Take Note of New Financial Reporting Standards

Combining two businesses is never simple. Myriad factors – many beyond anyone’s control – can affect each step along the way. The best-case scenario is an honest accounting of assets and fair third-party mediation throughout the merger process. Toward that end, the Financial Accounting Standards Board (FASB) rigorously deliberated accounting treatment of business unions. The results? Statements of Financial Accounting Standards 141 and 142.

Goodwill Hunting

Statement 141 addresses business combinations, while Statement 142 focuses on goodwill and other intangible assets.

Statement 141.Intangible assets are now recorded separately from goodwill at their fair values and amortized over their remaining lives. Previously, many companies recorded as goodwill any purchase price not allocated to an acquired company’s current assets’ fair market values and real and personal property.

Statement 142.This prescribes a new method of testing goodwill for impairment by establishing a separate test using fair value, which is based on market evidence or standard valuation techniques. If the goodwill’s fair value is less than its book value, goodwill is impaired. Impairment loss is measured by the amount that goodwill’s carrying value exceeds its implied fair value.

It’s now important to have an expert perform a business enterprise valuation of the reporting unit to estimate its value as an operating business and then value identifiable assets, such as working capital and real property.

The valuation’s underlying assumptions must be based on market participants’ transaction price expectations. For asset valuations, this would include assessing the asset’s current use. For reporting unit valuations, your expert should consider whether the acquiring entity would be willing to pay a premium for a controlling interest. If so, a publicly traded reporting unit’s market capitalization may not represent the unit’s fair value as a whole, because such a control premium would cause the unit’s fair value to exceed its market capitalization.

Now, only the purchase method accounts for business combinations. So why should you care? Well, that involves valuing acquired intangible assets as well as valuing current assets and real and personal property. Intangible assets that are separable from goodwill must be recorded at their fair values and amortized over their remaining useful lives. But, goodwill (both existing and future) and intangible assets with indefinite lives won’t be amortized under any circumstances.

Within six months of the closing, existing goodwill must have a benchmark value assessment, which must establish whether the existing goodwill’s book value is impaired.

Assessing Goodwill Impairment

Under the new statements, the goodwill impairment test requires a market-based valuation of the reporting unit (that is, the unit reporting the goodwill). There are several impairment hot spots, including:

The reporting unit’s current-period operating or cash flow losses, combined with a history of losses or a forecast of continuing losses, or

Significant adverse change in one or more of the assumptions or expectations (including competitive factors and loss of key personnel) used to determine fair value.

Other existing goodwill doesn’t require an immediate impairment test; however, such goodwill will need a benchmark assessment.

Finally, FASB itemized 29 intangible assets separable from goodwill. They’re based on the following categories:

  • Marketing
  • Customers
  • Contracts, and
  • Technology.

Fortunately, assessment isn’t as onerous as it might appear, because not all of the enumerated intangible assets exist within every business.

What’s It Worth?

Statement 142 requires measuring goodwill impairment based on market value. This means valuation by independent professionals specially trained in fundamental, discounted cash flow and market pricing analyses. So please call us to facilitate a FASB 142 valuation.

Sidebar: More Than Words

In addition to changing the rules, Statements of Financial Accounting Standards 141 and 142 have altered a few definitions. Here are two frequently encountered expressions:

  1. Reporting unit. Goodwill can often be associated with a specific operating or business unit. Statements 141 and 142 define a reporting unit as the “lowest level of an entity that is a business and that can be distinguished physically and operationally and for internal reporting purposes from the other activities, operations, and assets of the entity.”
  2. Fair value. The new accounting statements define fair value as “the amount at which that asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale.” Thus, fair value is not a book value concept. A reporting unit’s fair value is “the amount at which the unit as a whole could be bought or sold in a current transaction between willing parties.” According to Statement 142, quoted prices on active markets measure fair value best. But, if such quotes don’t exist, estimate fair value using standard valuation techniques.