Why Such a Fuss Over Goodwill?
"The Financial Accounting Standards Board's
proposed elimination of the pooling-of-interests method, which would
leave the purchase method the only accounting choice in business
combinations, has been met by vehement opposition from investment
advisors and CEOs, as has the proposal to shorten the maximum
amortization period for purchased goodwill from 40 years to 20.
Opponents argue that changing accounting methods for business
combinations will have dire consequences for the economy. Following
intemse lobbying, the board decided in May to reconsider the
proposed rules. Why has there been suh heated debate over the
choiceof two accounting methods and a non-cash amortization expense?"
[Source: "Viewpoint: Why Such a Fuss Over
Goodwill?" By Ole-Kristian Hope. CPA Letter September
2000. AICPA
Online.]
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FASB Changes the Rules
"Culminating months of redeliberations on
substantive issues raised by constituents in connection with the
proposal on Business Combinations and Intangible Assets, on July 20
the Financial Accounting Standards Board issued two final
statements. Statement No. 141, Business Combinations, and Statement
No. 142, Goodwill and Other Intangible Assets, replace APB Opinion
Nos. 16 and 17, respectively.
"The statements will change the accounting for
business combinations and goodwill in two significant ways.
Statement 141 improves the transparency of the accounting and
reporting for business combinations by requiring that all business
combinations initiated after June 30, 2001 be accounted for under
one single method - the purchase method. Use of the
pooling-of-interests method is no longer permitted.
"Statement 142 changes the accounting for
goodwill from an amortization method to an impairment-only
approach. It requires that goodwill no longer be amortized, but
instead be reviewed for impairment. The amortization of goodwill
ceases upon adoption of the statement, which for most companies
will be Jan. 1, 2002."
[Source: "FASB Issues Business Combinations
Statements." By Ellen M. Heffes. Financial Executive
17 (6): 70. September 2001. In ABI/INFORM.]
Goodwill
Valuations
Goodwill Valuations is a Website sponsored by
Ernst & Young and Edgar
Online that provides current information about accounting for
goodwill. You can download FAS 141 & 142 after your free
registration. Additional material summarizes the new rules,
explains the required documentation and lists companies that
report goodwill on their balance sheets.
Goodwill Games
"When AOL bought Time Warner last January,
it paid $147 billion to form the world's largest media concern.
But the accounting value of Time Warner's assets was only about
$51 billion. What was the other $96 billion for? It was the
premium AOL paid for scores of brands, trademarks and other
so-called intangible assets. The value of this stuff - called
goodwill - now sits on the asset side of the balance sheet of the
combined AOL Time Warner. In the magical world of accounting, all
assets, from factories to machinery, fall in value. The process
can take anywhere from four years (at tech companies) to 40 years
(old-line factories), depending on the asset's expected
usefulness, and is accounted for in a quarterly expense to the
income statement. In AOL's case, this amortization of goodwill, as
the expense is called, currently subtracts an astonishing $1.5
billion a quarter from the bottom line, leading the company that
owns the publisher of MONEY to post a near-billion-dollar net loss
in the third quarter.
"But the goodwill game is coming to an end.
A recent ruling by the Financial Accounting Standards Board no
longer requires AOL and other companies to deduct the value of
goodwill from their earnings. The new rule, called FASB 142,
sounds like something only a wonk could care about, but it's not:
FASB 142 will make earnings announcements even trickier to
decipher and muddy year-over-year profit comparisons across almost
every industry, especially among tech, telecom and media companies
that used their inflated stock to overpay for other firms during
the bull market frenzy
"Once FASB 142 starts on Dec. 15, companies
weighed down by goodwill amortization will see boons to their
bottom line. At software firms, earnings per share, or EPS, could
pop an average of 114%, says Credit Suisse First Boston. The
average telecom and media company could see EPS double. A recent
AOL filing says $59 billion will be added to operating income in
2002, doubling the amount analysts had forecast for the year.
"Two thoughts. First, savvy investors have
long ignored the cost of goodwill amortization in valuing a company
(many prefer cash flow). 'It's just cosmetics,' sneers Prudential
Securities analyst Ed Keon. But in a battered market searching for
any sliver of hope, investors may unwittingly forget and rush in
to buy. Keon's advice: Sell. 'If companies soar in value for the
sole reason of this accounting change, I would take advantage of
it and sell those stocks.'
"Second, FASB 142 also forces all companies
to reconsider the value of their not-so-goodwill, so get ready for
lots of headlines announcing record-setting losses over the next
year. Case in point: JDS Uniphase's mind-boggling $50 billion
"loss" (on $3.2 billion in sales) for its latest fiscal
year. Thanks to a crash in the value of telecom assets, 90% of
that net loss (or $45 billion) was due to a charge for the
reduction of the value of goodwill carried on its books."
[Source: "The Goodwill Games." By
Pablo Galarza. Money 30 (13): 61. In ABI/INFORM.]
Say Good-Bye to Pooling and
Goodwill Amortization
"As of June 30, 2001, FASB changed the
rules for the mergers and acquisitions game. Companies no longer
may use the pooling-of-interests accounting method for business
combinations. Nor will they account for mergers on their financial
statements under the traditional purchase method, which required
them to amortize goodwill assets over a specific time period.
Instead purchased goodwill will remain on the balance sheet as an
asset subject to impairment reviews. FASB's new standards,
Statement no. 141, Accounting for Business Combinations, and
Statement no. 142, Accounting for Goodwill and Intangible Assets,
are a radical change, and now management accountants, auditors and
financial executives must understand and work with a very
different accounting process.
"Some believe FASB eliminated amortization
to make purchase accounting techniques more appealing to corporate
America. Traditional purchase accounting required companies to
amortize 'purchased' goodwill on a periodic basis, for as long as
40 years. Now companies will be able to make acquisitions without
being forced to take large periodic earnings write-downs, which
some corporate executives view as an unnecessary drag on earnings.
"'The elimination of pooling is one of the
most significant and drastic modifications in accounting
methodology in many years," says CPA Norman N. Strauss,
national director of accounting standards at Ernst & Young,
LLP, and a member of FASB's emerging issues task force.
"Business combinations are important, and so is how they are
treated in financial statements. Analysts will have to understand
the impact of the two new FASB standards, and companies and their
auditors will have to learn how to implement them'"
[Source: "Say Good-Bye to Pooling and
Goodwill Amortization." By Stephen R. Moehrle and Jennifer A.
Reynolds-Moehrle. Journal of Accountancy 192 (3): p. 31
September 2001. In
Business Source Premier
(EBSCO).]
Summary of Statement No. 142:
Goodwill and Other Intangible Assets
(Issued 6/01)
"This Statement addresses financial
accounting and reporting for acquired goodwill and other
intangible assets and supersedes APB Opinion No. 17, Intangible
Assets. It addresses how intangible assets that are acquired
individually or with a group of other assets (but not those
acquired in a business combination) should be accounted for in
financial statements upon their acquisition. This Statement also
addresses how goodwill and other intangible assets should be
accounted for after they have been initially recognized in the
financial statements.
"Reasons for Issuing This Statement
"Analysts and other users of financial
statements, as well as company managements, noted that intangible
assets are an increasingly important economic resource for many
entities and are an increasing proportion of the assets acquired
in many transactions. As a result, better information about
intangible assets was needed. Financial statement users also
indicated that they did not regard goodwill amortization expense
as being useful information in analyzing investments."
[Source: Financial
Accounting Standards Board (FASB)]
No Accounting For...Goodwill
"FASB has proposed a new accounting standard
that would eliminate the use of the pooling of interests treatment
in acquisitions and also end the amortization of all goodwill.
Goodwill will remain on the balance sheet and be tested for
impairment if certain trigger events occur. Comapanies that have
made purchase acquisitions in the past will get a one time expected
step-up in EPS as soon as the proposal is adopted, likely at the end
of June this year (2001). These changes could result in increased
M&A activity since acquirers no longer have to consider the
possible dilution from goodwill charges. This proposal appears to
satisfy most of the constituents that opposed FASB's earlier
proposals on business combinations, in particular those in the
technology and finance industries. Those who object to the proposal
worry about giving managements more discretion in accounting
matters, in particular the discretion to potentially move assets
into the intangible and goodwill categories which not all may agree
belong there. The full practical impact of this proposal will become
clearer only after implementation, as is the case with many
accounting changes which start out simple and end up complex."
[Source: "No Accounting for...Goodwill:
Overview." By Jeanne Terrile, Director of Strategic Research.
Merrill Lynch & Co. March 1, 2001. In Investext Plus on
InfoTrac.]
Goodwill Gesture
"Just in time for the great tech shakeout comes
easier accounting rules for mergers. The Financial Accounting
Standards Board has decided to create a hybrid method for booking
mergers that lets an acquiring company carry
"goodwill"--the portion of the target company's value that
doesn't represent tangible assets--on its books indefinitely. The
merged company must periodically assess the items that go into
goodwill, such as brands, customer relationships, and other
intangibles, and take a write-off if their value falls. FASB is
backing down from its earlier plan to require a 20-year write-off of
all goodwill."
[Source: "FASB Make a Goodwill Gesture."
By Monica Roman. Business Week December 18, 2000 p. 68. In ABI/INFORM]
The Politics of Accounting Rule
Making
"Accounting rule making is a
thankless task. Whenever the Financial Accounting Standards Board
tries to change a rule that is being abused, companies complain to
politicians. The politicians too often seem to think that the rules
should make companies look good and that any rule that might hurt a
company's stock price is an attack on American capitalism that will
destroy the competitiveness of American business.
"So
it seems churlish to criticize the board just as it is finally
nearing the end of a long process - started more than four years ago
- to reform accounting for mergers. If all goes as planned, no
merger announcement after June 30 will be able to use pooling of
interests accounting. That means that companies will no longer be
able to keep the costs of acquisitions from showing up on their
balance sheets.
"The changes will be
made despite pleas from Capitol Hill, and the board deserves praise
for that. But the changes also include adjustments to the way the
other merger accounting technique - purchase accounting - is
applied. And there the board has come up with a method that will be
more costly for companies to apply and less useful for investors
than would an obvious alternative.
"The
changes relate to "good will," (sic) the intangible asset
that ends up going on books when a company is bought for more than
the apparent value of its individual assets. Under the current
rules, companies write off the good will over 40 years or less, thus
reducing reported earnings. Many investors think that is nonsense,
and companies routinely ignore the cost when reporting what they
call pro-forma earnings.
"Under the new
rule, amortization of good will will end. Companies love that,
because it will increase reported earnings. But companies sometimes
make acquisitions that do not work out, and the rules must deal with
reporting bad news.
"The new rule calls
for assigning the good will to a business unit when an acquisition
is made and then monitoring the value of that unit annually. If the
unit is worth less than its book value - including good will and all
other assets on the books - then it is time for a write-down."
[Source:
"A New Accounting Rule May Force Unnecessary Big Baths."
By
Floyd Norris. The New York Times, Section C, Page 1, Column
2. In Lexis-Nexis.)
AOL Writes Off
$54 Billion
"Accounting
for Business Combinations
"In July 2001, the FASB issued Statements
No. 141, "Business Combinations"
("FAS 141") and No. 142, "Goodwill and Other Intangible Assets" ("FAS
142"). These standards change the accounting for business
combinations by,
among other things, prohibiting the prospective use of
pooling-of-interests
accounting and requiring companies to stop amortizing goodwill and
certain
intangible assets with an indefinite useful life
created by business
combinations accounted for using the purchase method of accounting.
Instead, goodwill and intangible assets deemed to have an indefinite
useful
life will be subject to an annual review for impairment. The new
standards
generally will be effective for AOL Time Warner in the first quarter
of
2002 and for purchase business combinations consummated after June
30,
2001.
"AOL Time Warner is in the process of
finalizing the impact of adopting the
provisions of FAS 142, which is expected to be significant. Upon
adoption,
AOL Time Warner will stop amortizing goodwill, including goodwill
included
in the carrying value of certain investments accounted for under the
equity
method of accounting. In addition, AOL Time Warner will stop
amortizing
approximately $38 billion of intangible assets deemed to have an
indefinite
useful life, primarily intangible assets related to cable franchises
and
certain brands and trademarks. Based on the current levels of
goodwill and
intangible assets deemed to have an indefinite useful life, the
adoption of
FAS 142 will reduce annual amortization expense by approximately
$6.7
billion. Similarly, with respect to equity investees, other expense,
net,
will be reduced by approximately $500 million. Because goodwill
amortization is nondeductible for tax purposes, the impact of
stopping the
amortization of goodwill, certain intangible assets and the goodwill
included in the carrying value of equity investees, after
considering the
portion applicable to minority shareholders, would be to increase
AOL Time
Warner's annual net income by approximately $6.3 billion.
"As noted above, goodwill and intangible
assets deemed to have an indefinite
useful life will be subject to an annual review for impairment. In
addition, when FAS 142 is initially applied, all goodwill recognized
on the
Company's consolidated balance sheet on that date will need to be
reviewed
for impairment using the new guidance. Before performing the review
for
impairment, the new guidance requires that all goodwill deemed to
relate to
the entity as a whole be assigned to all of the Company's reporting
units
(generally, the AOL Time Warner operating segments), including the
reporting units of the acquirer, in a reasonable and supportable
manner.
This differs from the previous accounting rules, which required
goodwill to
be assigned only to the businesses of the company acquired. As a
result, a
portion of the goodwill generated in the Merger will be reallocated
to the
AOL segment resulting in a change in segment assets.
"As a result of this initial review for
impairment, AOL Time Warner expects
to record a one-time, noncash charge of approximately $54 billion
upon
adoption of the new accounting standard in the first quarter of
2002. Such
charge is non-operational in nature and will be reflected as a
cumulative
effect of an accounting change."
[Source: "Notes to Consolidated
Financial Statements: No.1 Organization and Summary of Significant
Accounting Policies."
AOL Time Warner,
Inc. 10-K405, Annual Report. Filed with the
SEC on 3/25/2002. In
Hoover's Online.]
NYSSCPA Presentation: New Accounting for Business Combinations,
Intangibles and Goodwill Impairment
"During the 1980's and
1990's a great number of business mergers and acquisitions took
place. The generally accepted accounting principles to record the
initial transaction and to account for the acquired assets during
their estimated useful lives this were well established.
"Over time however, users of financial
statements began to question whether those principles and practices
accurately reflected the market realities regarding the assets,
their useful lives and their contribution to a company's value. In
addition, intangible assets have become increasingly more important
as an economic resource.
"It was apparent that users of financial
statements did not accept that goodwill amortization expense
provided useful information. They realized that treating goodwill
as a wasting asset whose value deteriorates predictably over a fixed
period of time ignored the economic realities. Goodwill, in fact,
can be replenished and increased in value; alternatively, the value
of goodwill can decrease precipitously in a short period of time.
"During the 1970’s the FASB had an active
project on its agenda to reexamine the accounting for business
combinations and acquired intangible assets. However, action on the
project was deferred until, in 1981, the Board removed the project
from its agenda entirely, to focus on higher priority projects.
"In 1986 the Financial Accounting
Standards Board (FASB) included the project on business combinations
on its agenda. The purpose was to “improve the transparency of
accounting and reporting of business combinations, including the
accounting for goodwill and other intangible assets.” The FASB’s
study confirmed that users of financial statements placed greater
emphasis on the goodwill asset reported on the balance sheet, rather
than an allocation of goodwill amortization expense reported on the
income statement. This project resulted in FASB 141 – Business
Combinations, and FASB 142 - Goodwill and Other Intangible
Assets.
"This emphasis on asset valuation rather
than expense recognition reflected the FASB’s evolving emphasis on
fair value measurement of assets and liabilities. The FASB achieved
their two stated goals, that:
-
All business combinations be accounted for in the same manner
-
Goodwill and intangible assets are accounted for in a manner that
reflects economic reality.
"Another reason the Board undertook the
project is because “many perceived the differences in the
pooling-of-interests method and purchase method to have affected
competition in markets for mergers and acquisitions. Entities that
could not meet all of the conditions for applying the pooling method
believed that they faced an unlevel playing field in competing for
targets with entities that could apply that method.”
"This “unlevel playing field” was
perceived to extend internationally, as well. “Cross-border
differences in accounting standards for business combinations and
the rapidly accelerating movement of capital flows globally
heightened the need for accounting standards to be comparable
internationally.” Thus the Canadian equivalent of FASB conducted a
similar project concurrently with FASB.
"The FASB’s project culminated in two new
pronouncements, SFAS 141, Business Combinations, and SFAS
142, Goodwill and Other Intangible Assets."
[Source:
New Accounting for Business Combinations, Intangibles and Goodwill
Impairment. A Presentation for the Suffolk and Nassau Chapters
of the New York State Society of CPAs. Accounting and Auditing
All-Day Update. November 9, 2002. By Russell T. Glazer, CPA.]
Revised:
December 30, 2002
