Accounting & Tax

Will FASB Finish on Time?

Why the goodwill accounting proposal still needs a lot more work.
Craig SchneiderApril 16, 2001

Still months away from issuing its official standard, FASB made several adjustments to its proposal on accounting for goodwill and intangibles during its meeting last Wednesday.

The most notable changes to its 2001 Exposure Draft Business Combinations and Intangible Assets — Accounting for Goodwill surround the proposed goodwill impairment test and the criteria for recognizing acquired intangible assets separately from goodwill.

Drawing in part from about 200 comment letters it has received, the Board made changes that attempt to clarify the document and in some cases went so far as to redefine its guidance. How well senior financial executives respond to the changes remains to be seen.

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At least one accounting expert’s first impression is mixed, though.

Overall, however, FASB left its proposal’s fundamental structure intact. “The Board agreed to continue to pursue the non-amortization approach for goodwill,” says Kim Petrone, FASB project manager, in a interview.

However, FASB also tinkered somewhat with its proposals for impairment testing. And for good reason. “The fear is that companies will have hundreds of reporting units,” says Bob Willens, Lehman Brothers’ accounting and tax analyst. “[For example, under the initial definition,] a retailing unit may have to treat each store as a reporting unit. However, it would be almost impossible to measure the value of each store and get to the first impairment inquiry.”

So, at its meeting on Wednesday, the Board decided that the reporting unit would need to be at the operating segment level or one level below it for it to be subjected to the impairment test. Not good enough, says Willens. “I don’t know if that really helps much,” he says.

Why? A segment level as defined by FAS 131 is a component of an enterprise that engages in business activities where it generates revenues and incurs operating expenses. Under this definition, retail stores would still apply.

However, Petrone defends the definition, saying it is still a work in progress. “We are working on a [reporting unit] definition that will be available in the next few days,” she notes. The Board’s intent is not to make every retail store fit a description of a reporting unit, she says, adding that on Monday (today), FASB’s web site plans to post guidance so companies can figure out “which level you’re at.”

For other changes, Willens offered immediate praise. For example, based on the respondents’ suggestions, the Board chose what’s called “a lower- of-cost-or-market/purchase price allocation two-step approach” to testing goodwill for impairment.

The first half of this particular approach was not part of the revised Exposure Draft. It works as follows:

Companies will have a high level test in which they have to compare the fair value of the reporting unit with its book value, Petrone says. If the fair value is greater than the book value, nothing more needs to be done. But, if it is less, it is an indication that goodwill is impaired and therefore demands another step to measure the amount of the impairment loss.

To measure, companies need to take the value of the reporting unit and allocate it to all the assets and liabilities, recorded or unrecorded, of that reporting unit. The amount left over would be the applied value of goodwill, Petrone says. Then compare the applied value to what is on the books and write down goodwill for that amount.

“Presumably, this would alleviate the need to test for impairment as often as under the old (initially proposed) approach,” notes Willens.

The Board also clarified four types of customer-related intangible assets that meet the criteria for recognition separately from goodwill– customer lists, order backlogs, customer contracts, and the contractual customer relationships fit the criteria. Customer base would not be recognized separately from goodwill.

The group of four customer-based intangibles would be amortized over their useful economic life, unless the assets were determined to have an “indefinite life.” At the moment, “indefinite” has a limited definition wherein the asset’s life is determined to be “beyond the foreseeable horizon,” says Petrone. But she adds that in the final proposal, FASB will offer companies detailed examples and scenarios to help them make these determinations.

The more detailed the better, according to Willens. He was hoping that last Wednesday FASB would have simply deemed a customer list as an intangible asset with an indefinite life.

As reported in the article entitled “FASB’s Goodwill Proposal Confounds Experts,” there are precedents in the tax world that support Willens’ view on customer-based intangibles.

Petrone adds that remaining accounting issues, including the benchmark assessment and implementation, will be addressed during the FASB redeliberations during the first three weeks in May.