GAAP and IFRS

First Accounts

Early adopters wrestle with new purchase accounting standards. So far, it's not clear who's winning.
Craig SchneiderOctober 16, 2001

If there is one axiom to be drawn from the decline and fall of the dot-com economy, it is this: Last-mover advantage is vastly underrated. And if there is a corollary to this axiom for the finance function, it is: Early adopters often get the shaft.

Just ask Tony Ryan, CFO at Ansoft Corp. In April, Ryan was considering whether Ansoft should be an early implementer of the Financial Accounting Standard Board’s two new rules on purchase accounting. Released in June, the rules are designed to improve the quality of financial reporting for acquisitions. Specifically, Financial Accounting Statement No. 141 covers business combinations, while No. 142 deals with goodwill and other intangible assets.

Deciding to go ahead and embrace the new FASB rules early on wasn’t an overly tough decision, he says. For openers, the standards permit companies with fiscal years commencing after March 15, 2001, to adopt the new guidelines early (provided the first interim financial statements have not previously been issued). Ansoft’s fiscal year ends April 30, so it met the requirement. What’s more, Ansoft’s amortization of intangibles is approximately $4.5 million. That’s roughly 10 percent of the revenues at the Pittsburgh-based software maker. “We had every intention of being an early adopter,” says Ryan.

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But just before Ansoft was set to report its results for its fiscal 2001 first quarter — results that would reflect the new FASB standards — auditors from KPMG International advised Ryan to delay adoption for a full year. And KPMG wasn’t the only consultancy proffering such advice at that time to eligible early adopters like Ansoft. Accountants at a number of professional services firms concede that they are still trying to get a handle on FAS 141 and FAS 142 as regulators at the Securities and Exchange Commission remain mum. “In reality, there didn’t appear to be consensus among any of the accounting firms and the Securities and Exchange Commission about how to adopt the rules,” recalls Ryan.

With his auditors’ limited ability to interpret the new rules, Ryan eventually push backed Ansoft’s first quarter reporting by nearly a month. During that time, the Ansoft finance chief huddled with a third-party consultant to figure out how to implement the standards.

Tony Ryan is not the only CFO who’s confused by FAS 141 and FAS 142. The subjective nature of the new standards is a possible deterrent to early adoption, notes Brian Heckler, a partner at KPMG Transaction Structuring Services. Heckler says CFOs may want to wait to see how peer groups or finance managers at similar industries handle the new rules.

Not at Home on the Range

Managers at several companies appear to be ignoring that advice. In some cases, finance chiefs at businesses with sizable amounts of goodwill on the balance sheet want to stop amortizing the goodwill as soon as possible. “We considered delaying,” says Applied Films CFO Lawrence Firestone, who adopted the standards on July 1. He cites better GAAP earnings comparisons relating to a recent goodwill-heavy transaction. “I think it helps the investing public get an understanding of the true operating run rates of the business,” he says.

At Daisytek International, CFO Ralph Mitchell started applying the provisions of the new FASB standards on April 1. Although the SEC has issued statements noting that a company should seek independent counsel for valuations — if the company does not have the expertise in- house — Mitchell has not hired any valuation consultants. The Daisytek CFO, a former investment banker, seems comfortable relying on his expertise — along with that of his finance staff and auditors — to interpret the new FASB goodwill standards. “I don’t know that I need to pay a lot of money to some guy to tell me exactly what my goodwill is,” he explains.

Mitchell’s banking experience should prove useful, that’s for sure. To perform the goodwill impairment test under FAS 142, a company must first identify its reporting units, separating certain intangibles from goodwill. The company then allocates goodwill and intangibles to those reporting units for a two-step test.

The first of those steps is to assess the fair value of the reporting unit(s). In doing so, a company can determine whether the acquired goodwill associated with a reporting unit is impaired. If the fair value is less than the reporting unit’s carrying amount, the company moves to the second step of the test, which determines the size of the impairment. “I think there are times where it will be very obvious where there is no impairment whatsoever,” Mitchell asserts.

The Daisytek finance staff will be finished with the first step by next quarter. Mitchell, a big proponent of cash flow analysis for determining fair value, says he’s supplementing the methodology this year by using sales of comparable companies and marketplace multiples, as prescribed in FAS 142. “The problem with that is that there’s never really a good comparable to the thing you want to look at,” he notes. “You end up with different comparisons and justifications for moving up and down. You get to a range and you have to work out what works for you in that range.”

Cash and Carry

Finding an acceptable middle ground can be difficult. Mitchell cites a major goodwill component for which Daisytek did an appraisal last year to determine impairment. While the company is doing better now, he says he wants to make sure his assessment jibes with the wording of the new FASB standards. “The work won’t be in me having a common sense approach to whether I’ve got a problem,” he says. “The work will be me making sure I’ve looked at the exact words and say, ‘Now, did we really do that?’ ” Such backchecking can be a pain for finance staffers. “A lot of the times that’s really where reporting becomes a bit of a hassle,” argues Mitchell. “You end up 50 percent common sense and 50 percent wanting to justify you’ve met the letter of the rule.”

As Ansoft’s Ryan can attest, figuring out the letter of the FASB rules is not necessarily easy. Even in cases where the standards are very clear, disagreements can arise.

FASB, for instance, guides companies to value reporting units as if selling them. “In a blunt reading of the statement, there’s language in there about looking at what a unit be worth if you sold it,” says Mitchell. “Well, you don’t value most of the other assets on your balance sheet necessarily that way. I don’t look at the worth of my fixed assets as I if I sell them today — because I’m not going to sell them today.”

What’s more, FASB’s mark-to-market approach appears to ignore the possibility that a company might be worth more down the line. “Should I be looking at this today and say it’s making $1 million, and a good multiple is 10, so it’s worth $10 million?” asks Mitchell. “Or should I be looking at projections, and saying ‘You know what? I have a budget and a plan for it to be worth $1.5 million in profits?’ And if it’s worth $1.5 million in profits in a year’s time, and all the trends are back up, then maybe the better multiple is 12.”

Mitchell’s approach in such cases? Default to a cash flow analysis. “I might not be able to go out today and convince anyone to sell it for $18 million versus $10 million, but if my cash flow analysis says it’s worth $18 million, then I think I have a pretty good argument for that.”

Dusty Warehouse

Maybe so. But performing a cash flow analysis on a unit that was acquired years ago can be nettlesome. Mary Kabacinski, CFO at School Specialty Inc., points out that some of the company’s earlier acquisitions are hardly distinguishable at this point. “Everything is gone, totally integrated,” she says. “The trickiest thing is segregating intangibles and goodwill, and assigning valuations to intangibles and a life to intangibles.”

Currently, Kabacinski is considering bringing in an outsider valuation expert to help create a valuation template. “We acquired about 35 companies in the last 13 years,” she says. “It would get to be expensive and time consuming to get professional appraisals.” But once she has a standard methodology in place, Kabacinski believes valuing acquisitions will become a more straightforward process — and less costly.

Mitchell isn’t convinced appraisers can help in such situations, however. He points out that one company Daisytek acquired ten years ago is now fully integrated into the parent company. “There is no trace whatsoever of that business left anywhere,” he says. “Unless we go through and are lucky enough to find in some dusty warehouse exactly what customers and products the company had, I don’t know that we’re going to know for sure what the goodwill relates to in our business context today.” And, he adds, “I don’t know how any outside appraiser is going to come in and put a valuation on it, either.”

Even some of FASB’s more concrete guidelines appear to be causing confusion out in CFO Land. Kabacinski says Appendix A — which contains the intangible assets that FASB has identified as being separate from goodwill — can be particularly nettlesome. “We’re supposed to work from that, but there’s not much guidance how you do the valuation and determine the life,” she says. “If you have an intangible with indefinite life, I think you’re back to goodwill again.”

To avoid mistakes, Kabacinski says she’ll be watching her peers to get a better sense of how aggressive she can be with intangible valuations. “What I would look at is other public companies and maybe other small-cap public companies,” she says. While Kabacinski says that there aren’t direct comparables to her education supply business, she’ll also consider others in the distribution industry. “It will be a while before there will even be disclosures that will help us understand what other companies are doing.”

Nine to Three

Michael Hiemstra seems to have an idea what he’s doing. Hiemstra, CFO at manufacturer Parker Hannifin, adopted the FAS 141 and FAS 142 standards on June 30. By that point, Hiemstra says he and his manager of external reporting had already done most of the heavy lifting. Explains Hiemstra: “Fortunately, we had gone to the letter of the previous pronouncement,” including segregating intangibles such as patents and engineering drawings from goodwill. Hiemstra also valued plant and equipment.

Moreover, by the time Hiemstra adopted the new FASB rules, all but $11 million of Parker Hannifin’s $950 million in unamortized goodwill had been applied to the company’s three reporting units. “We leave nothing at the corporate level,” says Hiemstra.

Indeed, Hiemstra reduced the company’s nine operating segments to three reportable segments, grouped by similar characteristics: aerospace, industrial, and automotive/building products. Hiemstra has also already determined the life of all intangible assets other than goodwill: engineering drawings, for three to five years, and patents, for their remaining life.

In addition, Hiemstra has also been in the practice of doing two- and five-year measurements of goodwill for tests of recoverability to justify the company’s acquisitions — a solid preview of impairment. Ironically, he has the experience of a previous impairment to draw from. The purchase was for a business in the defense industry in the early ’90s. “When peace broke out all over, the market for this particular unit’s products — those aircrafts — did not go forward,” he says. “And the build rates of the aircraft platforms were reduced.” Parker Hannifan took the writeoff, which the company fully disclosed. According to Hiemstra, the writeoff had no adverse impact whatsoever. “I’m not expecting an impairment,” he says. “But the world changes.”