Break out the compasses. Starting early next year, many CFOs will be entering the uncharted territory of goodwill impairment charges.
The new disclosures come in the wake of companies’ adopting the Financial Accounting Standards Board’s Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. And while finance chiefs still struggle with the nuances of implementing the standards’ impairment test for the first time, possibly the bigger mystery is how investors will respond to the data.
Thus far, the transition has largely been a non-event for investors. All public companies have been required to report the impact of the rules and have done so mostly by disclosing the earnings added back to their books after adjusting for goodwill that no longer needs to be amortized.
Some industry experts, however, say investors might just start paying more attention when companies begin to test for goodwill impairment, take big goodwill write-downs, and start disclosing that information publicly. Croker Coulson, a partner at Coffin Communications, an investor-relations firm, thinks we’ll see a series of “headline-making, potentially record-setting losses” as companies begin to implement the new rules.
Tom Burnett, president of Merger Insight, a research affiliate of Wall Street Access, agrees. “This is definitely an area that will be very sensitive,” he notes. “Under the old rules, goodwill was being amortized, so you knew that companies were eating into it. Now it’s going to be hanging around, so it can have much more of an impact in a single stroke when it is written off.”
The impairment exam is a two-step process that first tests to see if existing goodwill is impaired and then determines the size of the impairment. One indication that a company’s goodwill may be impaired is that the intangibles on the company’s books greatly exceeds its market capitalization.
Burnett maintains that investors will pay more attention to those differences. “A high goodwill ratio to assets and equity will be a turn- off to investors,” he says. “If goodwill is more than 10 percent of equity or more than 5 percent of total assets, I think that will be a warning signal,” he adds.
But other analysts say the timing of goodwill impairment will move investors as much as the size of the write-downs. All companies are required to take the first step of their impairment tests within the first six months of adoption and disclose those results in the 10Q.
If necessary, companies have one year from adoption to complete the second stage of the impairment test. In the period that a goodwill- impairment charge is taken, companies are required to disclose the business unit that has taken the loss, the amount of the loss, and the remaining goodwill. They must also provide a description of the causes that led to the impairment. All impairment charges taken within the first year of adoption can be written off as the result of a change in accounting. Anytime thereafter, goodwill-impairment charges will need to be disclosed as operating expenses and taken as a hit to earnings.