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    Financial Reporting Financial Reporting Document Transcript

    • Financial Reporting September 2001 © & SM, March 2000 BDO Seidman, LLP Contents Introduction and Background .............1 Why Did the Board Do It? .........................1 Not an Easy Road ......................................2 Statement 141 – Accounting for Business Business Combinations ........................2 Application of the Purchase Method ......3 Combinations, Goodwill, and Contemporaneous Documentation ........5 Financial Statement Disclosures.............5 Other Intangible Assets Effective Dates and Transition .................5 Statement 142 – Goodwill and Other Intangible Assets........................8 Accounting for Goodwill ...........................8 Introduction and Background Accounting for Other Intangible Assets......................................14 Deferred Income Taxes............................15 In June 2001, after a long and grueling process Financial Statement Presentation.........15 that took nearly five years, the Financial Effective Dates and Transition ...............15 Transitional Impairment Tests...............17 Accounting Standards Board (FASB or the Board) Required Disclosures for SEC Reporting Companies.....................17 finalized FASB Statements of Financial Getting Ready.....................................19 Accounting Standards No. 141, Business Combina- Looking Ahead ...................................19 tions, and No. 142, Goodwill and Other Intangible Summary of Effective Dates ..............20 Assets. Statement 141 addresses business combi- nations and Statement 142 deals with intangible During its deliberations, the FASB issued a Special Report, an Invitation to Comment, and two Exposure assets acquired individually, with a group of other Drafts, held numerous public meetings, heard from 43 assets, or in a business combination. Collectively, constituents in 4 days of public hearings, read well over these new Statements not only eliminate the 550 comment letters, and conducted field visits at 14 com- pooling-of-interests method of accounting (pool- panies. The Board also worked with standard-setting bod- ies of other countries with the goal of obtaining interna- ing method), but also significantly change the tional convergence on this topic. accounting for goodwill by ending its amortiza- tion and introducing a new complex valuation Why Did The Board Do It? model to test it for impairment. All future busi- The Board added the project on accounting for business combinations to its agenda for several reasons. The prolif- ness combinations will be affected, as well as eration of business combinations in the early 1990s goodwill and recognized intangible assets previ- heightened awareness that companies could account for ously acquired. similar economic transactions using different methods,
    • resulting in significantly different of business combinations, neutrali- involved are incorporated or unin- financial statement outcomes. ty means that the accounting stan- corporated. Financial statement users advised dards should neither encourage nor Transactions covered by State- the Board that those differences discourage business combinations ment 141 include those where (1) were making comparisons among but rather, provide information one or more companies are merged companies more difficult. In addi- about those combinations that is or become subsidiaries, (2) one tion, there was a perception that fair and evenhanded.” company transfers net assets or its the adverse earnings-per-share In the end, the Board concluded owners transfer their equity inter- effect of the purchase method of that the new Statements would ests to another, (3) there is an accounting (purchase method) result in financial statements that exchange of a business for a busi- affected market valuations and better represent the underlying eco- ness, or (4) all companies transfer competition in markets for mergers nomics of a business combination, net assets or the owners of those and acquisitions. Many companies are more comparable, and provide companies transfer their equity believed that they were at a disad- more complete information. interests to a newly formed compa- vantage in competing for target The following analysis of the new ny (some of which are referred to as companies if they could not qualify Statements supplements our previ- roll-up or put-together transac- to use the pooling method, while a ous letter, The New Age of Goodwill. tions). Although some may argue competitor could do so. These cir- that not all of those types of busi- cumstances drove many to try to ness combinations are acquisi- expand the use of the pooling Statement 141 – tions, the Board plans to address method, thus pushing the guidance Business Combinations those issues in another project, in APB Opinion No. 16, Business including whether a company Combinations, to the breaking point. Under Statement 141, a company should account for a business com- As a result, the staffs of the FASB must account for all new business bination using the fresh start and SEC, public accounting firms, combinations using the purchase method (i.e., both the acquiring and company management expend- method; use of the pooling method and acquired companies would ed significant resources analyzing is prohibited for transactions adjust their assets and liabilities to transactions for compliance with initiated after June 30, 2001. The fair value) rather than the purchase the arcane criteria of Opinion 16. Statement continues the existing method for a transaction that is not practice of requiring a company to an acquisition. Not an Easy Road use the purchase method to The following are not considered The project proved to be highly con- account for the acquisition of some business combinations and State- troversial as the Board participated or all of the noncontrolling inter- ment 141 does not change the in several heated Congressional ests in a subsidiary. accounting for them: hearings. In October 2000, two The scope of Statement 141 is • Joint venture and other new Congressmen even introduced a bill essentially identical to that of entity formations in the House of Representatives in Opinion 16, which has been super- • Recapitalization transactions an attempt to stall the project. seded. Under Statement 141, a • Acquisition of some or all of the Opponents of the move to pull the business combination occurs noncontrolling interests in a plug on the pooling method when a company acquires net subsidiary requested that the Board keep that assets that constitute a business • Transfer of net assets or method for public policy reasons. or acquires a controlling equity exchanges of equity interests However, the Board responded by interest in a company. Statement between entities under com- stating that its decision to eliminate 141 applies regardless of (1) the mon control. the pooling method was consistent form of consideration, (2) whether Statement 141 does not apply to with its public policy goal of issuing the former owners of one of the a combination between two or accounting standards that result in combining companies as a group more not-for-profit organizations “neutral and representationally retain or receive a majority of the (NFPO) or to a NFPO’s acquisition faithful financial information.” The voting rights of the combined com- of a for-profit company. In addition, Board believes that “in the context pany, or (3) whether the parties it does not address transactions in 2 COPYRIGHT 2001, BDO SEIDMAN, LLP
    • which a company obtains control Application of the In addition, for business combi- through means other than an Purchase Method nations involving two or more com- acquisition of net assets or equity The core of the purchase method panies, the parties to the transac- interests (e.g., a previously owned is essentially the same under tion should also consider which unconsolidated majority-owned Statement 141 as it was under combining company initiated the company is consolidated as a result Opinion 16. Accordingly, the follow- transaction and whether the assets, of control being obtained by the ing discussion will focus primarily revenues, and earnings of one of lapse or elimination of participating on the new or additional guidance the combining companies signifi- veto rights that were held by minor- introduced by Statement 141. cantly exceeds those of the others. ity stockholders). If the parties form a new company Identifying the Acquiring Company to issue the equity interests, the The Statement supersedes The use of the purchase method acquiring company will be one of Opinion 16; all of the AICPA requires the acquiring company to the existing combining companies Interpretations of Opinion 16; FASB be identified. Ordinarily, identifying based on applying the above guid- Statements No. 10, Extension of the acquiring company will be obvi- ance and the evidence available. “Grandfather” Provisions for Business ous, such as where the acquiring Combinations; No. 38, Accounting for company distributes the cash or Goodwill and Other Preacquisition Contingencies of Purchased other assets or incurs the liabilities. Intangible Assets Enterprises; and No. 79, Elimination of Statement 141 continues the previ- However, transactions that involve Certain Disclosures for Business ous requirement for a company to the exchange of equity interests Combinations by Nonpublic Enterprises; recognize goodwill for the excess of (including reverse acquisitions) may and amends a number of other pro- require careful review of all the perti- the cost of an acquired company nouncements. Although a great nent facts and circumstances. In that over the fair value of the identifiable deal of that former guidance is regard, the parties should give equal assets acquired and liabilities gone, it is not forgotten, as State- weight to the following factors to assumed. It also indicates that ment 141 carries forward most of determine the acquiring company: intangible assets are those (exclud- the guidance relating to the pur- • The relative voting rights in the ing financial assets) which lack chase method. Specifically, combined company after the physical substance. Although the Statement 141 carries forward combination, which includes provisions of Opinion 16 required a guidance regarding (1) determin- considering which group of company to recognize identifiable ing the cost of an acquired compa- shareholders receives or retains intangible assets separately from ny, (2) allocating the costs of an the larger portion of the voting goodwill, in practice they may often acquired company to the assets rights, including the existence of have been included in goodwill. and liabilities assumed, (3) preac- any unusual or special voting Keeping past practice in mind quisition contingencies, and (4) arrangements, options, war- and because of its decision to pro- determining the acquisition date. rants, or convertible securities hibit goodwill amortization, the Guidance carried forward into • The existence of a large minority Board determined that explicit Statement 141 is clearly identified voting interest in the combined guidance was needed to determine by a reference to the original company when no other owner when to recognize an intangible source. The Board plans to address or organized group of owners asset separately from goodwill. As a some or all of those aspects of the has a significant voting interest result, Statement 141 requires the accounting for a business combi- • The composition of the board of acquiring company to recognize an nation in another project. directors of the combined com- acquired intangible asset separate- Statement 141 does not change pany ly from goodwill if it meets either of the consensuses reached in EITF • The composition of senior man- the following criteria: Issue No. 97-2, “Application of FASB agement of the combined com- • Control over the future economic Statement No. 94 and APB Opinion pany benefits of the asset results from No. 16 to Physician Practice • The terms of the exchange of contractual or other legal rights Management Entities and Certain equity securities, if publicly (the contractual-legal criterion) Other Entities with Contractual traded (e.g., whether a premium • The intangible asset is capable Management Arrangements.” is paid). of being separated or divided BDO SEIDMAN, LLP, FINANCIAL REPORTING 3
    • and sold, transferred, licensed, must sell the unpatented technical facts and circumstances of each rented, or exchanged either sep- expertise. As a result, the unpatent- individual business combination. arately or as part of a group of ed technical expertise meets the After initial recognition of good- assets (the separability criterion). separability criterion. will and acquired intangible assets, A company first must determine An exception to the above crite- the acquiring company should whether an intangible asset meets ria is that a company must include account for those assets using the the contractual-legal criterion, even an assembled workforce as part of guidance in Statement 142. if an asset’s rights are not transfer- goodwill. Although some believe Because earnings can be signifi- able or separable from the acquired that an assembled workforce could cantly affected by whether an item company or from other rights and meet the criteria for separate recog- is classified as non-amortizable obligations. For example, the value nition, the Board provided the goodwill or as an amortizable intan- of a favorable operating lease exception primarily because it gible asset, companies can expect agreement is an intangible asset believed that companies could not the SEC staff to review closely such that meets the contractual-legal cri- adequately measure its fair value. classifications. terion, even if the company could The following acquired assets Negative Goodwill not transfer the lease through a sale are examples of those that meet the In some business combinations, or sublease. contractual-legal criterion: the fair value of the acquired net If the acquired intangible asset • Registered or legally protected assets exceeds the cost of the does not satisfy the contractual- trademark or other mark acquisition (i.e., negative goodwill). legal criterion, the company must • Registered Internet domain The basic principle in accounting determine whether the asset meets name for negative goodwill is similar to the separability criterion, even if the • Order or production backlog what Opinion 16 required, with acquiring company does not intend arising from contracts, even if some exceptions. First, after to sell, transfer, license, or exchange cancelable reassessing the facts and circum- it. Exchange transactions provide • Customer contracts and the stances of the original purchase evidence of meeting the separability related customer relationship, price allocation, a company should criterion, even if they are infrequent even if terms prohibit transfers allocate the excess as a pro rata for that type of asset or a similar • Servicing asset reduction of the amounts assigned type asset and even if the acquiring • Legally protected artistic-related to all of the acquired assets (includ- company is not involved in them. materials, computer software, ing research and development For example, if the acquiring com- mask works, program formats, assets acquired and expensed), pany is capable of selling or renting databases, and trade secrets. except for: an acquired intangible asset (e.g., a In addition, the following • Financial assets, other than customer list), but does not plan to acquired items are examples of investments accounted for by do so, but other companies sell or those that meet the separability the equity method rent similar type items, the asset criterion: • Assets to be disposed of by sale meets the separability criterion. • Customer lists, except if terms or otherwise and assets of a dis- Although an intangible asset prohibit transfer continued operating segment may not meet the separability crite- • Databases, including title plants • Deferred tax assets rion by itself, it still may meet that that are not legally protected by • Prepaid assets relating to pen- criterion if it is separable in combi- copyright. sion or other postretirement nation with a related contract, asset, Paragraph A14 of Statement 141 benefit plans or liability. For example, assume provides a more detailed listing of • Any other current assets. that the company acquired assets intangible assets that meet the cri- A company should recognize that include a registered trademark teria for recognition as an asset any remaining excess as an extraor- and unpatented technical expertise apart from goodwill. This listing is dinary gain, unless the transaction to manufacture the trademarked not all-inclusive, so the acquiring involves contingent consideration. product. Because of certain legal company will need to evaluate all of If the purchase agreement requirements, if the acquiring com- the criteria for separate recognition includes contingent consideration pany sells the trademark, it also of intangible assets based on the that could increase the purchase 4 COPYRIGHT 2001, BDO SEIDMAN, LLP
    • price, the company should defer the Contemporaneous the Board issues interpretative excess as if it were a liability in an Documentation guidance related to the application amount equal to the lesser of the Statement 142 requires a company of the purchase method to those maximum amount of the contingent to assign the assets acquired and transactions. consideration or the excess. When liabilities assumed in a business Statement 141 carries forward the contingency is satisfied, the combination, including goodwill, to the Opinion 16 definition of initiated acquiring company should account a reporting unit (see discussion of in the context of a business combi- for the additional consideration as Statement 142) as of the date of the nation. A business combination is part of the cost of the acquired com- acquisition. In that regard, the initiated on the earlier of when (1) pany and then determine whether acquiring company should docu- the major terms are set and the negative goodwill still exists. If it ment at the acquisition date the exchange offer is announced pub- does, the company should allocate basis for and the method for deter- licly or formally communicated to that amount as a pro rata reduction mining the purchase price, includ- the shareholders of any one of the of the assets and liabilities as ing other related factors (e.g., combining companies, (2) the described above. The company underlying reasons for the acquisi- shareholders of either combining should recognize any remaining tion and management’s expecta- company are notified in writing of excess as an extraordinary gain in tions related to dilution and an exchange offer, or (3) the share- the period in which the contingent synergies). holders of a closely held company consideration is resolved. It is pos- grant an option to exchange shares sible for a company to report an Financial Statement at a future date to another compa- extraordinary gain in two different Disclosures ny. An exchange offer refers to the To enhance a financial statement major terms of a plan, including the reporting periods for the same busi- user’s ability to assess the effects of ratio of exchange (or formula to ness combination where the maxi- a business combination on postac- determine that ratio). The company mum amount of contingent consid- quisition earnings and cash flows, does not need to know the actual eration is less than the negative Statement 141 significantly expands exchange ratio of shares if the ratio goodwill (see Example 1). the previous disclosure require- of exchange is absolutely deter- ments of Opinion 16 (see the Table minable by an objective means in Example 1 on pages 6 and 7). the future. A formula would usually Extraordinary Gain in provide such a determination. More Than One Period Effective Dates and Transition Conversely, intent to negotiate Assume that the maximum or make an offer does not consti- Except for combinations between amount of the contingent con- tute initiation of a business combi- two or more mutual enterprises sideration is $1,000, negative (e.g., mutual insurance companies, nation, nor would granting a right of goodwill is $3,000, the acquisition credit unions, and farm and rural first offer or first refusal. Changes to date is in the company’s second electric cooperatives), Statement previously announced terms and quarter, and the contingency 141 is effective for all business conditions of the exchange offer period ends in nine months, at combinations initiated after June 30, result in a new initiation date. In which time the contingency is 2001 and for purchase method addition, if the parties formally ter- resolved for $300. In this case, the business combinations completed minate negotiations and then sub- acquiring company would report a on or after July 1, 2001. Accord- sequently resume negotiations, the $2,000 extraordinary gain ($3,000 - ingly, the pooling method is pro- resumption creates a new initiation $1,000) in the second quarter and hibited for business combinations date even if the terms and condi- another $700 extraordinary gain initiated after June 30, 2001. tions did not change from the previ- ($1,000 - $300) in nine months. However, Opinion 16 would con- ously terminated plan. tinue to apply to a pooling method Upon adoption of Statement transaction initiated on or before 142 (see below), for a purchase The above approach also June 30, 2001. For combinations business combination with an applies to equity method negative between mutual enterprises, acquisition date before July 1, 2001, goodwill. Statement 141 is not effective until a company should reclassify to BDO SEIDMAN, LLP, FINANCIAL REPORTING 5
    • Table 1 Statement 141 Disclosure Requirements Annual disclosures: 2) Goodwill by reportable segment (if segment 1. In the period a material business combination is information is required by Statement 131), completed: unless not practicable a. Name and brief description of acquired entity and 3. If individually immaterial business combinations are percentage of voting equity acquired completed during year that are material in the aggre- b. Primary reasons for acquisition, including descrip- gate: tion of factors that contributed to a purchase price a. Number of companies acquired and a brief that results in recognition of goodwill description of them c. Period that results of operations of acquired com- b. Aggregate cost, number of equity interests (such pany are included in the income statement as common shares, preferred shares, or partner- d. Cost of acquisition and, if applicable, number of ship interests) issued or issuable, and value shares of equity interests (such as common assigned shares, preferred shares, or partnership interests) c. Aggregate amount of any contingent payments, issued or issuable, the value of those interests, options, or commitments and related accounting and basis for determining value treatment that will be followed should any such e. Condensed balance sheet of acquired company at contingency occur acquisition date, disclosing the amount assigned d. The information described in item 2 above, if to each major asset and liability caption aggregate amount assigned to goodwill or other f. Contingent payments, options, or commitments intangible assets acquired is significant in relation and related accounting treatment that will be fol- to total cost of acquired companies lowed should any such contingency occur 4. For a public company, pro forma disclosures in the g. Amount of purchased research and development period a material business combination or a series of assets acquired and written off in the period and individually immaterial business combinations are where included in income statement completed that are material in the aggregate: h. Reason for any purchase price allocation not yet a. Results of operations for current period as though finalized; nature and amount of any material the acquisition(s) had been completed at begin- adjustments to initial allocation of purchase price ning of the period, unless acquisition at or near 2. If significant amounts are assigned to goodwill or to beginning of period other intangible assets, the following information b. Results of operations for only most recent compa- must be disclosed in the period in which a company rable prior period presented as though acquisi- completes a material business combination: tions completed at beginning of period a. For amortizable intangible assets: c. Pro forma information must include revenue, 1) Total amount assigned and amount assigned to income before extraordinary items and cumulative any major intangible asset class effect of accounting changes, net income, earnings 2) Amount of any significant residual value, in per share, and nature and amount of any material, total and by major intangible asset class nonrecurring items 3) Weighted-average amortization period, in total 5. In period there is an extraordinary gain for unallocat- and by major intangible asset class ed negative goodwill, disclose nature of transaction, b. For non-amortizable intangible assets, total amount principal items entering into determination of gain, assigned and amount assigned to any major intan- and related tax effect. gible asset class 6. Disclose, if practicable, information in items 1 and 2 c. For goodwill: above if a material business combination is complet- 1) Total goodwill and amount expected to be tax ed after balance sheet date but before financial state- deductible ments are issued. Continued on next page 6 COPYRIGHT 2001, BDO SEIDMAN, LLP
    • Interim disclosure requirements for publicly traded companies: If a material business combination is completed in the enue, income before extraordinary items and cumula- current year up to latest interim balance sheet date: tive effect of accounting changes (including those on 1. Information in items 1.a. – d. above an interim basis), net income, earnings per share, and 2. Pro forma results of operations for current interim nature and amount of material, nonrecurring items period and current year to date and for corresponding Appendix C of Statement 141 provides illustrative disclosures for periods in preceding year as though acquisition had a material business combination in the year of acquisition and sever- been completed as of beginning of period being al individually immaterial transactions that are material in the reported on. Pro forma information must display rev- aggregate. goodwill the carrying amount of there is other supporting evidence, Upon the earlier of adopting acquired intangible assets that do is it required to reclassify amounts Statement 142 or the first day of the not meet the criteria for separate from goodwill to intangible assets, fiscal year beginning after December recognition. If the intangible asset because reliable information might 15, 2001, a company must write off, reclassified to goodwill is an asset not otherwise exist to properly as a cumulative effect of a change for which amortization is not deduc- reclassify amounts, perhaps years in accounting principle, net of tible for income tax purposes after the fact. Except for the above taxes, any unamortized unallocat- because it does not have a tax reclassifications, the transition ed negative goodwill or equity basis, a company should consider provisions prohibit a company method unallocated negative good- the asset as nondeductible good- from reallocating the original pur- will from transactions completed will, which is exempt from the chase price. before July 1, 2001. deferred tax requirements. As a result, the company would elimi- nate any deferred tax liabilities associated with the reclassified Example 2 asset by reducing the carrying amount of the goodwill. If the amor- Reclassification of Goodwill and Other Intangible Assets Assume the following: The GCS Generator Company reported $8,000 of tization of the reclassified intangi- goodwill and intangible assets as a separate line item in its balance sheet. ble asset is tax-deductible, it should The internal accounting records indicated that goodwill and other intangible be deemed to be tax-deductible assets consist of the following, net of accumulated amortization: goodwill and should not affect an already recognized deferred tax Customer list $2,000 asset or liability balance. Employee workforce 500 The company should also re- Trademark 2,000 classify out of goodwill reported on Internet domain name 1,000 the balance sheet the carrying Goodwill 2,500 amount of any recognized intangible $8,000 assets that meet the criteria for separate recognition if the compa- Upon adoption of Statement 142, GCS should reclassify $5,000 (the cus- ny maintained a separate general tomer list, trademark, and Internet domain name) from goodwill to other ledger account or other accounting intangible assets because those assets meet the test for separate recogni- records (including separate analy- tion. The new carrying amount of goodwill will be $3,000 ($8,000 - $5,000), ses of the transaction) for those representing the employee workforce and goodwill. assets (see Example 2). For practi- However, if GCS did not separately identify those assets in its internal cal considerations, the Board con- accounting records or other supporting evidence does not exist, GCS should cluded that, only if a company has not reclassify those amounts from goodwill. identified other intangibles in its internal accounting records or BDO SEIDMAN, LLP, FINANCIAL REPORTING 7
    • Statement 142 – that goodwill is measured as the 131. As such, a company should residual amount at acquisition. A aggregate two or more components Goodwill and Other similar residual method to value of an operating segment if the seg- Intangible Assets goodwill is used under Statement ments have similar economic char- 141. A two-step impairment test is acteristics, and if the segments are Statement 142 addresses the initial used to identify potential goodwill similar in each of the following accounting for intangible assets impairment and to measure the areas: acquired individually or with a amount of goodwill impairment • The nature of the products and group of other assets that are not loss, if any. services part of a business, as well as the subsequent accounting for (1) good- • The nature of the production Reporting Unit will recognized under Statement processes Determining the reporting unit is a 141, (2) other intangible assets, • The type or class of customer for critical aspect in accounting for regardless of how acquired, (3) their products and services goodwill, including its related amounts recognized as goodwill in • The methods used to distribute impairment test. As mentioned ear- applying the equity method of their products or provide their lier, a company must assign the accounting, and (4) excess reorga- services acquired assets and liabilities nization value recognized in accor- assumed, including goodwill, to a • If applicable, the nature of the dance with AICPA Statement of reporting unit as of the date of regulatory environment (e.g., Position 90-7, Financial Reporting by acquisition. A reporting unit is an banking, insurance, or public Entities in Reorganization Under the operating segment (as defined in utilities). Bankruptcy Code. FASB Statement No. 131, Disclosures An operating segment is While Statement 142 supersedes about Segments of an Enterprise and deemed a reporting unit if all its APB Opinion No. 17, Intangible Assets, Related Information) or one level components are similar, none of its it carries forward the provisions below it (referred to as a compo- components is a separate reporting relating to internally developed nent). A company is required to test unit, or it comprises only a single intangibles. As a result, a company goodwill for impairment at the component. The Board believes should continue to expense when reporting unit level even if it is not that a company must aggregate incurred costs of internally deve- required to report segment infor- components that have similar eco- loping, maintaining, or restoring mation under Statement 131 (i.e., nomic characteristics into one intangible assets (including good- the company has only one report- reporting unit, even if management will) that are not specifically identi- able segment or it is a privately- separately reviews the operating fiable, that have indeterminate held company). A component of an results of a number of components. lives, or that are inherent in a con- operating segment is considered The Board’s rationale was that in tinuing company and related to the a separate reporting unit if the those instances allocating the company as a whole. component meets all of the follow- goodwill among the components ing criteria: would be arbitrary and unnecessary Accounting for Goodwill • It is a business for which dis- for purposes of testing goodwill. Under this Statement, a company crete financial information is The number of reporting units may no longer amortize goodwill, available could vary by company depending but now will have to test it for • Segment management regularly on the level at which performance impairment at the reporting unit level reviews its operating results of the operating segment is at least annually, absent some trig- • It has economic characteristics reviewed, how many businesses it gering event that would accelerate different from those of the other includes, and the similarity of those an impairment assessment. components of the operating businesses (see Example 3). As a Goodwill is considered impaired segment. result, it is possible for a reporting when its carrying amount exceeds To determine whether a compo- unit to be the same as an operating its so-called implied fair value. nent of an operating segment has segment, which could be the same Statement 142 acknowledges that it similar economic characteristics, a as a reportable segment, which is not possible to measure directly company must consider the guid- could be the same as the company the fair value of goodwill, noting ance in paragraph 17 of Statement as a whole. 8 COPYRIGHT 2001, BDO SEIDMAN, LLP
    • Example 3 Reporting Unit Same as the Operating Segment Assume the following facts: The GCS Generator Company of various products within each of the four operating seg- has four operating segments (A, B, C, and D) based on ments. The Company has discrete financial information product lines. There is a manager for each segment who for each of the products within each segment and man- reports directly to the chief operating decision maker agement of each segment reviews the products’ operat- (CODM). The CODM reviews the discrete and detailed ing results within that segment. Therefore, each product financial information for each of the four operating seg- is considered a component of the operating segment. In ments. Based on the criteria of paragraph 17 of addition, each of the products within the applicable Statement 131, the Company has aggregated Segments operating segment has similar economic characteristics A and B into one reportable segment and Segments C (e.g., similar long-term average gross margins). Since the and D into another. To identify the reporting units under components within each operating segment have similar Statement 142, management of GCS must start with each economic characteristics, GCS cannot use a lower level of the four operating segments and determine whether it than the four Statement 131 operating segments to is required to identify any reporting units one level below determine the Statement 142 reporting units (i.e., there the operating segment level. GCS’s components consist are four reporting units). Reportable Segment A/B Operating Segment A Operating Segment B (Reporting Unit) (Reporting Unit) Component 1 Component 2 Component 3 Component 4 Component 5 Component 6 Reportable Segment C/D Operating Segment C Operating Segment D (Reporting Unit) (Reporting Unit) Component 7 Component 8 Component 9 Component 10 Component 11 Component 12 The fact that GCS combined were changed such that GCS con- their economic characteristics. In certain of its operating segments sidered the products in operating that case, the SEC staff could raise to form its reportable segments segment A to have different eco- questions as to the composition of under Statement 131 is irrelevant nomics characteristics, and thus the reportable segments under for purposes of determining its considered each product line to be Statement 131. As is evident from reporting units in Example 3 a reporting unit, that conclusion this analysis, some companies because a company should always might be difficult to support, since may need to re-examine how they start at the operating segment level the operating segments A and B have determined their segments in making this determination. were combined into a reportable under Statement 131. However, if the facts in Example 3 segment based on the similarity of BDO SEIDMAN, LLP, FINANCIAL REPORTING 9
    • In many cases, it is expected by the acquisition) at the acquisi- • To ensure that the assets and that the Statement 142 reporting tion date if both of the following cri- liabilities the company assigns units will be the same as the teria are met: to a reporting unit are the same Statement 131 operating segments. • The asset will be employed in or net assets that the company However, Example 4 illustrates the liability relates to the opera- considers in determining the fair what happens when the reporting tions of a reporting unit value of that reporting unit – an unit is considered to be a level • The asset or liability will be con- “apples-to-apples” comparison below an operating segment. sidered in determining the fair • To ensure that a company value of the reporting unit. assigns to a reporting unit all of Assigning Assets and Liabilities to Other corporate items that a the assets and liabilities the Reporting Units company will need to consider in required for the reporting unit to For purposes of the goodwill this assignment process are: operate as a business. impairment test, a company must • Centralized cash and invest- To illustrate, if GCS does not assign the acquired assets and lia- ment accounts allocate corporate debt to a report- bilities (including corporate assets • Corporate level debt ing unit because it does not meet and liabilities, such as environ- • Current and deferred income the above criteria, the method used mental liabilities or a pension taxes. to determine the fair value of that obligation) to one or more report- There are two objectives of this reporting unit should exclude cor- ing units (either existing or created assignment process: porate debt. That would result in a Example 4 Reporting Unit One Level Below an Operating Segment Assume that AMS Publishing, Inc. has four operating which discrete financial information is available, they segments based on geographic location (such as North have different economic characteristics, and segment America, South America, Europe and Asia), rather than management reviews the information and reports direct- on product line, and there are three geographic areas ly to the CODM. The components within the other three within the North American segment, each with different geographic locations have similar economic characteris- economic characteristics. The CODM does not review tics. In this case, AMS would have six reporting units, financial information by product line. The components in three in North America and one for each of the other geo- the North American segment are separate businesses for graphic areas. South America North America Operating Segment Operating Segment (Reporting Unit) Component 1 Component 2 Component 3 Component 4 Component 5 Component 6 (Reporting Unit) (Reporting Unit) (Reporting Unit) Europe Asia Operating Segment Operating Segment (Reporting Unit) (Reporting Unit) Component 7 Component 8 Component 9 Component 10 Component 11 Component 12 10 COPYRIGHT 2001, BDO SEIDMAN, LLP
    • meaningful comparison of the lar to that used when a company Example 5 reporting unit’s carrying amount to disposes of a portion of a reporting Revising the Carrying Amount its fair value. unit (as discussed on page 13). Assume the fair value of Reporting Although it is possible for the Unit A of GCS is $5,000 and its cur- The Goodwill Impairment Test company’s allocation method to be rent carrying amount is $5,250. A company should test goodwill for very general, the methodology Also, assume that GCS tested vari- impairment using a two-step filter- should be reasonable, supportable, ous assets within that reporting ing approach. The bedrock of this and applied in a consistent manner. unit for impairment resulting in approach is the determination of In addition, a company must write-downs of $450 and a new fair values. assign all acquired goodwill to adjusted basis of the reporting reporting units at the acquisition unit of $4,800. Since the adjusted Step 1 carrying amount of the reporting date. A company could allocate First, to identify a potential impair- unit is now below its fair value, goodwill among a number of ment, a company should compare GCS will not have to perform the reporting units, including a report- the fair value (as discussed on page second step of the goodwill ing unit that the company expects 12) of a reporting unit to its carrying impairment test. However, if the to benefit from the synergies of the amount of the impairment loss amount, including goodwill. If the combination (e.g., incremental cost were only $100, GCS would have fair value of the reporting unit is savings, cash flows or revenues), greater than its carrying amount, to perform the second step of the even though the company may not goodwill is not considered impaired goodwill impairment test because have assigned other acquired and the second step is not required. the fair value of the reporting unit assets or liabilities to that reporting would be less than its carrying However, if the fair value of the unit. Paragraph 35 of Statement 142 amount ($5,150). reporting unit is less than its carrying indicates that a company, in con- amount, the second step should be company should recognize an cept, should assign acquired good- performed to measure the amount impairment loss for that excess as a will to a reporting unit in a manner of any impairment loss. separate line item in operating similar to how a company would rec- If goodwill and other assets income or include it in discontin- ognize goodwill in a business com- (e.g., long-lived assets, accounts ued operations, if applicable. bination. However, strict applica- receivable, long-term investments, Previously recognized impairment tion of that guidance may be costly etc.) are to be tested for impairment losses may not be reversed. in some cases. Therefore, the at the same time, those other A company should calculate the Statement provides for some flexi- assets should be tested for impair- implied fair value of goodwill in the bility by indicating that a compa- ment first and any resulting impair- same manner as goodwill arising in ny’s methodology for assigning ment loss should be recorded to a business combination. In that goodwill to reporting units should determine the carrying amount of regard, it should allocate the fair be reasonable, supportable, and the reporting unit. value of the reporting unit to all of applied consistently. We expect The impact of testing the other the assets and liabilities of that unit that this area will generate signifi- assets and recording the impair- (including any unrecognized intangi- cant implementation guidance. ment loss first is that a company ble assets – e.g., favorable leases If a company reorganizes its may not need to complete the sec- and internally developed customer reporting structure in a way that ond step of the impairment test lists) as if the company acquired alters the composition of one or because the carrying amount of the the reporting unit in a business more of its reporting units, it must reporting unit might now be less combination and the fair value of reassign the assets and liabilities than its fair value (see Example 5). the reporting unit is the purchase using the above guidance as if it price. The excess of the “purchase acquired those assets and liabilities Step 2 price” over the amounts assigned to as of the date of reorganization. The second step requires a compa- assets and liabilities is the implied However, a company should reas- ny to compare the implied fair value fair value of goodwill. In allocating sign to the reporting units goodwill of goodwill to its carrying amount. If the “purchase price,” a company affected by the reorganization using the carrying amount of goodwill should use the guidance carried a relative fair value approach simi- exceeds its implied fair value, a over from Opinion 16 to Statement BDO SEIDMAN, LLP, FINANCIAL REPORTING 11
    • 141. A company should perform dards. Thus, the increasing value of tative of the fair value of the report- that allocation procedure only for an existing reporting unit that is ing unit as a whole because of purposes of testing goodwill for growing and profitable could offset issues such as control premium. As impairment; it may not recognize an impairment loss of a recent a result, a company is not required the “step-up” in net assets or any acquisition that is included in such to use the quoted market price of unrecognized intangible assets (see a unit. However, if that reporting an individual share of stock as the Example 6). unit were performing poorly, recog- sole measurement basis to deter- If a company does not complete nition of an impairment loss might mine the fair value of such a report- the second step of the impairment be accelerated. Statement 142 ing unit. test before issuing its financial allows such offsetting within a When quoted market prices are statements for the reporting period, reporting unit, but does not permit not available at the reporting unit and a goodwill impairment loss is offsetting between reporting units. level, the company’s estimate of fair both probable and reasonably value should be based on the best estimable, the company should rec- Fair Value Measurements available information, including ognize the best estimate of the loss The fair value of an asset (or liabil- pricing for similar assets and liabili- in accordance with FASB Statement ity) is the amount at which that ties and the results of other valua- No. 5, Accounting for Contingencies. In asset (or liability) could be bought tion techniques, if those techniques that situation, the company should (or incurred) or sold (or settled) in a are consistent with the objective of disclose in the notes to the finan- current transaction between willing measuring fair value. A present cial statements that the measure- parties. Thus, the fair value of a value technique that includes rea- ment of the impairment loss is an reporting unit is the amount at sonable and supportable assump- estimate. Upon completion of step which the unit as a whole could be tions of future cash flows is often 2, a company should recognize any bought or sold in such a transac- the best available way to estimate adjustment to the estimated loss in tion. A company should use quoted the fair value of a group of assets the subsequent reporting period. market prices, if available, in situa- (such as a reporting unit). FASB The effect of reflecting unrecog- tions where there is only a single Concepts Statement No. 7, Using nized intangible assets in the fair reporting unit or tracking stock to Cash Flow Information and Present Value value determination of the report- determine the basis for the mea- in Accounting Measurements, discusses ing unit is essentially like capitaliz- surement. However, the market the essential elements of a present ing internally generated intangible price of an individual share of stock value measurement, provides exam- assets, including internally generat- (and thus the market capitalization ples of circumstances in which a ed goodwill, which is otherwise pro- of a reporting unit with publicly company’s cash flows might differ hibited by the accounting stan- traded stock) may not be represen- from the market cash flows, and dis- cusses the use of present value Example 6 techniques in measuring the fair Determining a Goodwill Impairment Loss value of an asset or a liability. Building on the fact pattern in Example 5, the fair value of the reporting unit It may be appropriate for a com- is $5,000 (including $1,000 fair value of internally developed intangibles) and pany to use multiples of earnings or the adjusted carrying amount is $5,150, including goodwill with a carrying revenues in determining the fair amount of $750. The second step of the impairment test is as follows: value of a reporting unit when the fair value of a company that has Fair value of: comparable operations and eco- Reporting Unit A $5,000 nomic characteristics is observable Tangible net assets $2,000 and the relevant multiples of the Recognized intangible assets 1,500 comparable company are known. Unrecognized intangible assets (favorable leases and customer list) 1,000 4,500 When to Test for Goodwill Implied fair value of goodwill 500 Impairment Carrying amount of goodwill 750 A company should test goodwill for Goodwill impairment loss $ (250) impairment on an annual basis or earlier if there is an event indicating 12 COPYRIGHT 2001, BDO SEIDMAN, LLP
    • that it is more likely than not that (thus, avoiding additional dis- being second-guessed by others as the fair value of the reporting unit is closure requirements if the test to whether the company met the less than its carrying amount. is not completed by the time short-cut conditions. Examples of such indicators include: financial statements are issued) Goodwill Impairment Testing by a • A significant adverse change in • The appropriate carrying Subsidiary legal factors or in the business amounts will be available as of Statement 142 applies to all good- climate the last day of the third quarter will recognized by a subsidiary in its • An adverse action or assess- (thus, possibly avoiding the separate financial statements. A ment by a regulator need to perform impairment subsidiary should test for goodwill • Unanticipated competition tests of other assets at the same impairment at the subsidiary level • A loss of key personnel time as testing goodwill for using its own reporting units. The • A more-likely-than-not expecta- impairment) parent company should not recog- tion that a reporting unit or a • There will be no need to assess nize any impairment loss recog- significant portion of a reporting whether impairment indicators nized at the subsidiary level in the unit will be sold or otherwise may exist later if the company consolidated financial statements disposed of performed the test earlier in the unless the reporting unit in which • The testing for recoverability of year. the subsidiary resides in consolida- a significant asset group within As a practical shortcut, a com- tion is also impaired. A company a reporting unit under FASB pany could carry forward the report- must test goodwill for impairment at Statement No. 121, Accounting for ing unit’s detailed fair value deter- the consolidated level if its sub- the Impairment of Long-Lived Assets mination from one year to the next sidiary recognized an impairment and for Long-Lived Assets to Be if all of the following criteria have loss and the event that gave rise to Disposed Of been met: that loss would more likely than not • A recognized goodwill impair- • The assets and liabilities of the reduce the fair value of the consoli- ment loss in the financial state- reporting unit have not changed dated reporting unit below its carry- ments of a subsidiary that is a significantly since the last fair ing amount. component of a reporting unit. value determination A company also should test • The last fair value amount Test for Goodwill Impairment When goodwill for impairment after a por- exceeded the carrying amount Minority Interest Exists tion of goodwill has been allocated of the reporting unit by a sub- When a company has a minority to a business to be disposed of. stantial margin interest, its test for goodwill should A company does not have to per- • Based on current events or cir- be consistent with the approach form the annual impairment test at cumstances, it would be remote used to measure the minority inter- its year-end. Instead, it may elect to that a current fair value determi- est at the acquisition date. For perform the test at any time during nation would be less than the example, if a company initially its fiscal year as long as it uses the current carrying amount. recorded goodwill based on the same measurement date consis- Although the Statement affords excess of the purchase price over its majority percentage of the fair value tently from year to year. Different this short cut method, it may be of the net identifiable assets measurement dates may be used for more prudent to update the valua- acquired, it should calculate the fair different reporting units. We believe tions at least on an annual basis. value of the reporting unit based on that the optimal date to perform the Once a valuation model is in place, that controlling interest. Likewise, it annual impairment test is the first a company should be able to should consider only its percentage day of a company’s fourth quarter. update the information with little ownership interest in determining Performing the test at that time has effort. The annual update also will the implied fair value of goodwill. several advantages. (1) allow for the timely identifica- • The company will have the entire tion of events and circumstances Disposal of All or a Portion of a quarter, including up to the due that may require the company to Reporting Unit date for filing or submitting complete an impairment test, (2) If a company disposes of a reporting annual financial statements, to provide enough time to complete unit in its entirety, goodwill of that complete the impairment test any impairment test, and (3) avoid reporting unit should be included in BDO SEIDMAN, LLP, FINANCIAL REPORTING 13
    • the carrying amount of the net acquired in a transaction other than company should analyze all perti- assets to be disposed of to deter- a business combination at its fair nent factors, including: mine the gain or loss on disposal. value. When a company acquires • The asset’s expected use by the When some, but not all, of a intangible assets as part of a group company reporting unit is disposed of, a com- of assets, it should allocate the total • The expected useful lives of pany should allocate goodwill to the cost to the individual assets related assets net assets disposed of if those net acquired based on their relative fair • Legal, regulatory, or contractual assets constitute a business. The values. This allocation does not provisions that may limit the amount of allocated goodwill result in goodwill, which arises only useful life or whether the com- should be based on the relative fair in a business combination. As a pany can renew or extend the value of the business disposed of result, the criteria in Statement 141 asset’s legal or contractual life and the fair value of the remainder to recognize intangible assets sepa- without substantial cost, provid- of the reporting unit. The goodwill rately from goodwill do not apply to ed there is evidence this can be remaining in the portion of the assets acquired in a transaction done without material modifica- reporting unit to be retained should other than a business combination. tions of the existing terms and be tested for impairment. conditions Determining the Useful Life However, if a business is dis- • The effects of obsolescence, The subsequent accounting for a posed of that was never integrated demand, competition, and other recognized intangible asset depends into the reporting unit after its economic factors on whether it has an indefinite use- acquisition, and thus the benefits of • The level of funds needed to ful life to the company. Consistent the acquired goodwill were never maintain the asset to achieve with current practice, a company realized by the reporting unit as a the expected future cash flows should amortize an intangible asset whole, the current carrying amount (e.g., a material level of required with a finite useful life. On the other of that acquired goodwill should be maintenance may suggest a lim- hand, it should not amortize an included in the carrying amount of ited useful life). intangible asset that has an indefi- the business to be disposed of. An intangible asset has an indef- nite useful life. The useful life is the inite useful life if, after performing Equity Method Investments period over which the company this analysis, a company finds that A company should no longer amor- expects the asset to contribute there are no legal, regulatory, con- tize the portion of the difference directly or indirectly to its future tractual, competitive, economic, or between the cost of an investment cash flows. However, cash flows other factors limiting its useful life. and the amount of underlying equi- and useful lives of an intangible Examples of indefinite useful life ty in the net assets of an equity asset that a company bases on intangible assets include, but are method investee that was recog- legal rights are constrained by the not limited to, certain trademarks, nized as goodwill (i.e., equity meth- duration of those rights. In that sit- renewable broadcast licenses, and od goodwill) in accordance with APB uation, the useful life cannot taxicab medallions. Opinion No. 18, The Equity Method of extend beyond the length of the Accounting for Investments in Common asset’s legal rights and may be Amortizable Intangible Assets Stock. However, equity method good- shorter. If an intangible asset has a A company should amortize a finite- will should continue to be tested for finite life, but the company cannot life intangible asset over its estimat- impairment in accordance with para- determine the precise length of ed useful life, up to its residual graph 19(h) of Opinion 18, rather that life, it should amortize the value, in relationship to the pattern than Statement 142. intangible asset over the best esti- in which the company uses up the mate of the useful life. intangible asset’s economic bene- Accounting for Other The useful life of an intangible fits. If the pattern of consumption Intangible Assets asset is indefinite if it extends cannot be reliably determined, the beyond the foreseeable horizon. straight-line method should be Initial Recognition and However, indefinite does not mean used. A company may not write Measurement infinite. down an intangible asset in the peri- A company should recognize and In determining the estimated od it is acquired unless it became measure an intangible asset useful life of an intangible asset, a impaired during that period. 14 COPYRIGHT 2001, BDO SEIDMAN, LLP
    • The residual value of an intan- Nonamortizable Intangible Assets this argument was made for other gible asset is assumed to be zero A company must reevaluate at each situations when Statement 109 was unless the useful life to the acquir- annual reporting period (absent debated, so no change in its provi- ing company is shorter than the some triggering event that would sions is warranted. asset’s economic life and (1) a accelerate the assessment) whether commitment exists from a third an indefinite life intangible asset Financial Statement party to purchase the asset at the continues to have an indefinite use- Presentation end of its useful life, or (2) the ful life. If a company subsequently Goodwill should be aggregated and residual value can be determined determines that an intangible asset shown as a separate line item on by reference to an observable mar- has a finite useful life (e.g., because the balance sheet. The aggregate ket for that asset and that market of unanticipated competition enter- amount of goodwill impairment is expected to exist at the end of ing the market), it should write down losses should be presented as a the asset’s useful life. Residual the asset if its carrying amount separate line item in the income value is determined net of any dis- exceeds its fair value. It would then statement before the subtotal posal costs. begin to amortize the intangible income from continuing operations (or A company should reevaluate asset on a prospective basis based similar caption), unless it is associ- the useful lives of amortizable on its remaining useful life. ated with a discontinued operation. assets at least each annual report- An indefinite life intangible In that case, the company would ing period, absent some triggering asset should be tested for impair- report the goodwill impairment event that would accelerate the ment annually, or more frequently if within the results of discontinued assessment, with any changes in an event or circumstance occurs operations, on a net-of-tax basis. the estimated useful lives account- between annual tests which indi- All other intangible assets must ed for prospectively over the revised cates that the asset might be be aggregated and shown on the remaining useful life. If an amortiz- impaired. The impairment test con- balance sheet unless a company able intangible asset is subse- sists of comparing the fair value of chooses to present individual intan- quently determined to have an the intangible asset to its carrying gible assets or classes of intangible indefinite useful life (e.g., due to a amount. An impairment loss is rec- assets as separate line items. change in legal requirements), the ognized if the carrying amount of Amortization expense and impair- company should test for impair- the intangible asset exceeds its fair ment losses for intangible assets ment under Statement 142 (see dis- value. The amount of any impair- should be shown within continuing cussion below) and cease amortiza- ment loss reduces the intangible operations in the income statement. tion on a prospective basis. asset to its new accounting basis. See Table 2 on page 16 for the dis- An amortizable intangible asset Previously recognized impairment closures required by Statement 142. is subject to the impairment guid- losses may not be reversed. ance in Statement 121. Under that Effective Dates and Transition Statement, if an impairment indica- Deferred Income Taxes Statement 142 is required to be tor is present, the company must Statement 142 does not change the applied in fiscal years beginning evaluate the recoverability of the requirements in FASB Statement after December 15, 2001 to all good- asset based on a two-part test. An No. 109, Accounting for Income Taxes, will and other intangible assets rec- impairment loss would be recog- related to goodwill and intangible ognized at that date, regardless of nized if (1) the carrying amount of assets. Accordingly, a deferred tax when those assets were initially rec- the intangible asset is not recover- liability should be recognized for ognized. A company may elect to able and (2) the carrying amount the excess of the book basis over adopt the provisions earlier only if it exceeds its fair value. The amount the tax basis of goodwill arising in has a fiscal year beginning after of any impairment loss reduces the taxable purchases. Respondents to March 15, 2001 and it has not issued intangible asset to its new account- the 2001 Exposure Draft argued that its financial statements for the first ing basis. Statement 121 prohibits such deferred taxes should not be interim reporting period. For those the reversal of a previously recog- recorded since the liability would companies, the attraction of early nized impairment loss for assets not be settled until the indefinite adoption resulting from cessation of held for use. future. However, the Board felt that goodwill amortization needs to be BDO SEIDMAN, LLP, FINANCIAL REPORTING 15
    • Table 2 Statement 142 Disclosure Requirements 1. For intangible assets acquired, either individually or 3. For each intangible asset impairment loss, disclose with a group of assets, disclose in the period of acqui- the following information in the period of loss: sition: a. Description of impaired intangible asset and a. For amortizable intangible assets: underlying facts and circumstances 1) Total amount assigned and amount assigned to b. Amount of loss and method for determining fair any major intangible asset class value 2) Amount of any significant residual value, in c. Where loss is included in income statement total and by major intangible asset class d. Segment in which impaired intangible asset is 3) Weighted-average amortization period, in total included under Statement 131 and by major intangible asset class 4. For each goodwill impairment loss recognized, dis- b. For non-amortizable intangible assets – total close the following in the period of loss: amount assigned and amount assigned to any a. Description of facts and circumstances leading to major intangible asset class impairment c. Amount of research and development assets b. Amount of loss and method of determining fair acquired and written off in period and where value of reporting unit (whether based on quoted included in income statement market prices, prices of comparable businesses, a 2. For each period for which a balance sheet is present value or other valuation technique, or a presented: combination thereof) a. For amortizable intangible assets: c. If loss is an estimate not yet finalized, that fact and 1) Gross carrying amount and accumulated amor- reasons and, in subsequent periods, adjustments tization, in total and by major intangible asset made to initial estimate class 2) Aggregate amortization expense for period Transitional disclosures 3) Estimated total amortization expense for each 1. When first step of goodwill impairment test is com- of next five years pleted, disclose in interim financial information the b. For non-amortizable intangible assets – total car- reportable segments in which an impairment loss rying amount and the carrying amount for each might be recognized and period potential loss will be major intangible asset class measured. c. Changes in carrying amount of goodwill during the 2. In period of initial application and thereafter, until period including: goodwill and other intangible assets are accounted 1) Total amount of goodwill acquired for under Statement 142, disclose (i) what income 2) Total amount of impairment losses recognized before extraordinary items and net income would 3) Amount of goodwill included in gain or loss on have been, excluding amortization expense for good- disposal of a reporting unit will, intangible assets that will no longer be amor- 4) If segment information required by Statement tized, any deferred credit related to negative goodwill 131: and equity method goodwill, and adjusted for a) Provide above information about goodwill changes in amortization periods for intangible assets in total and for each reportable segment that will continue to be amortized, (ii) a reconciliation b) Disclose significant changes in allocation of of reported net income to adjusted net income, and goodwill by reportable segment (iii) adjusted earnings-per-share. c) If any portion of goodwill is not yet allocated to a reporting unit, disclose that unallocated Appendix C of Statement 142 provides illustrative disclosures for amount and the reasons for non-allocation periods subsequent to a business combination and for transition. 16 COPYRIGHT 2001, BDO SEIDMAN, LLP
    • weighed against the acceleration of as of the beginning of the fiscal year company determines that there is a the need to cope with the complex in which the Statement is first potential impairment loss, it must impairment test. In all cases, a com- applied. The first step of this tran- disclose that information in any pany must apply the provisions of sitional goodwill impairment test interim financial reporting period. the Statement as of the beginning of (i.e., comparing the carrying In addition to the required tran- its fiscal year. Retroactive applica- amount of the net assets, including sitional goodwill impairment test, a tion is not permitted. goodwill, with the fair value of the company must also complete the At the date of initial application, reporting unit) should be complet- required annual goodwill impair- a company should establish its ed within six months of initial ment test in the year of adoption. reporting units, assign the recog- adoption of the Statement. A calen- However, the company may use the nized net assets and the existing dar year company should complete transitional test as the annual test, goodwill to those units, and, if nec- this step by June 30, 2002; however, if it designates the beginning of the essary, reclassify amounts among a company with a June 30, 2001 fis- fiscal year as the date for its annual goodwill and other intangibles. In cal year-end, that does not elect impairment test. addition, an SEC-reporting compa- early adoption, would have until Other Intangible Assets ny will need to disclose in filings December 31, 2002 to complete it. If In the first interim reporting period through the date of initial adoption a company determines that events after initial adoption, a company the potential effects of adopting the or changes in circumstances indi- should reassess the useful lives of Statement unless the impact on the cate that goodwill of a reporting intangible assets other than good- financial statements is not expect- unit might be impaired before the will that were acquired before July 1, ed to be material. (See separate six-month deadline, it should accel- 2001 and, if necessary, adjust the section below on such disclosures.) erate its impairment test. If the first remaining amortization periods. At A company should not amortize step indicates that the carrying the same time, a company is also goodwill and indefinite life intangi- amount exceeds the fair value of required to test indefinite life intan- ble assets acquired in a purchase the reporting unit, the company gible assets for impairment as of business combination or other should complete the second step of the beginning of the fiscal year, with transaction completed after June 30, the test as soon as possible, but no any resulting impairment loss 2001. However, until a company first later than the end of the fiscal year reported as a cumulative effect of a applies all of Statement 142, it of adoption. change in accounting principle. should continue to use existing Any impairment loss resulting See Table 3 on page 20 for a impairment guidance for all good- from the transitional impairment summary of the complex effective will and other intangibles and con- test should be reported as a cumu- date and transition requirements. tinue to amortize such assets aris- lative effect of a change in account- ing from acquisitions completed ing principle. However, if a loss Required Disclosures for SEC before July 1, 2001. As a result, for results from an accelerated impair- Reporting Companies the period between July 1, 2001 and ment test, the company should An SEC registrant should disclose the date the new Statement is generally present the loss as a sep- the potential effects of adopting applied, a company could find itself arate line item in operating income. Statements 141 and 142 in its fil- in the anomalous situation of amor- If the company completes the test ings with the SEC for periods sub- tizing previously acquired goodwill after the end of the first quarter, no sequent to June 30, 2001, unless and indefinite life intangible assets amendment of prior SEC filings is the impact on the financial state- at the same time it is not amortizing required for any resulting impair- ments is not expected to be mater- such newly acquired assets, and ment loss. However, a restatement ial. Under Staff Accounting with all such assets being subject to of each of the prior quarters’ results Bulletin Topic 11M, Disclosure of the the old impairment tests. should be included in the filing for Impact that Recently Issued Accounting the quarter in which the company Standards Will Have on the Financial Transitional Impairment Tests adopts the new accounting princi- Statements of the Registrant When Goodwill ple and in the annual Form 10-K Adopted in a Future Period (SAB 74), a A company should test goodwill of quarterly financial information. If, registrant should provide the fol- each reporting unit for impairment after completing the first step, the lowing disclosures: BDO SEIDMAN, LLP, FINANCIAL REPORTING 17
    • • A brief description of State- • The expected impact of the mated amount should be dis- ments 141 and 142 Statements on the reported closed. However, if the amount • The date the company must financial position and results of is immaterial or the impact is adopt the Statements or, if the operations. If the company has not known or reasonably estim- company is eligible for early adop- quantified the impact and that able, a statement to that effect tion, the date it plans to adopt amount is material, the esti- should be made. SAB 74 Sample Disclosure In June 2001, the Financial Accounting Standards Board transitional goodwill impairment test by six months finalized FASB Statements No. 141, Business Combinations from the date of adoption. The Company is also required (SFAS 141), and No. 142, Goodwill and Other Intangible Assets to reassess the useful lives of other intangible assets (SFAS 142). SFAS 141 requires the use of the purchase within the first interim quarter after adoption of SFAS 142. method of accounting and prohibits the use of the pool- The Company’s previous business combinations ing-of-interests method of accounting for business com- were accounted for using both the pooling-of-interests binations initiated after June 30, 2001. SFAS 141 also and purchase methods. The pooling-of-interests requires that the Company recognize acquired intangi- method does not result in the recognition of acquired ble assets apart from goodwill if they meet certain crite- goodwill or other intangible assets. As a result, the ria. SFAS 141 applies to all business combinations initi- adoption of SFASs 141 and 142 will not affect the results ated after June 30, 2001 and for purchase business com- of past transactions accounted for under the pooling-of- binations completed on or after July 1, 2001. It also interests method. However, all future business combi- requires, upon adoption of SFAS 142, that the Company nations will be accounted for under the purchase reclassify the carrying amounts of intangible assets and method, which may result in the recognition of goodwill goodwill based on the criteria in SFAS 141. and other intangible assets, some of which may subse- SFAS 142 requires, among other things, that compa- quently be charged to operations, either by amortization nies no longer amortize goodwill, but instead test good- or impairment charges. For purchase business combina- will for impairment at least annually. In addition, SFAS tions completed prior to June 30, 2001, the net carrying 142 requires that the Company identify reporting units amount of goodwill was $18,165 and other intangible for the purposes of assessing potential future impair- assets was $8,916 as of September 30, 2001. ments of goodwill, reassess the useful lives of other Amortization expense during the nine-month period existing recognized intangible assets, and cease amorti- ended September 30, 2001 was $1,624. The Company is zation of intangible assets with an indefinite useful life. assessing but has not yet determined how the adoption An intangible asset with an indefinite useful life should of SFAS 141 and SFAS 142 will affect its future financial be tested for impairment in accordance with the guid- position and results of operations. ance in SFAS 142. SFAS 142 is required to be applied in fiscal years beginning after December 15, 2001 to all goodwill and other intangible assets recognized at that Information in the last paragraph of this example should be based date, regardless of when those assets were initially rec- on the individual facts and circumstances of a particular company ognized. It also requires the Company to complete a at the time of filing its financial statements with the SEC. 18 COPYRIGHT 2001, BDO SEIDMAN, LLP
    • Getting Ready Companies will need to plan carefully to implement – Reassess the useful lives of the amortizable the new Statements. In summary, a company will need intangible assets to perform the following steps: – Complete the transitional impairment test for non- • Determine whether it will be necessary to reclassify to amortizable intangible assets by comparing the fair goodwill the carrying amount of any intangible assets value to the carrying amount of the asset acquired before July 1, 2001 that do not meet the cri- • Prepare any necessary interim disclosures, including teria for separate recognition those required by SAB 74 • Determine whether it will be necessary to reclassify • Determine the date(s) for the annual impairment out of goodwill the carrying amount of any test(s) recognized intangible assets that meet the criteria for • Consider engaging a valuation specialist to perform separate recognition if a separate general ledger or provide advice on the following procedures during account or other accounting records are maintained the transition period and annually thereafter: • Determine whether it will be necessary to write off, – Determining the value of indefinite life intangible as a cumulative effect of a change in accounting assets and the residual value of amortizable principle, net of taxes, any unamortized unallocated intangible assets negative goodwill or equity method unallocated – Valuing the assets and liabilities in allocating negative goodwill from transactions completed purchase prices on new acquisitions before July 1, 2001 – Valuing the reporting unit(s) and the assets and • Determine the reporting unit(s) liabilities within the reporting unit(s) • Assign assets and liabilities to the reporting unit(s) – Developing the company’s own valuation model to • Assign all acquired goodwill to the applicable allocate the purchase price, to value the assets and reporting unit(s) liabilities within reporting unit(s), or to determine • Complete the following transition steps by their the value of the reporting unit(s). required dates: – Test goodwill of each reporting unit for impairment as of the beginning of the year in which Statement BDO is prepared to assist you, where appropriate, in implement- 142 is first applied ing these steps. Looking Ahead dards. We anticipate that the judg- Statements and the services BDO ment needed to determine report- can provide, please contact your The new Statements for business ing units and fair value will spawn a BDO engagement partner or, for combinations and goodwill and whole new body of interpretive lit- non-clients, please contact our other intangible assets represent a erature. So, the new Statements, as Director of Accounting, Frank landmark in financial reporting. The originally issued, may only be the Scheuerell: complexities of the pooling method tip of the iceberg. Phone: (212) 885-8194 have been replaced by a more judg- If you would like to obtain Fax: (212) 697-5076 mental set of impairment stan- more information on the new e-mail: fscheuerell@bdo.com. BDO SEIDMAN, LLP, FINANCIAL REPORTING 19
    • Table 3 Summary of Effective Dates Amortization of Goodwill and Other Adoption of New Rules on Company Year-End Indefinite Life Intangibles Impairment of Goodwill Calendar year • Business combinations completed before 7/1/01 – 1/1/02 cease amortization 1/1/02 • Business combinations completed after 6/30/01 – 1/1/02 no amortization Fiscal year beginning • Business combinations completed before 7/1/01 after 3/15/01 but – If first quarter 10-Q not yet filed – cease amortization Apply as of same date before 12/15/01 as of the beginning of fiscal year starting in 2001 or 2002 amortization ceases – If first quarter 10-Q has been filed – cease amortization Beginning of fiscal year as of the beginning of fiscal year starting in 2002 starting in 2002 • Business combinations completed after 6/30/01 – If first quarter 10-Q not yet filed – no amortization Beginning of fiscal year starting 2001 or 2002 – If first quarter 10-Q has been filed – no amortization Beginning of fiscal year starting in 2002 Other fiscal year-end • Business combinations completed before 7/1/01 – Beginning of fiscal year (e.g., 1/31/01, 2/28/01) cease amortization beginning of fiscal year starting in 2002 starting in 2002 • Business combinations completed after 6/30/01 Beginning of fiscal year – no amortization starting in 2002 Material discussed in this Financial Reporting newsletter is meant to provide general information and should not be acted upon without first obtaining professional advice appropriately tailored to your individual facts and circumstances. 20 COPYRIGHT 2001, BDO SEIDMAN, LLP PERMIT #1 GRAND RAPIDS, MI PAID U.S. POSTAGE Grand Rapids, Michigan 49546 FIRST-CLASS MAIL Suite 300 PRESORTED 770 Kenmoor S.E. BDO Seidman, LLP