Goodwill Traps -- Establishing Reporting Units
Being slapped around by the SEC is not fun as accounting management at Sony, Johnson Controls and Caterpillar can attest. The SEC beat up those companies over their reportable segments. Goodwill and reportable segments are inextricably linked, since goodwill itested for impairment on a segment-by-segment basis.
In the 90s, Sony reported only two segments, Electronics and Entertainment. Entertainment included both Sony’s music and motion pictures divisions, which had radically different customers, cycles and operating results and presumably separate management. In 1994, Sony announced a $3.2 billion write-off related to Columbia Pictures that wiped out nearly 25% of Sony’s shareholders’ equity. Sony lost money on 17 of the 26 movies it released in 1994. Remember Cops and Robbersons? Brainscan? City Slickers II: The Legend of Curly's Gold? (I'm betting you wish you don't remember). How about Arnold Schwarzenegger's The Last Action Hero, one of the highest budget pictures in history (it bombed). Segment and MD&A disclosures prior to the write downs never showed any indication of problems. Eventually, the SEC served Sony with a "cease and desist" order.
In nailing Sony, the SEC cited their action against Caterpillar: In Caterpillar, the Commission determined that “Caterpillar's MD&A disclosures failed to adequately apprise investors of a material risk of lower earnings and did not quantify the impact of lower earnings from a Brazilian subsidiary on Caterpillar's overall results.”
The SEC again reached the end of its rope in 2001 in a speech by the Chief Accountant: “Let me warn you that our patience with deficient segment disclosure has been exhausted. Expect the staff to request an amendment, rather than suggest compliance in future filings, if components regularly reviewed by the chief operating decision maker are not presented separately.”
By 2005 they finally nailed Johnson Controls for 2002 through 2005, and forced them to revise their segment disclosures for their Automotive Group. Johnson originally had TWO segments. The SEC objected to a bloated Automotive segment, which made up 77% of Johnson’s the 2004 revenues. The SEC forced Johnson’s hand and they ultimately broke Automotive down into four segments, for a total of FIVE operating segments. In 2006, after more thought (and with the SEC looming over their thinking) decided in Q2 2006, (after an acquisition) determined that it had TEN reportable segments. None of this ever affected Johnson Controls’ goodwill, because all of their segments continued to make profits, so goodwill was never at risk. But in their two segment period, goodwill impairment in, say, their North America auto interiors division could have been covered up by a goodwill cushion in say, their European auto operations, if it had losses or other indications of impairment.
Imagine the cost in legal and accounting fees and lost time to correct the above errors. Not to mention embarrassment and career damage. Choose your segments and allocate goodwill to them carefully.