Question

One objective of financial accounting is providing relevant information about the operating success or failure of companies. In this case, the measurement of LinkedIn’s expenses was very different before and after it was acquired by Microsoft, due principally to differences in the amount of amortization of intangible assets.

LinkedIn chose to disclose an alternative measure of its operations, “Adjusted EBITDA.” This measure ignores depreciation, amortization, interest, income taxes, and stock compensation expense. i. Would this measure have been affected the same way as net income by the acquisition accounting done by Microsoft? ii. Do you feel that ignoring amortization provides better information for investors than including amortization? Explain your answer.

Answer 1

i. The measure of providing adjusted EBITDA that is earning before interest, taxes, depreciation and amortization does not include net income after subtracting interest, taxes, depreciation and amortization. In the acquisition accounting done by Microsoft the EBITDA would be perceived without the expenses or charges against profit like tax, interest, depreciation and amortization. This is not a correct measure of determining profitability or operating conditions of business as it does not take into account the interest expense and tax burdens. These expenses are to be borne by the company before transferring the surplus to reserves. For a company with huge debt this might not be a good idea to measure the profitability using EBITDA as it will not take into account the interest cost. The net income after taking into account interest, taxes, depreciation and amortization would be the appropriate measure to measure operating conditions of business and could be further used to determine the market price of shares which in turn would assist in calculating goodwill or capital reserve (loss or gain in acquisition). Thus, taking EBITDA would have effected in a different way than net income in the acquisition accounting done by Microsoft.

ii. Amortization is writing off an intangible asset during the life of asset. It is charged against profit of business. This does not involve any cash flow. Moreover when an investor wants to invest they would require details of every asset present in the company and the real profits of the company. Intangible assets like goodwill, patents, trademarks and the like must be reflected in balance sheet to give the investors an informed idea about their existence and the value at which they were acquired. That way an investor knows what lead the company to generate them in the first place. Amortization of intangible assets would reduce profits when in reality there is no expenses in the firm's record. Thus, ignoring amortization gives an informed idea about the company's operating conditions. Thus, in my opinion amortization must be ignored.