FASB 142 goodwill impairment accounting standards

¶ … accounting rule change there was bound to be ensuing fallout from FASB 142. That fallout has been tremendous for companies such as Tyco, AOL and World Com. Because these companies (and many more like them) acquired other business entities by paying inflated prices, and in many cases used inflated shares to pay those higher prices, the ensuing carnage has been remarkable. Previously these acquiring companies had the accounting wherewithal to write down those grossly inflated prices over a time period as long as 40 years. The companies were amortizing inflated costs on a quarterly basis.

"In AOL's case, this amortization of goodwill, as the expense is called, currently subtracts an astonishing $1.5 billion a quarter from the bottom line, leading the company that owns the publisher of MONEY to post a near-billion-dollar loss in the third quarter" (Galarza 2001-page 61). Since the time that Galarza wrote this in 2001 the public has seen numerous companies similar to AOL that have had to change their accounting practices in regard to FASB 142.

"Historically, accounting for business combinations has been one of the most controversial issues in financial reporting" (Goodwill 2006). This statement is especially true when seen through the eyes of companies that in the decades of the 1990's and early 2000's were purchasing entities at inflated values and paying for those purchases with stocks that also had an inflated value. When the bubble burst it was a double whammy for a lot of those companies.

"With the rapid pace of change in today's marketplace-driven by technological advances, new business models and other factors, the role of financial reporting in maintaining stability of capital markets will only increase. FASB 141 and 142 are intended to address critical issues of currency and accuracy in financial reporting" (Goodwill 2006).

Some of the key components in FASB 142 will help to address those critical issues. One of those key components addressed by FASB 142 is that "A company should measure an intangible asset at its fair value at the time of acquisition" (Mueller 2004).

Many of the companies that are now experiencing problems with the implementation of this rule are companies that valued their respective acquisitions at a value that was inflated.

"Companies that got caught up in the takeover frenzy at the end of the bull market could be about to get a hard lesson in 'fessing up" (Krantz 2003). Confessing to paying to high of a price for an acquisition did not used to be as painful as what it is currently. Before the implementation of FASB 142 companies could pay an exorbitant price for a company and label the premium paid as goodwill. The company could then amortize that goodwill over a period of time, sometimes as long as 40 years. As of the implementation date (Dec 31, 2001) for FASB 142 that is no longer the case.

"The major change of FASB 142 is that amortization of goodwill will no longer be permitted, although it will still be recognized as an asset. Instead, goodwill and other intangibles will be subject to an annual test for impairment of value

In the past, goodwill has been amortized over its useful life, up to a period not to exceed 40 years" (Goodwill 2006).

That the rule was changed is probably evidence enough that there was a problem to begin with. "Case in point: JDS Uniphase's mind-boggling $50 billion "loss" (on $3.2 billion in sales) for its latest fiscal year. Thanks to a crash in the value of telecom assets, 90% of that net loss (or $45 billion) was due to a charge for the reduction of the value of goodwill carried on its books" (Galarza 2001).

When investors see companies such as JDS Uniphase declare a $51 billion dollar loss, its perception of such losses can lead to a state of no-confidence in the financial markets overall. Many savvy investors knew enough to not use goodwill as any part of the analysis when considering whether to invest in certain companies (or not), but there are plenty of investors that are not savvy. These individuals may see the resulting changes in net income for companies such as AOL as signals to buy, instead of what the signs really are, which are signals to sell.

Many analysts believe the same way and have been attempting for years to get the FASB to set higher standards, while demeaning companies attempts at obscuring the true costs of their acquisitions.

"It's just cosmetics," sneers Prudential Securities analyst Ed Keon. But in a battered market searching for any sliver of hope, investors may unwittingly forget and rush in to buy. Keon's advice: Sell. If companies soar in value for the sole reason of this accounting change, I would take advantage of it and sell those stocks" (Galarza 2003).

Observing the events that have occurred since the implementation of this rule, the rule has had the effect that was initially stated.

"Previous standards provided little guidance about how to determine and measure goodwill impairment, as a result, the accounting for goodwill impairments was not consistent and not comparable and yielded information of questionable usefulness" (FASB 2001).

Companies are now required to test goodwill yearly for impairment along with other specific guidance (provided by FASB) on the testing process for impairment. The process for the testing is a two-step process beginning with the estimation of the fair value of a reporting unit. The first step that a company should take is to screen for the potential impairment, and the second step measures that impairment, if any is there.