Accounting & Tax

CFOs Sweat FASB’s Goodwill Accounting Changes, Says Study

And how a number of industries will likely be affected by the new rules.
Craig SchneiderMarch 19, 2001

The changes to goodwill accounting and elimination of pooling have largely been met with positive reviews from the financial community. But according to a recent Merrill Lynch study, a number of CFOs may be in for a rude awakening as they start putting the new rules into practice.

Many senior financial execs have already been dealt a reality check as the target July 1 implementation date set by the Financial Accounting Standards Board (FASB) fast approaches. “The speed at which this new proposal is likely to be implemented has caught many CFOs by surprise,” notes Jeanne Terrile, director of strategic research at Merrill Lynch, in the report entitled “No Accounting For… Goodwill”.

Specifically, as the rule takes effect, the focus will shift from impacts on the income statement, such as boosts to EPS, toward impacts on the balance sheet. Herein lies the difficulty for CFOs, who will be required to test goodwill assets for impairment.

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“[The new accounting changes] are likely to absorb a lot of man-hours inside corporate offices (for a while, this may be for CFOs what the impending millennium was for CIOs in 1999),” she adds.

Moreover, recently reported in an earlier story, that the experts are still ambiguous about some of the procedures proposed by the FASB. The Board still has to consider fine tuning the revised Exposure Draft in response to letters that it has received.

Merrill Lynch’s study of 44 industries finds that the FASB changes will result in accelerated merger and acquisition activity for companies with strong cash flows as well as a decline in P/E ratios for certain industries.

Other key conclusions:

  • Auto makers will experience an average 37 percent earnings decline in 2001 — dwarfing any EPS pickup–from the accounting change.
  • Pharmaceuticals will be disadvantaged because the new rules would require them to amortize acquired patents since the assets have a clearly defined life.
  • Waste, death care, engineering and construction may face significant impairment issues because a number of companies in those industries now carry a goodwill asset that exceeds their market capitalization (a potential trigger event for an impairment review).
  • Life insurance companies in the U.S. may become more active acquirers compared with European firms, which have driven M&A activity in the industry.
  • For airlines, foreign ownership limits will likely keep acquisition activity light.
  • Some utilities could experience a negative impact on cash flow because goodwill is a recoverable regulatory asset in the rate base.
  • Oil refiners and marketers have little goodwill and get little boost to EPS because they’ve bought most of their refinery assets below book value.

Alas, few CFOs are publicly acknowledging that the new accounting rules will make their companies more aggressive acquirers. “Our surveys of CFOs almost without exception indicate that, for the record, no company is abandoning long held acquisition criteria such as discounted cash flows, internal rates of return, etc,” Terrile notes. “Most say that their approach to acquisitions will not change.”

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