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									ADMS 4510 SUMMER 2002: STUDENT # 205807177 JESSY DAVID




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              GOODWILL ACCOUNTING




           JESSY DAVID STUDENT #205807177

           ADMS 4510 SECTION A SUMMER 2002

         BUSINESS COMBINATIONS- JOY KEENAN




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          ADMS 4510 SUMMER 2002: STUDENT # 205807177 JESSY DAVID




                                          Topic: Business Combinations


                                           Title: Accounting For Goodwill


                                                       Table of Contents

ABSTRACT ...................................................................................................................................... 3

INTRODUCTION ............................................................................................................................. 4

THE PURCHASE METHOD AND GOODWILL .............................................................................. 5

GOODWILL DEFINITION ............................................................................................................... 6

EXPOSURE DRAFT ....................................................................................................................... 7

NEW STANDARDS ......................................................................................................................... 9

IMPAIRMENT AND AMORTIZATION .......................................................................................... 11

EARNINGS MANIPULATION ....................................................................................................... 13

INVESTOR’S PERSPECTIVE ....................................................................................................... 18

THE OPINIONS ............................................................................................................................. 22

SUMMARY AND CONCLUSION .................................................................................................. 26

ENDNOTES ................................................................................................................................... 28

BIBLIOGRAPHY ........................................................................................................................... 30




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     ADMS 4510 SUMMER 2002: STUDENT # 205807177 JESSY DAVID




                                   ABSTRACT

The purpose of this paper is to discuss the current accounting method for

goodwill in relation to the purchase method of accounting for business

combinations. This paper focuses on goodwill in terms of how it arises, gets

identified and measured. I will also discuss the issue of amortization and

impairment of goodwill and whether amortization is needed or not. I will begin by

defining goodwill and discuss some of the reasons why this topic has become of

an increasing concern. Next, I will examine the purchase method and how

goodwill arises as a result of using this method. The problems of accounting for

business combinations will be discussed incorporating the exposure draft and the

new standards. I will also examine the current position of the Canadian Institute

of Chartered Accountants (CICA); our authoritative body on generally accepted

accounting principles (GAAP), and Financial Accounting Standards Board

(FASB) – US on goodwill and the purchase method relating to goodwill. FASB

and CICA have taken a definitive stand on this issue. I will discuss this stand and

to what extent this will affect financial reporting and most importantly the users.

Finally I will discuss the impairment and the amortization approach using different

sources and viewpoints. I will conclude with opinions and an analysis on whether

the standards are correct on discarding amortization of goodwill




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                                 INTRODUCTION

Corporate mergers, acquisitions, ventures and reorganizations continue to play a

key role in today’s economic activity. This has increased the importance for

accounting for business combinations. Accounting for business combinations has

been a highly controversial financial topic that has made headway both in

Canada and the States. As a result new standards have emerged that have

changed the way business combinations are accounted for. A huge part of the

change is in the area of goodwill. The issue of goodwill has evolved into an

extremely complicated and expansive area of accounting. Mergers, acquisitions

are occurring at a high pace and these companies need to understand the

concept of goodwill and how to account for it. The current issue of amortization

model versus the impairment model has triggered many discussions and

debates. These new standards eliminate the pooling-of-interests method of

accounting. It also significantly modifies the accounting for goodwill by putting an

end to amortization and introducing a new complex valuation model to test for

impairment. My approach to writing this paper is to first understand the concept

of goodwill accounting in the realms of the purchase method. This involves going

back to the exposure draft and the new standards for guidance. Through articles,

comments and theories the current standard will be assessed in relation to

goodwill accounting. Different perspectives on the views of goodwill amortization

and impairment with the investor in mind are also considered. Finally, I will




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examine the authoritative sources CICA Handbook and FASB as I felt that they

are an excellent source for this topic



                             DESCRIPTIVE SECTION

                  THE PURCHASE METHOD AND GOODWIL


With regards to goodwill the purchase method is the key accounting model used

to measure and determine goodwill. A business combination occurs “when an

enterprise acquires net assets that constitute a business, or acquires

equity interests of one more other enterprises and obtains control over that

enterprise or enterprises” Canadian Institute of Chartered Accountants,

Section 1581.06, CICA Handbook. Essentially there are two method of

accounting for business combinations – the purchase method and the pooling of

interests method. As mentioned the purchase method gained momentum

recently as it is now the official method of recording business combination. The

way the purchase method works in a business combination is that one entity

acquires the net assets of other combining companies. The acquiring company

records net assets received at fair value at the date of combination. Any excess

of cost over the fair value of net assets acquired is allocated to goodwill and

amortized over a period of years. In the pooling method, the consolidated

balance sheet is a creation of simply adding together the balance sheets of the

combined companies. Fundamentally the concept of a pooling of interest is that

nothing of real economic substance has occurred in the combination. All the

previous shareholders remain as shareholders; the assets of the combined



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companies are same as before. Pooling recognizes the transaction as a merger

of equals, thus the transaction is recorded as company A plus company B. Both

companies are viewed as equal and there is no acquirer or amortization of

goodwill.

                                    GOODWILL


To better understand the core concept of goodwill a solid fundamental approach

of the definitions are required. If you look at financial statements, you will see

goodwill as an asset that is created when one company acquires another. This is

one way that goodwill can be generated and represents what the acquirer pays

to buy the company less the fair market value of the acquired company’s assets.

For example, if Coke bought Pepsi for $ 15 billion, and it was determined that

Coke's assets were worth $ 13 billion, $ 2 billion of the purchase price would be

allocated to goodwill on the balance sheet. Goodwill is the excess of cost

(purchase price) over the fair value of net assets acquired inclusive of other

intangibles. In our coke example, the name coke over a no name brand has

value that you and I perceive and can be thought of in simpler terms as goodwill.

So how have experts defined goodwill? As noted by Johnson “a major part of

accounting for goodwill is agreeing on the definition itself”. Johnson,

Jeanine, “ Goodwill an eternal controversy.” CPA Journal, April 1993. Goodwill is

defined using two main approaches - the residuum approach and the excess

profit approach. The residuum approach is an old approach and as the name

suggests it is what ever is left over. By that I mean the consideration less the fair

market value of net assets. “ In the excess profits approach, goodwill is the



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difference between the combined company’s profits over normal earnings

for a similar business. Under this definition, the present value of the

projected future excess earnings is determined and recorded as goodwill”

Johnson, Jeanine, “Goodwill an eternal controversy.” CPA Journal, April 1993.

According to the CICA Handbook Section 1581, “Goodwill is the excess of the

cost of an acquired enterprise over the net of the amounts assigned to

assets acquired and liabilities assumed” Canadian Institute of Chartered

Accountants, Section 1581.06, CICA Handbook. It is imperative that the concept

of goodwill be understood, as it is the basis of the purchase method. My next

point will provide some background on how accounting for goodwill changed.

                              EXPOSURE DRAFT

Essentially Section 1580 was the basis for business combinations. This Section

basically permitted three methods of accounting for business combinations

namely the purchase accounting, pooling of interest method and the new entity

method. In terms of practice the purchase method was by far the most popular

and practiced in Canada and goodwill was amortized over 40 years. Pooling of

interest was very rare in Canada. In the United States it was predominant

however there were specific criteria that had to be met in order to apply it. The

question then arises why the big change. Both goodwill and the purchase method

had been there for a long time. It was FASB that initial started this project

recognizing a need for change and Canada joined the task force. Standard

setters got together to increase the comparability of financial statements. This

was a big problem as different methods were being used and there was no basis




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of comparability. Accounting should be the motivation for which method to use

and not the other way around. It seemed that the driving force behind mergers

was the method to be used. Therefore there was a need created for comparable

and consistent financial statement, which was recognized by the authorities.

Competition in markets was also a cause that led to change. Users were not

getting the information they needed with regards to intangibles as a lot of assets

were missed out as intangibles. Finally one method of accounting was needed to

account for similar financial transactions, as a single method would eliminate

problems of inconsistencies. This eventually led to the exposure draft issued by

CICA and FASB.

FEATURES OF EXPOSURE DRAFT:

The main features of exposure draft are outlined as follows. The purchase

method of accounting will be used for all business combinations. With regards to

goodwill, it is to be capitalized and amortized over its useful life, not exceeding 20

years. Goodwill charges (amortization and write down) are to be presented on a

net basis. On that note the separation of goodwill charges from earning was an

attempt aimed at consistency and comparability of financial statements. The

earnings per share is permitted for income before goodwill. In terms of Intangible

assets will generally be amortized over their useful life, which is to be no more

than 20 years. Certain intangible assets, for which there is an observable market,

would not be amortized. Canadian Institute of Chartered Accountants. “ Exposure

draft – Business Combinations” September 1999. Due to intense lobbying in the

United States the exposure draft was revised and the results are the new




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standards. The new standards achieve harmonization with US standards. It is

called “ level the playing field” by the CICA – in their media release. Canadian

Institute of Chartered Accountants, “ CICA’s Accounting standards board

proposal will lead to harmonized accounting for business combinations in

Canada and the US – Media release y. CICA Website, September 1999.



Therefore the exposure draft led to the new statements Section 1581 for

Business combinations and Section 3062 for Goodwill and intangibles. FASB on

the other hand also issued SFAS 141 for business combination and SFAS 142

for goodwill and intangibles. There is no divergence in both standards.



                            THE NEW STANDARDS

These new standards state that the purchase method is the only method that can

be used to account for business combinations. The main features of Section

3062 for Goodwill Amortization State that,

“Goodwill should be recognized on an enterprise’s balance sheet as the

amount initially recognized, less any write down for impairment. Goodwill

is not amortized. It is tested for impairment in accordance to this section.

”Canadian Institute of Chartered Accountants, Goodwill and other Intangible

Assets.” Section 3062.

In terms of recording goodwill it is to be reported as a separate line item on the

balance sheet and an impairment loss is also to be reported in the same manner

but on the income statement. Goodwill is also separated from intangibles by




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carving out all the identifiable intangibles out of goodwill. Additional guidance is

given to identify intangible assets apart from goodwill acquired in a business

combination. These intangibles include customer lists, construction permits,

secret formulas, etc. Therefore analysts, creditors and users of financial

statements will find it easier to know precisely what goodwill consists of. It will not

be a number on the balance sheet that consists of different values lumped up

together and called goodwill.

FASB on the other hand have exactly the same standards just documented

differently. The features of new standards are summed up pretty well by Moehrle

S and Reynolds J articles. The new FASB standards ”prohibit the pooling of

interest methods of accounting for business combinations and require a

purchase     accounting      method     that   does     not   allow    for   goodwill

amortization”. Moehrle, R, Stephen and Reynolds, A Jennifer” Say Good – Bye

to Pooling and Goodwill Amortization”, September 2001. Say goodbye to pooling

and Goodwill Amortization is a pretty good way of summing up new standards,

which are now the future of business combinations. In essence goodwill

impairment means that companies have to change their income statement only

when goodwill suffers a decline in value. This is a fundamental change regarding

the concept of goodwill. It was always viewed as a wasting asset; now it can

maintain its value indefinitely unless severe impairments happen. These changes

are radical changes in the world of mergers and acquisitions. Accountants,

auditors, investors and users of financial statements will have to understand

these new rules work with them. The standards were a result of a lot of




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deliberations and are trying to seek a better accounting model that will combat all

the problems encountered with accounting for business combination.



Perhaps the most important thing to remember about the new accounting rules is

that they have absolutely no cash flow impact. Accounting rules dictate how

transactions are reflected in financial transactions; they do not create or eliminate

wealth or cash flow. A decision to enter into a business combination transaction

that makes good economic sense should not depend on the accounting

treatment of the transaction. While the new accounting rules will surely not

please everyone, they at least level the playing field so that all transactions are

afforded the same accounting treatment.



However the success of measuring how well a standard is working can only be

told by time and practicality. According to FASB, the new standards are geared

towards improving financial reporting. How will these changes affect financial

reporting will be illustrated later on in the paper.



                       IMPAIRMENT AND AMORTIZATION


Amortization is a systematic and rational method of accounting and essentially it

is a straight line. Therefore you have to determine the benefit period from the

acquisition and then amortize the goodwill over the benefit period. Basically it is

the same amount every year for the benefit period chosen. Under the old method

whether the expected benefits exist for the benefit period, let’s say ten years, the



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company will still continue to amortize the goodwill for ten years. If there is a

severe impairment then only will there be a write down. Impairment testing works

differently. A year after purchase the fair value of assets is calculated. Let us

assume it is 20 million and what the company recorded it at is lower than the fair

value, then there is a write down right away. The impairment approach has more

ups and down and is not easily manageable but it gives management more

flexibility in determining earnings like systematic amortization. The new rules call

for companies to access goodwill for impairment annually and during an interim

period if events or circumstances would more likely than not reduce the fair value

of a reporting unit below its carrying value. It is a complicated and new concept.

In theory the impairment approach works by first dividing the company into

reporting units. It is a two-step impairment approach. The first step is to compare

the carrying amount of the reporting unit (including goodwill) to its fair value. If

the carrying amount of the reporting unit is less than its fair value, goodwill is not

impaired. If the carrying amount of the reporting unit is greater than its fair value,

the second step is necessary to measure the amount of goodwill impairment. The

second step is to compare the carrying amount of the goodwill to its implied fair

value. If the carrying amount of the goodwill exceeds its implied fair value, this

impairment loss is recognized. The fair value of a reporting unit will not be equal

to the net fair value of its identifiable assets and liabilities. An entity must

measure the fair value of the reporting unit as a whole. If the reporting unit’s

stock is actively traded, a quoted market price should be used as the basis for

the measurement. The second step is a difficult task that likely entails a third-




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party valuation. In practice the determination of the fair value of a reporting unit is

very challenging and can be a costly and timely procedure especially for small

organizations. The methodology used to estimate fair value would be subject to

close scrutiny by regulators and auditors. Because even minor variances from

assumed earnings, revenues or other criteria used to determine fair value could

result in impairment loss. Hence careful consideration should be given to the

assumptions underlying the valuation of reporting units. In a volatile economy,

these assumptions can be subject to rapid and dramatic change.



                    DISCUSSION AND ANALYSIS SECTION

                            EARNING MANIPULATION

What is the trade off between the amortization and impairment approach? Does

the new standard have room for manipulation? In the area of goodwill there might

be room for earnings manipulation. Earning manipulation works mainly through

management. For the purpose of this paper, I took two theoretical approaches to

demonstrate earning manipulation using the impairment and amortization

approach. In the first illustration let us assume that management wants to write

everything off. This is referred to as the big bath theory and is defined in the

article “ Numbers Game” by Henry and Schmitt as

“ A Company takes a huge restructuring charge one year, often when it’s

making losses or much lower profits than before. It may sound crazy to

make losses look worse, but the ploy gives the company big help in




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reducing expenses and enhancing earnings in the future.” Henry, David,

Schmitt H Christopher “The numbers Game”, Business Week, May 15, 2001.

For example let us say that a company was acquired for ten million and out of

that two million is goodwill. Under the new standards this goodwill will be tested

to see if it is impaired. If the stock price of the company has decreased, that

means that the goodwill is impaired. What does impaired goodwill indicate? It

shows that the company paid too much for previous acquisitions and will have to

write off that goodwill. This will put management to the test, as a write down will

affect earnings and management’s credibility will then be questionable. In

addition management will have to admit that they paid more for the acquisition

than they should have. The temptation to engage in “big bath” accounting moves

in bad year is always there, and goodwill impairment is another area where we

may see many such “one time charges”. This is an earnings management

strategy. Basically by taking a big bath management wants to reduce current

period income. The impairment write down is a perfect opportunity for a big bath

and therefore leads to earning manipulation. Let us go back to our example

where a company acquired another and as a result there was goodwill on the

books. Management determined that this goodwill was impaired. Therefore

management announced a half a million charge against this year’s earnings.

While this charge will penalize this years earnings, it will eliminate these charges

over the next years. The current impairment charge will boost subsequent

earnings. While this charge will penalize this years earnings, it will eliminate

these charges over the next years. The current impairment charge will boost




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subsequent earnings. This will also create an illusion of growth. However the

situation can get worse. Let us say that out of two million of goodwill only half

was impaired. Therefore management has inflated this charge. Therefore this

charge will be buried into the current write off and no one will have to know. It

can then be used for as a reserve for future years typically known as a “ cookie

jar approach”. The “cookie jar approach” is explained by McGregor in his study of

earning manipulation as a technique where in “times of strong earnings, the

firm establishes additional expense accruals and subsequently reduces the

liability to generate earnings when needed in the future – pulling a “cookie

from the jar”. Mc Gregor, Scott, “Earnings Management and Manipulation

Study.

Had amortization been used to account for goodwill, it would be very difficult for

management to participate in this earning manipulation strategy. Another issue

that comes up from this illustration is that of judgment.

Companies may also be tempted to minimize the number of reporting units. The

greater the number of reporting units, the greater the chance of goodwill

impairment charges diluting future earnings. This is because an increase in the

value of one unit cannot be “netted” against a decrease in the value of another.

Thus, if unit A has declined in value by $50 million and unit B has increased in

value by $ 70 million, unit A will have to write off a portion of its goodwill. Had the

company successfully combined the two units into one, there would be no

impairment and no earnings charge.




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Companies also have an incentive to allocate the greatest share of goodwill to

units that are doing well and are expected to increase in value. This will minimize

the expected write-offs associated with the expected decline in the value of

poorly performing units.

In particular, in the transition year (the first fiscal year when companies

implement the new rules) the incentive to take very large non-recurring charges

will be great, since any such charges upon implementation will be treated below-

the-line charges due to a change in accounting principles.

By increasing the number of reporting units, there is a greater chance of

increased goodwill impairment charges. Therefore management can be very

subjective. Going back to the big bath manipulation technique, it will become

more popular in merger acquisitions where a lot of write off are taken to provide

for a reduced current period income. Users overlook these unusual and non-

recurring charges and the focus is diverted to future earnings. Managers are

always motivated towards earning management. Their main motivation is

management bonuses that are based on accounting figures. It is a pretty

fascinating game. Managers try and achieve beyond their bonus target in bad

years. In good years they will hit below the targeted bonus number. This way

they will have some reserve and will not look bad. Through big baths

management can make huge write-downs due to impairment of goodwill as a

one-time charge in bad years.

Another technique that management can use is making no write down to the

assets. This will portray a healthy picture to investors. There will only be a write




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down when needed. Management can use this discretion to help them look good.

Now that there is an impairment approach management has the option of

deciding whether to take an impairment or not. Had amortization been a required

procedure, there would be a predictable amortization expenses against income.

A lot of subjectivity and management judgment will influence the amount and

timing of the write down. In an article by Edward Ketz, he vehemently supports

the fact that management will be manipulative with goodwill impairment. He

claims that no one can precisely value goodwill and it is therefore difficult to do

an impairment test. Therefore investors will have a hard time estimating the true

figure of goodwill. He further his point by taking the position that

“Managers will choose several “reliable” sources to measure goodwill for

them. In this context, “reliable”, of course, refers to professionals who will

reliably provide answers managers want; I’m taking about reliable

measures rather than reliable measurements. In this case, managers can

make reasonably sure that goodwill is not impaired.” Ketz, Edward J,

“Goodwill Gunked” Smartpros Ltd, January 2001. Even though the impairment

method is aimed at achieving fairness, management has more discretion to

manipulate. Let us take a manager’s compensation for example that is based on

achieving a certain percentage of ROA. By not taking amortization charges and

an increase in the total assets will increase this number. This is good news to

managers who are going to maneuver that number to increase their

compensation. Where does the investor fit into all of this? Assuming that the

investor is a rational investor, it is better that the investor focuses on cash flows




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than earnings. One point that can put investor’s minds at ease is the role of the

SEC. The SEC is always on the look out for companies that try to engage in

earnings management strategies. In fact this scrutiny will increase because of the

implementation of the new rules and once SEC discovers any diversion,

companies will be asked to explain the analyses behind its judgment. The worst

case scenario require them to restate their earnings



                          INVESTOR’S PERSPECTIVE

Let us look at goodwill from the investor’s perspective. Goodwill in the old

method definitely affected net income, as it was a charge against income. With

the new model goodwill impairment will have to be written off at once and over a

number of years. Are investors ready to see this kind of write down all at once?

Investors guide the market. The market reaction to this would either be positive

or negative. They could consider it positive in the notion that two companies have

merged and now there is a clean slate to work with as all the impairment is

written off. Investors could view the drastic write-offs as a one time non-recurring

charge. These could have occurred if the company paid more for the earnings

and overstated the prior period earnings. However, the market generally views

large write-offs as water under the bridge. Therefore, impairment losses could be

viewed as one-time non-cash charges that have no impact on the size of the

company’s cash-flow streams. Alternatively, they could consider the value of the

net worth of the assets less than what they wanted it to be.




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One of the objectives of financial reporting is to provide decision-useful

information. Using the same method of accounting for all combinations, goodwill

and intangibles by following specific rules should increase comparability between

companies. Requiring all combinations to be recorded at fair value is going to

enhance the concept of representational faithfulness. Reducing income only

when there is evidence that goodwill has declined will also increase

representational faithfulness in the world of investors. Therefore, the new

requirements should provide better decision-useful information.



Beginning in 1998, the Association of Investment Management and Research

began a study with the aim of determining whether the elimination of goodwill

amortization from income will reduce the usefulness to investors. The study was

essentially designed to reflect the importance of amortization on the investors.

The study compromises of data compiles from 1993 –1998. As mentioned before

decision usefulness is important for investors, as investors are concerned about

impacts of financial accounting method. The study is a valuable aid to most

investors. The result of this study indicated that

“When investors approximate share value by capitalizing accounting

earnings, perhaps as a prelude to further analysis, the goodwill

amortization component of reported earnings can be best viewed as a

source of noise. Thus, excluding goodwill amortization from corporate

income statements under the new rules will not reduce the usefulness of

earnings but, rather, may eliminate a source of noise in earnings as




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measured under previous standards. Jeannings, Ross, Leclere Marc and

Thompson II Robert B, “Goodwill amortization and the usefulness of earnings”

Financial Analysts Journal, Charlotteville, Sep/Oct 2001



In article by Caplan, “Investors can see clearly now” she thinks that investors are

in a better position now and her position is that investors

“Will now have more access to information about business combinations

and the value of intangible assets. Greater transparency will enable

investors to gauge the value of acquisitions for the overall business more

easily. It will also help them to better evaluate management’s judgments.

The rules require companies to disclose the value of their goodwill down to

the reporting-unit level, as well as the primary reasons for an acquisition,

the allocation of the purchase price, and description of and amounts

allocated to intangible assets.”Caplan, Jennifer investors Can See more

Clearly Now” CFO magazine, October 2001

Can investors clearly see more? The new rules are geared towards giving

investors a clearer picture of the company. However amortization is a pretty

straightforward and precise concept as opposed to the impairment method.

Despite all the positive things critics argue that investors will not get the

information desired by the current model of impairment testing. The subject of

income manipulation comes into the picture. How are investors going to avoid

that aspect? This is an area that investors have no control over; however if the

standards were stringent then investors would have less to worry about. The




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standard has proposed benefits to investors in terms of transparency. However in

reality this might just be fabricated. As an example consider an acquisition where

a firm could write off a $1000 asset that continues in use or otherwise depreciate

the asset over the next five years at $ 200 a year. If the investor were to ignore

this write down, then they will not be effective in evaluating the current year as

company earnings will have increased by $ 200 due to depreciation expense not

accounted for. If investors write down the entire amount, the earnings will be

penalized in the current year.

Investors can evaluate the effect of the entire write off however they will not be

able to see the effect in the span of five years. Therefore while the initial amount

of nonrecurring charge is relatively transparent, the implications of that charge for

future fiscal periods’ earnings are more opaque. So basically what does all this

mean to investors? By not amortizing goodwill, net income is higher as there will

be no charge to earnings. However is that a reliable number? Will the companies

inform the investor where the earnings are coming from? Companies want to

look as positive as they can be in terms of reported earnings. The fact that 2001

was a difficult year and the fact that the new standard came into existence at the

same time can make things look pretty deceiving. Investors will have to study

and examine cash flows reports to make a correct assessment of the situation.



COST OF THE NEW RULES

Implementation of the new rules will be costly in a number of different ways:




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Amortization expense resulting from purchase method (when there are other

intangible assets) will reduce earnings. Cost of analyzing and valuing prior

purchase transactions. Valuation of assets upon completion of a purchase. On

going assessment for potential impairments. Maintaining records consistent with

the new concept of reporting unit. Developing new disclosures.




                                   The Opinions

After presenting some of the proposals on how to deal with the topic of goodwill

accounting. I feel it is necessary to present opinions, which deal with this topic.

                                 SEC INTERVIEW

In this paper, I wanted to illustrate this method through the governing body of

SEC. What has SEC to say about these new changes especially the issue of

goodwill versus impairment? In an article by Robert Colson, the Securities and

Exchange Commission Chief Accountant Lynn Turner is interviewed on her

opinion on the recent FASB ruling on goodwill. She comments that

“I have concluded that there are good, rational arguments for both major

positions on goodwill accounting. On the one hand, in the context of the

traditional accounting model, purchased goodwill does “waste out” if

ongoing expenditure and investments are not made and, accordingly,

should be amortized. On the other hand, common sense tells you that if the

value of a business has not declined, you should not be charging a loss for

a decline in value.” Colson, Robert H,”In the interest of the investor: An




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     ADMS 4510 SUMMER 2002: STUDENT # 205807177 JESSY DAVID

interview with Lynn Turner.” CPA Journal, November 2001. However her next

comments showed that she had valid concerns about the impairment test.

According to her the impairment test            “does not provide adequate

implementation guidance to ensure comparable, consistent application.

Comparability and consistency are two qualities FASB has said are

necessary for quality financial reporting. My concern is that the test is not

tied directly to fair values and relies on impairment triggers” Colson, Robert

H, “In the interest of the investor: An interview with Lynn Turner.” CPA Journal,

November 2001. She is concerned about the investors who are affected by the

flaws of the proposed standard. With the new impairment approach companies

will have inflated goodwill and other intangible assets that have never been

impaired. Even though declines occur in values over time, statistics show that

there are those large write offs that are done on an overnight notice leaving the

investor hanging. This questions the credibility of the financial statements and the

accounting standards that perpetuated them. I think LynnTurner has raised

important issues that we cannot afford to ignore. The impairment testing is a new

phenomenon in the goodwill arena. Rarely was goodwill ever tested for

impairment and the test will truly test the issues of comparability and consistency.



                   FASB COMMENTS ON TRANSPARENCY

Currently goodwill amortization is a well-established concept that everyone has

become accustomed to using and understanding. The movement away from it by

eliminating it could result in confusion among the users as some are




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     ADMS 4510 SUMMER 2002: STUDENT # 205807177 JESSY DAVID


sophisticated, but most are unsophisticated. Although this can be considered a

disadvantage, FASB spent months trying to work around all the issues behind

business combinations. The good thing that came about with all this was the use

of one method. This will definitely improve the comparability and consistency of

financial information. Users will be able to compare apples to apples, as all

mergers will be treated the same way. Users will also have a better

understanding on the investment made in an acquired company. Using one

method is advantageous not only for the reasons explained but also that it is less

costly. However the benefits of these costs will be compromised by the costs for

valuation and impairment testing. The shock has not sunk in but companies will

have to be spending a lot more time and money in evaluating reporting units fair

values etc. Going back to FASB decision on the new impairment testing,

obviously they thought that the impairment testing had enough benefits to

actually make it accounting law. FASB is very confident about the new method

and it is clearly stated in all summaries the goodwill impairment will enhance

financial reporting, as there will be better understanding of goodwill.

In the article “Say goodbye to pooling and amortization ”CPA Particia McConnell,

senior managing director at Bear, Stearns & Company, Inc., and head of its

accounting and taxation equity research group, further emphasizes FASB

sentiments. She also believes that transparency can be achieved through

impairment testing of goodwill. McConnell says

“If properly applied and enforced it will give users of financial statements

more insight than the current system of arbitrary amortization, which tells




                                                                                24
       ADMS 4510 SUMMER 2002: STUDENT # 205807177 JESSY DAVID


little or nothing. A goodwill impairment charge may be an important signal

of a decline in a business for reasons not obvious to financial statement

users.” Stephen R Mohrle and Jennifer article” Say good-bye to Pooling and

Goodwill Amortization, September 2001.

In a response to this comment letter in the CPA journal by Kavanagh she

questions FASB’s reasoning behind impairment testing as she relates that “the

statement tells us that the quality of financial reporting is enhanced by not

amortizing goodwill (i.e. financial statements are more useful and relevant),

and that the board believed that amortization of goodwill was in many

cases ignored by users of financial statements anyway. But if that were the

case, why did the board need to “fix” the accounting?” Linda Kavanagh,

“Untangling FASB’S Convulated logic “ letter to the editor, CPA Journal, January

2002

Basically this response stems up from the reasoning behind impairment, as it is

believed that the impairment model maintains the value of recorded goodwill. I

think whether we use the impairment or amortization approach, supporters

believe that goodwill is not a wasting asset and will always retain its value. In the

amortization approach goodwill consistently loses its value over time and so is

amortized. I agree that goodwill is not a wasting asset however the aspect of

impairment testing could result in writing the whole thing off. Then how does this

maintain the value of goodwill? On the other hand amortization is as systematic

and standardized approach, A whole write off of goodwill is not permitted using

the amortization approach. Given this analogy how can users ignore the concept




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     ADMS 4510 SUMMER 2002: STUDENT # 205807177 JESSY DAVID


of goodwill? On the end of the spectrum CICA has the same view with regards to

goodwill amortization. Does CICA realize that by adopting this standard, it is

forever eliminating the amortization model? At least the good part about it all is

that both Canada and US will have the same standards. CICA accepted the new

standards well.

                                  CONCLUSION

We had a choice in using two methods before the new standard came about. We

could choose the purchase method with amortization of goodwill or the pooling of

interest method with no goodwill impairment. Due to intense lobbying the FASB,

passed the standard that eliminated both the pooling of interest and goodwill

amortization. This became law in Canada too. Both FASB and CICA have taken

a definitive stand on accounting for business combinations. Goodwill impairment

a new concept is now the core concept behind goodwill amortization. The

exposure draft that outlines all the issues led to new standard. One good thing

about the standard is that it definitely improves the issues of comparability and

consistency. As one single method is used, things are more standardized.

Therefore analysts will not have to make adjustments like they used when two

methods were used. However a big gray area is the measurement of goodwill.

Have the standards covered all the loopholes by bringing in the new impairment

approach. It was determined that the new impairment approach has a lot of

loopholes. Goodwill after the date of acquisition also fails the test of

representational faithfulness. The computed goodwill, however, can be easily

tainted with “internal goodwill” generated from other activities, events, resources,




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     ADMS 4510 SUMMER 2002: STUDENT # 205807177 JESSY DAVID


and social arrangements. The calculated number may thus have little to do with

the purchased goodwill. This new approach is subjective to income manipulation.

As the impairment approach brings about an increase in the earnings it is viewed

a conceptually pure however it is not. The proposed impairment test is not

verifiable, for managers will have the opportunity to deny impairment in many

situations. Auditors will have no benchmark by which to evaluate the treatments,

so they will sign off on almost anything the managers want. The systematic

rational method of amortization is very verifiable. Yet the FASB believe that the

method will improve transparency of financial statements and give users better

reporting. SEC however criticized the impairment approach and felt that investors

will not get credible information. The investor’s perspective was illustrated and

both sides of the issue were demonstrated. “While write-downs hurt many

companies’ earnings this year, they boost earnings in the long run as long

as the companies don’t have to take additional impairment charges” said

Dan Noll, director of accounting standards for the American Institute of Certified

Public Accountant.” “ If you don’t have to expense that over time, your net

income is going to be higher,” he said. “ Bottom-line net profit will look

better.” Alan, Clendenning “ Goodwill Accounting rules are hitting corporations

hard. The Associated Press, April 2002. Other opinions and viewpoints were also

looked into. Basically this is a brand new concept; it is a reinvention of the old

method but just sugar coated. In every new standard, there are always benefits

and deterrents. As illustrated in the paper different people have their own

perception of the methods. In my opinion this whole process of goodwill




                                                                                27
        ADMS 4510 SUMMER 2002: STUDENT # 205807177 JESSY DAVID


impairment is very complex and will incur great costs and time. However the

effect of the standards will not be noticeable at the present time. The flaws will be

released when there is a huge financial crisis like Enron for example. This is just

a Band-Aid solution to a problem we could have rectified had we not discarded

amortization. I end my opinion with quote from Jeanne Temmile in her article “No

Accounting for Goodwill” where she describes my sentiments by indicating “ The

full practical impact of this proposal will become clearer only after

implementation, as is the case with many accounting changes which start

out simple and end up complex.”No accounting for goodwill” Investext Plus

March 1, 2001




                                   ENDNOTES

i Johnson, Jeanine, “Goodwill an eternal controversy.” CPA Journal, April 1993.

Pp.1.

ii Johnson, Jeanine, “Goodwill an eternal controversy.” CPA Journal, April 1993,

pp.1.

iii. Canadian Institute of Chartered Accountants, Section 1581.06, CICA

Handbook.

iv Canadian Institute of Chartered Accountants. “ Exposure draft- Business

Combinations” September 1999.




                                                                                   28
     ADMS 4510 SUMMER 2002: STUDENT # 205807177 JESSY DAVID

V Canadian Institute of Chartered Accountants, “CICA’s Accounting standards

board proposal will lead to harmonized accounting for business combinations in

Canada and the US- Media Release y, CICA Website, September 1999.

vi Canadian Institute of Chartered Accountants, Goodwill and other Intangible

Assets.” Section 3062.

vii Moehrle, R, Stephen and Reynolds, A Jennifer” Say Good-Bye to Pooling and

Goodwill Amortization”, September 2001

viii Henry, David, Schmitt H Christopher “ The numbers Game”, Business Week,

May 15, 2001

ix Mc Gregor, Scott, “ Earnings Management and Manipulation Study.

x Ketz, Edward J. “Goodwill Gunked” Smartpros Ltd, January 2001.

xi Jennings, Ross, Leclere Marcand Thompson II Robert b. Goodwill amortization

and the usefulness of earnings” Financial Analysts Journal, Charlotteville,

Sep/Oct

xii Caplan, Jennifer” Investors Can see more clearly Now” CFO Magazine,

October 2001

xiii Colson, Robert H,”In the interest of the investor: An interview with Lynn

Turner.” CPA Journal, November 2001

xiv Stephen R Mohrle and Jennifer A Moehrle article” Say good-bye to Pooling

and Goodwill Amortization, September 2001.

xvi Comments Concerning Exposure Draft ( Revised): Business Combinations

and Intangible Assets- Accounting for Goodwill – Timothy Lucas




                                                                            29
     ADMS 4510 SUMMER 2002: STUDENT # 205807177 JESSY DAVID

xvii Linda Kavanagh, “Untangling FASB’S Convoluted Logic” letter to the editor,

CPA Journal, January 2002

xviii Terrille, Jeanne, “No Accounting for goodwill” Investext Plus March 1, 2001

xviiii Espen, Robak,” Are America’s CFO’s Ready for their Impairment Test?”

http://www.fmvopinions.com

xv Anthony, Cocco and Moores, Tommy, “Accounting for Business Combinations

and Intangible Assets”. CPA Journal, April 2002

xvi Clendenning, Allan, “Goodwill Accounting rules are hitting corporations hard”

The Associated Press, April 27, 2002

xvii Ketz, Edward “ The Accounting Cycle: Wash, Rinse and Spin FASB’s

Exposure Draft on Accounting for Goodwill” Smart Pros March 12, 2001

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Canadian Institute of Chartered Accountants” Business Combinations”, CICA
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Canadian Institute of Chartered        Accountants.    “Exposure    draft-Business
Combinations” September 1999.




                                                                                    30
     ADMS 4510 SUMMER 2002: STUDENT # 205807177 JESSY DAVID


Hope, Kristen O, “ Why Such A Fuss Over Goodwill?” The CPA letter, September
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Caplan, Jennifer” Investors Can See More Clearly now” CFO Magazine, October
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                                                                             31
      ADMS 4510 SUMMER 2002: STUDENT # 205807177 JESSY DAVID


Financial Accounting Standards Board, Summary of Statement no 141 Business
Combination (2001)

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Complex and costly new rules announced for mergers and acquisitions (#01-12)
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Espen, Robak “Are America’s CFO’s Ready for their Impairment Test?
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Anthony, Cocco and Moores, Timothy “Accounting for Business Combinations
and Intangible Assets”. CPA Journal, April 2002

Clendenning, Allan “Goodwill Accounting rules are hitting corporations hard” The
Associated Press, April 27, 2002

Ketz, Edward “ The Accounting Cycle: Wash, Rinse and Spin FASB’s Exposure
Draft on Accounting for Goodwill” Smart Pros March 12, 2001




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