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How to account for negative goodwill

Goodwill is a kind of intangible asset; it is especially relevant in the sale of a business because the term is used to account for items that factor into the purchase price or value of the company but are not easily quantifiable, including proprietary or intellectual property and brand recognition.

Amortization refers to an accounting technique that is intended to lower the value of a loan or intangible asset over a set period of time. In 2001, a legal decision prohibited the amortization of goodwill as an intangible asset. However, in 2014, parts of this ruling were rolled back; amortization is now allowable in certain situations.

Key Takeaways

  • Goodwill is a kind of intangible asset; in the context of the purchase or transfer of business, it may refer to proprietary property, intellectual property, and/or brand recognition.
  • In accounting, goodwill is accrued when an entity pays more for an asset than its fair value, based on the company’s brand, client base, or other factors.
  • In 2001, a legal decision prohibited the amortization of goodwill as an intangible asset; however, in 2014, parts of this ruling were rolled back.
  • Now, private companies can elect to amortize goodwill on a straight-line basis over 10 years, although this election is not required.

Here are a few important characteristics of goodwill:

  • Goodwill can't be separated or divided from the entity with which it is associated.
  • Goodwill can't be sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability.
  • Goodwill does not carry contractual or other legal rights, regardless of whether those are transferable or separable from the entity, other rights, or obligations.

Changes to Accounting Rules for Goodwill

In 2001, the Financial Accounting Standards Board (FASB) declared in Statement 142–Accounting for Goodwill and Intangible Assets–that goodwill was no longer permitted to be amortized.

In accounting, goodwill is accrued when an entity pays more for an asset than its fair value, based on the company’s brand, client base, or other factors. Corporations use the purchase method of accounting, which does not allow for automatic amortization of goodwill. Goodwill is carried as an asset and evaluated for impairment at least once a year.

However, in 2014, this policy was partially rolled back with the FASB Accounting Standards Update No. 2014-02, "Intangibles—Goodwill and Other (Topic 350)." The FASB re-allowed private companies to elect to amortize goodwill on a straight-line basis over 10 years. However, the election is not required. If desired, the option to amortize enables private companies to forgo the costly annual impairment tests that are required of public companies.

How Goodwill Is Calculated

Until 2001, goodwill could be amortized for a period of up to 40 years. Many companies used the 40-year maximum to neutralize the periodic earnings effect and report supplementary cash earnings that they then added to net income. The FASB changed this in June 2001 with the issuance of Statement 142, which prohibits this.

The first step of the impairment test required under the new standard must be performed within the first half of the company’s fiscal year. If an impairment is found, the company reduces the goodwill carrying value and recognizes an impairment loss. Any material impairments found are listed as line items above “income from continuing operations.”

Because the annual valuation of goodwill is particularly expensive and time-consuming for private companies, the FASB created alternative goodwill accounting provisions for them. FASB Accounting Standards Update No. 2014-02, Intangibles—Goodwill and Other (Topic 350): Accounting for Goodwill allows these companies to use straight-line amortization of goodwill for up to ten years, or less if the company is able to demonstrate a useful alternative lifespan. Private companies only need to conduct impairment tests when a triggering event indicates that the company’s fair value is less than its carrying amount rather than having to do so every fiscal year.

The negative goodwill (NGW) amount, also known as the “bargain purchase” amount, is the difference between the purchase price paid for an asset and its actual fair market value.

How to account for negative goodwill

Negative goodwill is an accounting principle that occurs when the price paid for an asset is lower than its value in the market and can be thought of as a “discount” to the buyer.

Tangible/Intangible Assets and Negative Goodwill

It is important to distinguish between tangible and intangible assets:

Tangible assets come in a physical form and hold monetary value. Primary examples include property, plant, and equipment.

Goodwill accounts for the value of the intangible assets – such as brand recognition and intellectual property – which can be highly valuable for well-established and/or innovative companies. Intangible assets are not included in the calculation of the market value but may be included in the purchase price.

However, the presence of negative goodwill itself implies that the purchase price was lower than the market value – indicating that intangible assets had a discounted or no value or that the company is being sold under pressure without reaping the benefits of its intangible assets.

Therefore, negative goodwill implies that the selling company is under extremely unfavorable circumstances – it could either be financially distressed, under high selling pressure, and/or facing high debt obligations, which lead to a discount on the purchase price of a company.

Practical Example

Company XYZ faced growing competition and incurred debt obligations that it could not cover. The board of directors had two choices – either file for bankruptcy Bankruptcy Bankruptcy is the legal status of a human or a non-human entity (a firm or a government agency) that is unable to repay its outstanding debts or sell the company.

The company was recently sold for $288,000, which was lower than its fair market value. The table below reports consolidated information from Company XYZ’s financial statements:

How to account for negative goodwill

  • The purchase value of accounts receivable is lower than the fair market value due to deteriorating relations with debtors and difficulty in recollecting payments.
  • The purchase value of property, plant, and equipment (PP&E) is lower than the fair market value because the company failed to account for depreciation accurately.
  • The intangible assets of the company, including intellectual property and customer base, were weighed down due to the current financial situation – growing competition and high debt obligations.

Negative Goodwill vs. Goodwill

Negative goodwill occurs when the purchase price paid for an asset is lower than its value in the market. In contrast, goodwill occurs when the purchase price is higher than its market value – i.e., the goodwill amount is the premium paid by the buyer for the intangible value of the company’s assets.

While negative goodwill is an indicator of unfavorable circumstances, the presence of goodwill (i.e., “positive” goodwill) implies that the intangible value of assets is high, and the company is under relatively low pressure to sell – this situation favors the seller.

Why Does Negative Goodwill Arise?

Negative goodwill usually arises due to one of the following:

Forced or financially distressed sale of the company

Companies that are financially distressed and under pressure to sell may be willing to sell the company at a discount in the form of negative goodwill since the value of intangible assets for a distressed firm is likely to be lower.

Incorrect valuation of assets

Valuation of assets, especially long-term fixed assets, may be incorrect – given that macroeconomic factors Macroeconomic Factor A macroeconomic factor is a pattern, characteristic, or condition that emanates from, or relates to, a larger aspect of an economy rather are constantly changing – and result in inaccurate market values. Similarly, an inaccurate valuation of intangible assets may also result in lower market values and negative goodwill.

Accounting for Negative Goodwill

According to US GAAP and IFRS, both goodwill and negative goodwill must be recognized and accounted for in the acquiring company’s financial statements.

NGW in the Income Statement

Negative goodwill must be recognized as a “gain on acquisition” in the acquirer’s income statement, under non-cash sources of income.

NGW in the Balance Sheet

In the balance sheet of the selling company, goodwill is recorded as an asset, whereas negative goodwill is part of the liabilities since it reduces the valuation. Alternatively, goodwill may be recorded as a contra-asset, or a reduction to assets to indicate the amount of NGW.

NGW in the Statement of Cash Flows

In the statement of cash flows, negative goodwill is usually recorded as a “gain on acquisition” or “gain on bargain purchase” to indicate the additional value acquired in the form of NGW.

Related Readings

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  • Net Asset Value Net Asset Value Net asset value (NAV) is defined as the value of a fund’s assets minus the value of its liabilities. The term “net asset value” is commonly used in relation to mutual funds and is used to determine the value of the assets held. According to the SEC, mutual funds and Unit Investment Trusts (UITs) are required to calculate their NAV
  • Fair Market Value Fair Market Value The fair market value (of a good or service being exchanged) refers to the price at which both transacting parties agreed to independently.
  • IFRS vs. US GAAP IFRS vs. US GAAP The IFRS vs US GAAP refers to two accounting standards and principles adhered to by countries in the world in relation to financial reporting
  • Statement of Cash Flows Statement of Cash Flows The Statement of Cash Flows (also referred to as the cash flow statement) is one of the three key financial statements that report the cash

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Goodwill has been defined under IFRS 3 as following:

An asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised.

On analysing the definition we can understand that goodwill is an asset but is not the asset which can individually be identified and thus recognized separately.

Goodwill is measured by comparing:

(A) the aggregate of consideration transferred by the acquirer + Non-controlling interest + any previous equity interest in acquiree held by acquirer

WITH

(B) The net identifiable assets acquired and the liabilities assumed

Usually (A) is more then (B) in business combinations and a positive good will arise in this case. However, in some cases (B) can exceed (A) in which case negative goodwill will arise. IFRS 3 discusses it as gain on a bargain purchase.

Why negative goodwill or gain on bargain purchase may arise?

Negative goodwill or gain on bargain purchase or simply bargain purchase may arise because of:

  • forced sale
  • recognition or measurement exceptions for particular items discussed under IFRS 3
  • error in the valuation of identifiable assets, non-controlling interest and/or equity interest.

Conditions to be fulfilled

In case a negative goodwill arises then before this gain is recognized, acquirer must review the calculations to make sure that everything is arithmetically correct and no mistakes are made in measurement of different elements as negative goodwill does not arise normally and IFRS 3 requires the reassessment is done to be sure that no mistakes are made.

With the economy slowly but surely improving, merger and acquisition activity has been on the rise the past couple of years. Many Los Angeles and Southern California business owners and entrepreneurs have taken advantage of this favorable M&A environment to acquire other companies in an effort to increase their sales volume and boost market share.

Businesses face many different challenges when acquiring other companies — everything from performing adequate due diligence on the target company to merging sometimes divergent corporate cultures. One challenge that many acquirers aren’t familiar with is how to handle the accounting associated with the goodwill a business acquires when it mergers with another business.

What Exactly is Goodwill?

From an accounting perspective, goodwill is an intangible asset that arises when a business buys another firm for more than the fair market value of its net assets — or in other words, for more than total assets minus total liabilities. The excess of the purchase consideration (or money paid to buy the business) over the business’ assets and liabilities is considered to be goodwill.

Goodwill typically includes such things as the value of a business’ brand name in the marketplace, patents and proprietary technology owned by the company, an established customer base, solid customer relations, and an experienced and stable workforce. Unlike plant, buildings and equipment, goodwill can’t be seen or touched — this is why it’s considered to be an intangible asset and categorized as such on the balance sheet.

The issue of accounting for goodwill in a business acquisition has undergone many changes over the years. In particular, changes in accounting rules in 2001 gave acquirers more discretion to include the value of intangible assets like goodwill in the book value of companies they are acquiring. These changes also required businesses to revalue acquired companies at regular intervals. If the company has declined in value, the acquirer must impair (or write down) the acquired goodwill.

At the time of a business merger, goodwill accounting might not seem like it’s that important. However, it’s critical that goodwill accounting be done properly in a business acquisition. Otherwise, a number of different problems can arise, including:

§ Disputes between the owners of the acquiring and acquired businesses. These disputes can lead to potential litigation down the road.

§ Decreased efficiency, lower profits and lost opportunities. These are a result of the business not running at peak capacity while disputes are being resolved.

§ Lower worker productivity as employees inevitably get drawn into the disputes.

§ Inequitable and unexpected liability assumed by one party. Both sides must be specific about the assets and liabilities to be transferred — for example, by spelling them out, assigning a proper cut-off date, and not adding additional items after the fact.

§ Wasted legal and valuation resources along with legal problems and issues. A valuation of the target company should be obtained upfront as part of the acquisition accounting, not after the fact to justify the accounting.

How an Outsourced CFO Can Help

An outsourced CFO services provider can help with accounting for goodwill as part of an acquisition. Such a provider has experience in mergers and acquisitions and knows what the acquisition agreement should look like and what needs to be done from an accounting perspective. An outsourced CFO will make sure everything is clearly spelled out, documented and properly archived so there are no outstanding issues left to chance. He or she will understand the more complex issues involved in the merger and thus can help ensure that acquirers negotiate the most favorable deal possible.

Engaging the services of an outsourced CFO for help in goodwill acquisition accounting can result in a number of positive outcomes. For example:

§ Management can focus on running the newly acquired business and integrating it into existing operations, not rehashing the acquisition.

§ Ownership and shareholder disputes are minimized or eliminated, thus eliminating distractions for both management and employees.

§ Unnecessary legal and other professional expenses down the road may be reduced or eliminated with the proper acquisition agreement, backed up by the proper accounting, in place from the beginning.

§ Equity fundraising or even a potential future sale of the company are not encumbered due to legal actions (or the threat of them).

Concluding Thoughts

Businesses face many different challenges when acquiring other companies, including how to handle the accounting associated with goodwill. At the time of a business merger, goodwill accounting might not seem like it’s that important, but it’s critical that goodwill accounting be done properly in a business acquisition. An outsourced CFO services provider can help with accounting for goodwill as part of an acquisition by making sure everything is clearly spelled out, documented and properly archived so no outstanding issues are left to chance.

© 2011-2021 CFO Edge, LLC – This article is only for general information and should not be used in lieu of professional advice.

All type organisations have goodwill asset. It does not show physically but it has the value when we sell or buy any other business. When we buy another company, we have to pay extra amount of goodwill to vendor because vendor has done the same business before us and his reputation has some value because on his company name or his reputation, we can get unsecured loan. So, it is necessary to pass the journal entries of Goodwill.

How to account for negative goodwill

Following are the main journal entries of Goodwill.

1. When company buys the goodwill and pays the amount for goodwill

Sometime, vendor of company will demand excess value business than market value, difference will be goodwill. It is intangible asset but we have to record it by passing following journal entry.

Rule Debit : Goodwill will come in business. Everything which comes in business will be debit. Goodwill is asset. So, increase in asset of our business will be debit. So, Goodwill will also debit.

Rule Credit : Cash will go from our business. It will decrease in the amount of cash. So, cash will be credit.

For example, ABC has bought XYZ company. ABC has paid $ 5,00,000 for goodwill of XYZ company. Pass the journal entry.

Goodwill Account Debit 5,00,000

Cash Account Credit 5,00,000

Now, we will show this goodwill as our intangible asset in our balance sheet.

2. When Company Sells the Goodwill and Get the Amount for Goodwill

It is not sure, you will get same amount of goodwill what is showing in your books or balance sheet because. Time is changing and if you have sold the goodwill also with your business, you can get excess or low amount of goodwill difference will be profit or loss on selling of goodwill.

Rule Debit : You have received the cash by selling goodwill. It will increase your cash asset, so it will be debit. If you get loss, it will be also debit because you loss will decrease your invested capital. Moreover all losses and expenses will always debit.

Rule Credit : Goodwill account will be credit because it will decrease the asset of goodwill. If company is gaining profit from sale of goodwill, it will also credit

For example : ABC company sold same XYZ after buying to MNO company at $ 6,00,000 but book value is same as $ 5,00,000. Pass the journal entry.

Cash Account Debit 6,00,000

Profit on Sale of Goodwill Account Credit 1,00,000

Goodwill Account Credit 5,00,000

3. When Goodwill will be Impair

Goodwill is intangible asset, so we do not depreciate its value after spending of time. But if goodwill’s book value is high but market value is low, it means, our goodwill’s value has decreased. So, we have to written off by transferring it to profit and loss account’s debit side.

Rule Debit : Loss of Goodwill impairment is the decrease in value of goodwill. It will be debit

For example, we and our employees do not talk in sweet voice and properly. It will decrease our customer. Decrease in the customer will decrease our goodwill. For example, in day, we have just 1 customer but our competitor has 20,000 customers in day. We have started our business before our competitor. In past our sale was 20,000. Now, due to our bad behaviour, our goodwill value has decreased in the market. So, show this in balance sheet through journal entry.

Rule Credit : Goodwill account will credit because our asset will decrease due to loss in its value.

Snow Corporation purchased all of Cogner Corporation’s voting shares on January 1, 2002, for $365,000. At that time Cogner reported common stock outstanding of $80,000 and retained earnings of $130,000. The book value of Cogner’s assets and liabilities approximated their fair vales, except for land, which had a book value of $80,000 and a fair value of $100,000, and buildings, which had a book value of $220,000 and a fair value of $400,000. Land and buildings are the only noncurrent assets that Cogner holds.

a. Compute the amount of negative goodwill at the date of acquisition.
b. Give the eliminating entry or entries required immediately following the acquisition to prepare a consolidated balance sheet.

E4-12 Push-Down Accounting

Jefferson Company purchased all of Louis Corporation’s common shares on January 2, 2003, for $789,000. At the date of combination, Louos’s balance sheet appeared as follow:

Cash and Receivables 34,000 Current payables 25,000
Inventory 165,000 Notes Payables 100,000
Land 60,000 Stockholder’s Equity
Buildings (net) 250,000 Common Stock 200,000
Equipment (net) 320,000 Additional Capital 425,000
Retained Earnings 79,000
Total 829,000 Total 829,000

The fair values of all Louis’s assets and liabilities were equal to their book values except for its fixed assets. Louis’s land had a value of $75,000; the buildings, a fair value of $300,000; and the equipment, a fair value of $340,000.
Jefferson Company decided to employ push-down accounting for the acquisition of Louis Corporation. Subsequent to the combination, Louis continued to operate as a separate company.

a. Record the purchase of Louis’s stock on Jefferson’s books.
b. Present any entries that would be made on Louis’s books related to the business combination, assuming push-down accounting is used.
c. Present, general journal form, all elimination entries that would appear in a consolidation work-paper for Jefferson and its subsidiary prepared immediately following the combination.

© BrainMass Inc. brainmass.com March 4, 2021, 7:49 pm ad1c9bdddf
https://brainmass.com/business/accounting/eliminating-entries-negative-goodwill-push-down-124861

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E4-6 Eliminating Entries with Negative Goodwill

Snow Corporation purchased all of Cogner Corporation’s voting shares on January 1, 2002, for $365,000. At that time Cogner reported common stock outstanding of $80,000 and retained earnings of $130,000. The book value of Cogner’s assets and liabilities approximated their fair vales, except for land, which had a book value of $80,000 and a fair value of $100,000, and buildings, which had a book value of $220,000 and a fair value of $400,000. Land and buildings are the only noncurrent assets that Cogner holds.

a. Compute the amount of negative goodwill at the date of acquisition.
b. Give the eliminating entry or entries required immediately following the acquisition to prepare a consolidated balance sheet.

a. Amount of negative goodwill
Book value of Conger’s net assets:
Common stock outstanding 80,000
Retained Earnings 130,000
Total 210,000
Fair .

Solution Summary

The solution explains the eliminating entries with negative goodwill and push-down accounting

A proposed accounting rule expected to be finalized later this year may cause short-term problems for companies that have scooped up assets at bargain prices. The proposal on business combinations, a rewrite of FAS 141, changes the way companies book a gain known as negative goodwill.

That change could lead to an increase in a company’s reported assets, net income, and shareholders’ equity, thereby skewing performance ratios tied to those underlying items, according to a report released this month by the Financial Analysis Lab at the Georgia Institute of Technology.

For example, if the value of assets and equity are boosted by negative goodwill, then the return on assets and equity will appear to be lower, noted Charles Mulford, an accounting professor at Georgia Tech and the director of the lab. At the same time, an increase in equity might cause debt to look comparatively lower.

Negative goodwill is the gain created when a company buys an asset — including another corporation — for below the asset’s fair value, or current market price. The proposal, issued jointly by the Financial Accounting Standards Board and the International Accounting Standards Board in June 2005, would force companies to carry negative goodwill as an immediate extraordinary gain on the day of the sale, rather than write down the gain to zero through a series of allocations, as they currently do.

Traditionally, accountants and even FASB, “were somewhat loathe to recognize negative goodwill because they questioned whether there was such a thing as a bargain price,” Mulford told CFO.com, noting that accountants typically believed that an efficient marketplace would rarely yield a bargain price. Essentially, accountants “do not believe in a free lunch,” he said.

And while inking a merger deal that includes negative goodwill is rare, the accounting change could end the current quest by acquirers for distressed assets, at least until the market sorts out the potential accounting change and factors its affects into deals.

But don’t expect financial statement controversies to rein in the standard setter’s efforts. “FASB has been on a fair value tear,” Mulford said. To be sure, the update of FAS 141 – and Wednesday’s approval of FAS 157 – are two examples of the FASB’s commitment to replacing historical pricing with fair-value accounting.

Mulford, who authored the study along with Georgia Tech colleague Eugene Comiskey, explained that the current accounting rule generally does not allow companies to recognize negative goodwill as an immediate gain. Rather, FAS 141 instructs financial statement preparers to first allocate the gain to assets that are considered hard to value, and thus most likely to be overvalued.

Those assets include intangibles, property, plant and equipment, and other non-monetary and non-current assets. Under FAS 141, if there’s any negative goodwill remaining after the allocations are made, the residual is booked as an immediate extraordinary gain.

The study looked at 11 companies that recorded negative goodwill in their financials during 2005 and 2006. The report cited eight corporations that would have had to adjust their accounting if the proposed rule had been in affect at the time of the acquisitions.

The two largest swings shown in the study occurred at Claymont Steel and AIDA Pharmaceuticals. Under the new proposal, the value of Claymont Steel’s assets after H.I.G. Capital, a private equity firm, bought the company, would have increased by 58 percent, to $280 million. Net income would have climbed by 252 percent to $144 million and shareholder’s equity would have gone from a negative $30 million to a positive $73 million.

Similarly, after AIDA bought a 78 percent stake in Shanghai Qiaer Bio-Technology and consolidated the target company’s financials into its own, the assets of AIDA would have risen by 23 percent, to $66 million. Net income would have increased by 850 percent to $14 million, and equity up by 1119 percent to $23 million.

Less dramatic adjustments were recorded in the cases of retailer The Children’s Place and holding company The Vector Group. After the Children’s Place bought several hundred Disney Store businesses, the company’s assets would have risen by 6 percent, to $806 million, net income would have climbed by 71 percent to $112 million, and equity would have jumped by 7 percent to $422 million.

After it purchased New Valley Corp., assets of the The Vector Group would have risen 2 percent, to $618 million, with net income up by 30 percent to $64 million, and equity up by 44 percent to $48 million.

Mulford thinks that what he considers the questionable valuations of the assets under a fair-value model will be a headache for CFOs. If a finance chief learns later, for instance, that the asset isn’t worth the value recorded, the company runs the risk of a writedown and recorded loss. “It’s easy to look more profitable if you don’t record full fair value,” Mulford contended.

Officials at FASB declined to comment on the rule at this time.

Despite the study’s findings about how the proposal may distort year-over-year comparisons of financials, Mulford points out that the first fair-value jolts felt by companies will fade fairly quickly as fair-value accounting replaces historical pricing models.

Mulford says he doesn’t disagree with the fair-value concept, although the study’s findings support current criticism of fair value accounting, specifically its short-term affects on financial statements. “I understand the attraction of fair-value accounting,” he said. “However, there may be pain [in applying it.]”

If a subsidiary's value declines, it needs to be reflected on the parent company's balance sheet.

If one company owns another company in its entirety, or controls more than 50% of its voting stock, the owned or controlled company is known as a subsidiary. When acquiring a subsidiary, there are two main components of the acquisition price — the subsidiary’s net asset value, and the premium paid over this amount, which is known as goodwill.

For example, let’s say that a large company bought a small oil company for $30 million last year. If the net value of the company’s assets (equipment, real estate, etc.) are $10 million, the other $20 million of the sales price is the goodwill amount, and is recorded as such.

Goodwill is recorded on the balance sheet as a noncurrent asset, and is subject to an “impairment test” at least once per year. This means that the goodwill, or the premium paid for the subsidiary, is tested to determine whether or not the value of the goodwill asset has declined.

If the fair value of the goodwill is less than its carrying value (the value listed on the balance sheet), the difference is written off as an “impairment charge” on a company’s income statement in order to adjust the goodwill listed on the balance sheet to reflect its fair market value.

An example
Using our hypothetical oil company discussed earlier, let’s say that an analysis of the subsidiary’s value is conducted, and it is determined that the value of the goodwill has fallen from $20 million to $15 million as a result of lower profits caused by falling oil prices.

In this case, the $5 million difference is an impaired goodwill expense, and is recorded as such on the company’s income statement as a line item. Then, the impairment amount is subtracted from the previous goodwill asset listed on the balance sheet, which will now show $15 million to reflect the current market value of the subsidiary.

Why it’s important
The reason it’s important to accurately account for impairment charges is to prevent financial statements from becoming inflated. For example, during the tech bubble, companies were actively acquiring other firms for huge premiums, and balance sheets often reflected this goodwill as an asset, even after the subsidiaries’ values had clearly declined.

Finally, it’s important to take goodwill and impairment charges with a grain of salt. Estimating a subsidiary’s intangible assets isn’t an exact science, and several different analysts could come up with slightly different valuation estimates.