The CPA Journal

February 2002

What You Need to Know About New FASB Pronouncements that Target Business Combinations and Goodwill

By Eugene DeMark

Two recent FASB pronouncements will profoundly affect how companies account for business combinations, goodwill, and other acquired intangible assets. SFAS 141, Business Combinations, requires that entities account for all combinations initiated after June 30, 2001, using only the purchase method. SFAS 142, Goodwill and Other Intangibles, eliminates the amortization of goodwill and requires annual impairment testing of goodwill using a complex two-step, fair value method.

SFAS 142 must be adopted in fiscal years beginning after December 15, 2001, as of the beginning of the year. Companies with fiscal years beginning after March 15, 2001, may adopt the standard early if they have not yet issued their first-quarter financial statements.

Dealing with Intangibles

Among other requirements, entities must now identify and account for intangible assets acquired in a business combination apart from goodwill if the intangible assets arise from either contractual or other legal rights or are separable. Intangibles must be reported at fair value. Where fair values are determined using present value techniques, estimates of future cash flows should incorporate marketplace assumptions.

"As a first step, management should identify all intangible assets acquired in prior business combinations, and evaluate them to determine if they may be recognized apart from goodwill under the provisions of SFAS 141," advises Eric W. Casey, a partner with KPMG's department of professional practice. "If not, they should be folded into goodwill as of the date SFAS 142 is adopted." Casey adds that the remaining useful lives of all intangible assets should be evaluated as of the date SFAS 142 is adopted.

"Intangible assets with estimable useful lives should continue to be amortized over their respective remaining useful lives, with adjustments made as appropriate," says Casey. "Meanwhile, companies must discontinue amortizing those intangible assets acquired prior to June 30, 2001, that are determined to have indefinite useful lives as of the SFAS 142 adoption date, and test them for impairment within the first quarter after adoption. Any impairment losses on these intangible assets should be recognized within the first quarter of adoption, as a cumulative effect of a change in accounting principle. Valuations must be as of the date of adoption."

Impairment Issues

Another impact of the new statements is that a company will test goodwill for impairment at the new reporting unit level, not the acquisition specific level. A company must identify reporting units based on the reporting structure as of the adoption date.

Companies should assign assets and liabilities, including corporate assets and liabilities, to the reporting units at the date of adoption. All goodwill should be assigned to the reporting units that benefit from the factors that give rise to the goodwill. Moreover, any negative goodwill or equity-method negative goodwill remaining at the date of adoption should be written off as a cumulative effect of a change in accounting principle.

A company's responsibilities regarding goodwill do not end there: "Within six months of adopting SFAS 142, each reporting unit should be tested for an indicator of reporting unit goodwill impairment, with valuations as of the date of adoption," says Charlene Maucione, a director in KPMG's transaction structuring services practice.

"If an indicator of impairment is determined, then a second, more complex test to measure the impairment must be performed. It's generally advisable to complete the second stage test as soon as possible but no later than the end of the year of adoption, and any impairment loss should be recognized as a cumulative effect of a change in accounting principle at the date of adoption, with valuations as of the date of adoption."

Improving Transparency

The new pronouncements will influence whether acquisitions are accretive to reported earnings per share and therefore will be important to corporate development personnel, notes Chris McWilton, partner in charge of KPMG's information, communications, and entertainment practice in New York.

"These two statements represent the first phase of FASB's attempts to improve the transparency of accounting and reporting of business combinations," says McWilton. "The increased disclosures that come with the introduction of these pronouncements may prove to be a challenge for CFOs. Given the extent and complexity of the new rules, companies and their advisors should begin to prepare for them at the earliest available opportunity."

Eugene DeMark, CPA, is the partner in charge of KPMG's northeast area business development, located in New York City. The views and opinions are those of the author and do not necessarily represent the views and opinions of KPMG LLP.