GAAP and IFRS

Cramming for the Final

Get up to speed on the latest accounting rule changes for treating goodwill and intangibles.
Craig SchneiderJune 29, 2001

Are you ready?

On June 29, the Financial Accounting Standards Board voted in favor of new standards that require goodwill be tested for impairment on an annual basis instead of amortized. And plenty of senior financial executives have been taking a wait and see approach to the new rules.

However, experts advise companies to plan ahead for implementation. CFOs need not wait until late July when FASB expects to issue Statement 141, Business Combinations, and Statement 142, Goodwill and Other Intangible Assets.

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In the long run, the forethought given to the new rules early on may pay off big-time. While the non-amortization of goodwill goes into effect at year-end, the so-called “impairment test” will likely require significant time and resources to implement.

Companies have six months from their adoption to complete the first step of the two-part test, which CFOs fear may be costly. “I don’t like make-work projects, and I am concerned that when the new standards are published that they create a lot of work and expense,” Anthony Muller, CFO at JDS Uniphase, tells CFO.com. He’s particularly concerned that the work and expense “may provide only limited value, at best to investors.”

Once the new rules become effective for a company, it must:

  • Identify what its reporting units will be to test goodwill for impairment.
  • Allocate purchase prices of past acquisitions with existing goodwill to those units.
  • Determine identifiable intangible assets separate from goodwill.

Why? Under the new rules, most identifiable intangible assets will likely need to be amortized. In the past, companies simply aggregated goodwill and other intangibles into one line item and amortized it all together.

Still, some CFOs are going to wait it out. Says Muller, “We have too much work to start changing our reporting until the new rules become effective.”

However, once things get going, there is little rest. Consider the new two-step impairment test:

  • Companies calculate the fair value of each reporting unit– for most CFOs, a first-time analysis—and compare that to each reporting unit’s book value.
  • If the book value is determined to be below the fair value assessment, there is no impairment loss. But if the fair value is below book, this means that goodwill has been impaired, and a company needs to perform the second step.
  • The second step similarly takes the difference between the fair value of goodwill and its book value to determine how much a company will have to write-off.

Companies will also have to develop methodologies and likely use costly outside valuation experts for the reporting unit and identifiable intangible asset appraisals lest face a potential inquiry or worse — a restatement — by the Securities & Exchange Commission.

JDS Uniphase previewed the future of this regulatory issue in April when the hyper-acquisitive, fiber-optic giant announced that it would record a $40 billion loss in the value of goodwill out of a total $56.2 billion on its balance sheet. Its policy was to assess enterprise level goodwill if the market capitalization of the entire company was less than the value of its net assets, including goodwill not yet amortized.

Most companies to date have avoided making similar disclosures to the SEC, choosing simply to rely instead on the regular amortization of goodwill to tell the story of goodwill impairment. But with no amortization of goodwill to speak of under the new rules, that strategy is out the window.

Therefore, it comes as little surprise that experts expect to see more companies recording goodwill impairment losses in the future, particularly with the market downturn highlighting fair values that are a fraction of what was offered to a business at the close of a deal. Most recently, Nortel Networks announced a $19 billion charge to earnings related to goodwill.

If you’ve missed CFO.com’s play-by-play of FASB’s progress during its last months of redeliberations, consider the following additional summary of key points:

  • The provisions in the statement on business combinations (FAS 141), including the recognition of identifiable intangible assets separately from goodwill, would be effective for any business combination accounted for by the purchase method that is completed after June 30, 2001.
  • A reporting unit is the same level as or one level below an operating segment (as that term is used in FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information). “How to Survive the SEC’s Second Guessing”
  • Goodwill should be tested for impairment annually and on an interim basis if an event or circumstance occurs between the annual test that might reduce the fair value of a reporting unit below its carrying value or book value. They include a legal factor, a regulatory action, an introduction of competition, or loss of key personnel.“Four Ways to Say Goodbye to Goodwill Amortization”
  • The value of an assembled workforce of at-will employees acquired in a business combination should be included in the amount recorded as goodwill regardless of whether it meets the criteria for recognition apart from goodwill. “Intangibles Revealed”

Kim Petrone, FASB project manager for business combinations, says both the information available on FASB’s Web site and the final standard should be read together. “Technically, they need them in hand” to implement the new rules,” she says. But people can use tentative decisions provided thus far “as initial guidelines for what the standards may look like.”

Granted, further implementation details, including more guidance, illustrations and basis for conclusion, will not be available until the hard copy is published, so, Petrone adds, “Companies that choose to early adopt are going to have to do some fast reading.”