How can charges against company surplus be used to reduce a goodwill account?

Question

I am presently reading the second edition of Security Analysis by Benjamin Graham. In chapter 29, "The Dividend Factor in Common-Stock Analysis", to illustrate the relationship between dividend policy and overcapitalization Graham discusses the example of Woolworth's initial common stock offering.

In the original sale of F. W. Woolworth Company shares to the public, made in 1911, the company issued preferred stock to represent all the tangible assets and common stock to represent the good-will. The balance sheet accordingly carried a good-will item of $50,000,000 among the assets, offsetting a corresponding liability for 500,000 shares of common, par $100. As Woolworth prospered, a large surplus was built up out of earnings, and amounts were charged against this surplus to reduce the good-will account, until finally it was written down to $1.

I don't understand the last sentence of the excerpt above. Why would Woolworth's wish to write the goodwill down to $1, and how could this be accomplished by making charges against the surplus it accumulated in its first years of operation? Additionally, doesn't goodwill only appear on a company income account through the acquisition of another company?

Answer 1

To understand this, it is important to start with the beginning of the section, "Plowing back due to Watered stock".

Company had a large amounts of Goodwill, 50,000,000 which is obtained when a business is acquired. But since goodwill largely consists of patents, brand name value etc., the amount written as a goodwill can be easily exaggerated, as in the case of Woolworth.

Company used goodwill for its calculation of par(nominal)value. The catch to understand this was knowing how the surplus earnings(retained earnings) are calculated.

The loss on intangible asset account is reported on the company’s income statement as a line item. After finalizing the income statement at year end, the company sweeps the income and expense accounts into the retained earnings account. In this case, the company reported loss on goodwill to reduce the goodwill account(to pocket money) + the earnings = Retained earnings. The loss on an intangible asset adjusts retained earnings in the downward direction.

Basically, the company pockets the difference while making it look like a loss on Goodwill. Since dividends are paid on earnings, this must have had an affect on the dividends of the company, if there were any.