Accounting & Tax

Cisco Braces for New Rule on Treatment of Goodwill

New rules could shine spotlight on companies' acquisition decisions.
CFO.com StaffMay 22, 2001

Last quarter Cisco Systems Inc. took $3.37 billion in accounting charges. One of the charges may speak of things to come, according to Peter Loftus of Dow Jonews Newswires in the Wall Street Journal.

The San Jose network-equipment giant took an asset-impairment charge of $289 million, most of which stemmed from its 1999 all-stock acquisition of Monterey Networks Inc., a Richardson, Texas, startup.

Cisco wrote down the value of its Monterey assets because it recently discontinued the product line it inherited with the $500 million purchase.

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Although the write-down was noncash and thus had no effect on operating results, it showed that Cisco basically threw a half billion dollars out the window for a product that never got off the ground.

The Financial Accounting Standards Board’s new accounting rule for goodwill amortization could force Cisco and other tech companies to take similar charges in the future, putting a spotlight on their acquisition strategies. According to Dow Jones, accounting experts says such charges could create the perception that acquiring companies are making imprudent buying decisions. For instance, it could appear that Cisco paid too much to acquire too many companies back when its shares were soaring, before the current tech market downturn began last year.

Under FASB’s new rule, effective later this year, companies will no longer have to amortize on a quarterly basis the goodwill from acquisitions.

Instead of amortizing goodwill, companies will now be required to periodically test the value of their acquired assets. If the value drops and meets a complex set of criteria, the company must write down part or all of the goodwill from the acquisition.

Such write-downs would be similar — though not identical — to the one taken by Cisco to reflect the discontinuation of the Monterey optical product line.

Cisco’s strategy has been to maintain leadership by both developing its own technology and also purchasing new technology through acquisitions.

Many of Cisco’s acquisitions were accounted for as purchases, and as a result, Cisco had $4.96 billion in goodwill and purchased intangible assets on its balance sheet as of April 28, the end of its fiscal third quarter.

Mark Cheffers, chief executive of AccountingMalpractice.com, an accounting education Web site, told Dow Jones he suspects Cisco will take several goodwill and other asset write-downs in the company’s fiscal fourth quarter, which ends in late July.

Given that Cisco expects to report a relatively weak fourth quarter, the company might decide to throw in the write-downs even before the FASB rule goes into effect, cleaning the books in hopeful preparation for an improved fiscal 2002, Cheffers said.

Because Cisco’s fiscal year ends in July, it doesn’t have to implement the new FASB rule until late July 2002. But under FASB guidelines, Cisco is permitted to implement the rule at the start of fiscal 2002, in late July 2001, says the Dow Jones report.