on “instantaneous” evaporation of book value, however. In the fourth quarter of 2000, Sherwin-Williams recognized an impairment charge of $352.0 million ($293.6 million after taxes). Most of the write-off represented a reduction of goodwill that the manufacturer of paint and related products had created through a string of acquisitions. Even after the huge hit, goodwill represented 18.8% of Sherwin-Williams’s assets and accounted for 47.9% of shareholders’ equity.
Both Old Economy and New Economy companies, in short, are vulnerable to a sudden loss of stated asset value. Therefore, users of financial statements should not assume that balance sheet figures invariably correspond to the current economic worth of the assets they represent.
A more reasonable expectation is that the numbers have been calculated in accordance with GAAP. The trick is to understand the relationship between these accounting conventions and reality.If this seems a daunting task, the reader may take encouragement from the success of the bond rating agencies (see Chapter 13) in sifting through the financial reporting folderol to get to the economic substance. The multi- billion-dollar goodwill write-offs in 2001 did not, as one might have expected, set off a massive wave of rating downgrades. As in many previous instances of companies writing down assets, Moody’s and Standard & Poor’s did not equate changes in accounting values with reduced protection for lenders. To be sure, if a company wrote off a billion dollars worth of goodwill, its ratio of assets to liabilities declined. Its ratio of tangible assets to liabilities did not change, however. The rating agencies monitored both ratios, but had customarily attached greater significance to the version that ignored intangible assets such as goodwill.