Full Answer Section

• Talbots’ Motivation for Paying More: If Talbots paid more than $X for J. Jill, the difference represents goodwill. This indicates Talbots believed J. Jill possessed intangible assets worth the additional amount. These intangibles could be a strong brand name, loyal customer base, or a complementary distribution network that would benefit Talbots’ business.

Elimination of Amortization of Goodwill:

Prior to SFAS No. 142 (issued in 2001), goodwill was amortized (spread as an expense) over a fixed period (typically 40 years). However, this process was criticized for being arbitrary and not reflecting the underlying value of goodwill. SFAS No. 142 eliminated the mandatory amortization of goodwill. Here’s a summary of the rationale behind this change:

• Difficulty in Estimating Useful Life: The useful life of goodwill is inherently difficult to predict. It can remain valuable indefinitely or become worthless quickly depending on various factors. Amortization based on an arbitrary lifespan wasn’t considered a reliable measure.
• Focus on Impairment Testing: SFAS No. 142 replaced amortization with annual impairment testing. This requires companies to assess whether goodwill’s carrying value (recorded value) is still supported by its fair value. If not, an impairment loss is recognized in the income statement.
• Improved Transparency: Impairment testing provides a more dynamic and realistic approach to valuing goodwill. It reflects changes in the acquired company’s performance, market conditions, and overall business environment.

While eliminating amortization simplified accounting, it has also been criticized for potentially overstating goodwill’s value on the balance sheet if not properly tested for impairment.