For What Its Worth - Winter 2001/2002
Winter 2001/2002 PDF
Winter 2001/2002 Articles
In a long-anticipated pair of Standards issued on June 30, 2001, the Financial Accounting Standards Board (“FASB”) dramatically rewrote the rules of accounting for business combinations. While it had been known for some time that the pooling of interests accounting treatment for mergers and acquisitions would be eliminated, the Standards Board also included substantial modifications to the accounting for goodwill associated with acquisitions under the purchase method of accounting.
Statement no. 141, Accounting for Business Combinations, and Statement no. 142, Accounting for Goodwill and Intangible Assets, are a radical change, and now management accountants, auditors and financial executives must understand and work with a very different accounting process.
The effective date for eliminating pooling-of-interests accounting for business combinations (Statement no. 141) is June 30, 2001; transactions entered into after that date must use the purchase method.
Using the purchase method, a buyer company records on its balance sheet the assets purchased at fair market value. Any premium beyond the fair market value is considered an intangible asset and recorded as goodwill. Since goodwill used to be amortized over its economic life (up to 40 years), this approach had the effect of diluting the new entity’s earnings until the amortization accounting was changed.
Under the previously allowed pooling method, the balance sheets of merging companies are combined. In other words, the assets, liabilities, and equities of the companies are combined at their historic book values, and no goodwill is recorded. As a result, net income would be higher than if the purchase method were used.
Pooling was specifically prescribed for true mergers; combinations in which there is no clear acquirer or acquiree. However, acquirers had gone to tremendous lengths to secure pooling treatment in transactions that were not really true mergers. The ongoing conflict and confusion over purchase versus pooling accounting led the FASB to reconsider this practice in August of 1996 and hence, nearly five years later, we have the new standards issued.
The effective date for changing the accounting for goodwill and intangible assets (Statement no. 142) will be for fiscal years beginning after December 15, 2001 with early adoption permission under certain circumstances.
Under Statement no.142, companies will test for goodwill impairment using a two-step approach.
Financial statement preparers will compare the fair value of the entity to its carrying amount, including goodwill. If the entity’s fair value is greater than its carrying amount, goodwill is not impaired and the company doesn’t have to do anything else. Impairment occurs when the implied fair value of an entity’s goodwill is less than its recorded value. In this case, the second step follows.
Financial statement preparers will compare the fair value of goodwill to its carrying amount. If the fair value is less than its carrying amount, goodwill is considered impaired and the company must recognize a loss on the balance sheet.
FWIW - Winter 2001/2002
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