Take Note of Financial Reporting Standards

Under the new statements, the goodwill impairment test requires a market-based valuation of the reporting unit. 

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

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

Statement 142: This prescribes a new method of testing goodwill for impairment by establishing a separate test using fair value, which is based on market evidence or standard valuation techniques. If the goodwill’s fair value is less than its book value, goodwill is impaired. It’s important to have an expert perform a business enterprise valuation of the reporting unit to estimate its value as an operating business and then value identifiable assets, such as working capital and real property.

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

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

Within 6 months of the closing, existing goodwill must have a benchmark value assessment, which must establish whether the existing goodwill’s book value is impaired.

Under the new statements, the goodwill impairment test requires a market-based valuation of the reporting unit (that is, the unit reporting the goodwill). There are several impairment hot spots, including: the reporting unit’s current-period operating or cash flow losses, combined with a history of losses or a forecast of continuing losses; or significant adverse change in one or more of the assumptions or expectations (including competitive factors and loss of key personnel) used to determine fair value.

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

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

Matthew J. Miller is a managing director at BlueWater Partners, a middle market investment-banking firm. He can be contacted at matt@bluewaterpartners.com.