Note from Column Editor Tracey J. Niemotko: Jack Woods is currently a senior at Marist University, pursuing a bachelor’s degree in professional accountancy. He is the founder and president of the Accounting Club, which established the first student chapter of the NYCPA and a student chapter of the ACFE. He also serves as the student representative and assistant site coordinator for the Marist VITA program. Woods will be attending New York University’s Stern School of Business for graduate studies and will return to KPMG in their New York City office.
As an accounting major graduating in the spring, I have had the opportunity to study the ways in which environment, social capital, human capital, business models, and governance sustainability concerns can impact how businesses operate. For example, in the classroom, we consider how the demands of stakeholders have created a sustainability “market force” that can influence corporate goals as well as the organizational structure of entities. Today, most large, publicly traded companies list top managerial positions pertaining to sustainability within their organizational charts, such as VP of Sustainability. Furthermore, we study how the demands of stakeholders for corporate sustainability agendas can arguably influence corporate assessment and thus the entity’s stock price. In my studies, I chose to explore a less obvious aspect of sustainability’s impact on corporate assessment: its role in goodwill valuation. Specifically, I explored whether sustainability accomplishments should be recognized as intangible assets and included in goodwill calculations. If sustainability forces can influence business operations and assessment, then perhaps sustainability accomplishments should also be considered as an additional intangible asset when considering the calculation of goodwill.
Sustainability
The establishment of sustainability accounting standards reflects growing stakeholder demand for corporate accountability. In 2011, the Sustainability Accounting Standards Board (SASB) introduced guidelines to help companies disclose their environmental and social impacts. SASB defines sustainability accounting as “the management of a corporation’s environmental and social impacts arising from the production of goods and services, as well as its management of the environmental and social capitals necessary to create long-term value.” The increasing emphasis on sustainability has reshaped corporate decision-making. Investors and creditors increasingly prioritize businesses committed to sustainability initiatives due to concerns over transparency, risk management, and corporate ethics. Sustainability initiatives are now integral to corporate governance, influencing long-term profitability and competitive positioning.
Financial reporting has also evolved to incorporate sustainability metrics. Many companies now publish sustainability reports alongside their financial statements. These reports lack standardization and independent verification, however, reducing their reliability. Unlike financial statements, sustainability disclosures are not subject to the same rigorous auditing standards. A similar assurance framework, alongside mandated and standardized reporting, could enhance the credibility of sustainability disclosures.
Goodwill
Goodwill is recognized when a company acquires another entity for a price exceeding its fair market value, representing a premium paid for intangible assets that contribute to long-term profitability. While tangible assets such as property, plant, and equipment (PP&E) have measurable market values, intangible elements—such as brand strength, customer relationships, and workforce expertise—are difficult to quantify and are recorded under goodwill. During mergers and acquisitions, determining a company’s fair market value is a complex process. If the acquiring company perceives additional value beyond the identifiable net assets of the target, the excess amount is recorded as goodwill. The key components of goodwill typically include brand reputation: a well-established brand fosters customer loyalty and drives revenue growth. Workforce expertise also plays a crucial role, as a skilled and experienced workforce enhances operational efficiency and innovation. Customer relationships contribute to goodwill by providing recurring revenue streams and supporting long-term earnings potential. In addition, strategic positioning, such as market dominance or advantageous geographic location, can justify a valuation premium, further influencing goodwill valuation. For example, pharmaceuticals often have a lot of unpatented technology that is classified as intellectual property (IP), an intangible asset. The IP is classified as goodwill. From an accounting perspective, goodwill is classified as an indefinite-life intangible asset under Accounting Standards Codification Topic 350, “Intangibles – Goodwill and Other.” While it is no longer subject to amortization, goodwill must undergo annual impairment testing to determine whether its value has declined. If a company’s performance deteriorates, goodwill impairment losses are recognized, reducing net income and shareholder equity. It is important to note that unless the company contributes more money to the goodwill account through a take-over, the goodwill account will only decrease through impairments. An impairment is caused by a triggering event, which is an event or circumstance that indicates the carrying amount of an asset or asset group may not be recoverable, requiring an entity to assess the asset for impairment. The process of identifying triggering events is often complex. The challenge lies in determining whether sustainability initiatives are already reflected in goodwill under brand value or if they warrant separate recognition within the financial statements. Companies that integrate sustainability into their business models often experience enhanced brand perception and increased investor confidence, potentially leading to higher goodwill valuations. If sustainability contributes measurable economic benefits, however, it may justify classification as a standalone intangible asset.
Sustainability and Goodwill
Sustainability and goodwill share key similarities: both involve intangible value drivers that contribute to a company’s long-term success. But financial reporting standards have yet to establish a clear framework for recognizing sustainability initiatives as financial assets. Investors rely on financial statements to make informed decisions, yet traditional accounting captures only a fraction of the factors influencing corporate value.
Research suggests that financial information accounts for a small amount of the decision-relevant data for investors (see, e.g., Baruch Lev, et al., https://tinyurl.com/hjvnz4tk). This raises an important question: should sustainability be included in financial statements as a distinct component, separate from goodwill? Currently, goodwill acts as a catch-all category for intangible elements that are difficult to quantify. If sustainability is already embedded within goodwill, it risks being undervalued and overlooked in financial analysis. Alternatively, if a standardized framework for measuring and reporting sustainability performance were mandated, companies could disclose sustainability as a separate balance sheet item. The process of quantifying sustainability might be comparable to identifying triggering events for goodwill impairment, following a similar evaluation and recognition framework. One potential solution I would like to propose is Sustainability-Adjusted Goodwill (SAG), a new reporting category that incorporates sustainability metrics into business valuation. This approach would provide greater transparency into how sustainability initiatives contribute to corporate value, aligning financial reporting with investor expectations.
Improving Standardization
In light of the impact that sustainability market forces are having on corporate America, perhaps it is time for accounting principles to address the value of sustainability outcomes. One measure would be to recognize the intangible value that sustainability contributes when considering the calculation of goodwill. Goodwill, like sustainability, has ambiguous reporting guidelines, making accuracy and consistency a challenge. Therefore, it is essential to standardize these gray areas of accounting by establishing clear, uniform rules. Together, goodwill and sustainability accounting can drive the profession toward the higher level of accuracy it requires.
The Case of Patagonia
In 2022, Patagonia’s sale set a significant precedent for how a company can prioritize sustainability over financial gain. In Earth Is Our Only Shareholder, founder Yvon Chouinard reflects on his journey in building and ultimately transferring ownership of the company. Patagonia’s initiatives, from its buyback program to its commitment to sustainable product development, have been instrumental in shaping its reputation. By embedding sustainability into its core framework, the company has not only gained consumer trust, but also strengthened its credibility among shareholders. To preserve these values, rather than taking the company public, Chouinard ensured its mission remained intact by placing 100% of voting stock into a trust dedicated to maintaining Patagonia’s principles. Additionally, all non-voting shares were transferred to a nonprofit committed to combating climate change, reinforcing the company’s long-term commitment to environmental stewardship.
While Patagonia does not intend to go public, it is necessary when valuing the entity to consider the goodwill it could produce. The company has bought smaller apparel companies and accumulated goodwill through these acquisitions. If a publicly traded corporation were to buy Patagonia, however, should their sustainability practices be included in part of the purchase price? Could Patagonia reasonable take different financial positions that each represent a different method of accounting for its sustainability efforts and goodwill?
