M&A

J&J CFO Fears Investor Ignorance on FASB

Why Robert Darretta is concerned about investor reactions to the new FASB rules.
Ed ZwirnMarch 22, 2001

Johnson & Johnson CFO Robert Darretta hopes that analysts and investors will show some “sophistication” in evaluating earnings in the wake of FASB’s plan to eliminate pooling and amortization of goodwill.

As a result of the planned elimination of the requirement to amortize goodwill, firms that have done acquisitions and still have a great deal of goodwill yet to be amortized stand to post huge increases in reported earnings once the new rules go into effect, probably at the beginning of July.

On the other hand, some tech firms, including those in the pharmaceutical sector, stand to lose, at least on paper, particularly because the new regulations would require the write-up and amortization of “intangible” assets such as the patents protecting products.

The situation at J&J is more complicated than that.

As a firm involved in the worldwide manufacture and sale of a broad range of health care products ranging from baby shampoo to high-tech pharmaceuticals, the firm has acquired assets and accounted for them through both the pooling and purchase methods, according to Darretta.

“The impact [to J&J] will be initially positive because of the goodwill aspect,” he said. “But over time it will be adverse compared to an environment where you could have had pooling.”

“A technology company is going to be faced with significant new changes,” he said.

“Some people would argue that pooling shows transactions in too positive a light while the purchase method shows them in too negative a light,” he said. “These new regulations are more favorable for where we use purchase accounting but unfavorable compared to pooling.”

“On the whole, FASB has reached a very good compromise,” he said.

Some Understanding, Please

But good compromise or not, Darretta also echoes the concerns of many who fear that the hordes of investors that closely watch all updates of earnings per share may overlook the footnotes intended to explain the changes, for better or worse, that will hit EPS of firms as a result of the changes in accounting method.

“What people are worried about is that people look at earnings as a proxy for cash flows,” he said, while predicting that analysts will be “sophisticated enough” to discern the difference.

In any event, “since it’s a level playing field everybody will have to move in the same direction.”

International Harmonization

Darretta also commented on the FASB changes as a component of the attempts to unify GAAP with International Accounting Standards.

Officials involved with the IAS effort to globalize accounting standards have argued that U.S. regulatory and professional standards bodies need to change GAAP to eliminate both pooling and goodwill amortization.

With the International Accounting Standards Board set to begin work full-time in April, the new FASB proposals are widely seen as an attempt to show U.S. cooperation with the effort.

But some domestic critics have charged that globalization of accounting standards will make it easier for foreign companies to enter U.S. markets, but offer little in return for domestic firms.

“It is correct that [the new rules] will come closer to harmonization,” said the J&J CFO. “[But] I’m not sure that it would be seen as an advantage for U.S. CFOs.”

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