Around midyear, investors will be getting a better look at corporate balance sheets, thanks to new accounting rules covering goodwill and how to reflect its impairment. The big question is, will they like what they see?
Financial Accounting Standards Board Statements Nos. 141 and 142, of course, require companies to disclose a great deal of information–about acquisitions, fluctuations in the value of merger-related goodwill, and what their other intangible assets are worth, as well. Now, for example, acquiring companies will have to describe, in notes to their financial statements, why they paid a premium over the market price, if they did. They also must prepare condensed balance sheets disclosing goodwill amounts assigned to each major asset.
But for investors, perhaps the most important requirement is that companies discuss the circumstances leading to any impaired goodwill, and provide information about the reporting units for which impairment losses are recognized. (Calendar-year companies must adopt the standards starting January 1, and prepare any necessary initial impairment assessment reports by June 30.)
To date, most discussion about the rules has focused on the confused reaction of many CFOs to the revised reporting requirements. And Wall Street seems to be considering the reporting changes something of a non-event. In some cases so far, companies have added earnings back on their books after adjustments for goodwill that no longer needs to be amortized under the new rules. Hardly a worry for shareholders.
Any CFO caught up in the M&A mania of past years, though, should start focusing attention on investor reactions right away. As companies begin to test for impaired goodwill, major write-downs will result. Last week, management at AOL Time Warner announced that the media giant will be writing down as much as $60 billion because of FAS 142.
Expect more where that came from. Crocker Coulson, a partner in the Sherman Oaks, California, investor relations firm of Coffin Communications Group, for one, expects a series of “headline- making, potentially record-setting losses” as companies implement the rules. “Under the old rules, goodwill was being amortized, so you knew that companies were eating into it,” notes Tom Burnett, president of New York-based Merger Insight, a research affiliate of Wall Street Access. “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.”
Write-offs will depend on the results of an impairment exam, a two- step process that first tests to see if existing goodwill is impaired and then determines the size of any impairment. One instant indicator of potential impairment: goodwill that exceeds market capitalization.
Timing Is Everything
Burnett believes shareholders will indeed pay more attention. “A high goodwill ratio to assets and equity will be a turnoff 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.”
Other experts expect the timing of goodwill write-downs to carry as much weight as their size. Companies must take the first step of their impairment test within the first six months after adoption of the approach, disclosing the results in a quarterly 10Q report. If necessary, companies have one year from adoption to complete the second stage: a disclosure, in the period that a charge is taken, of the business unit recognizing the goodwill-impairment loss, how much that loss is, its causes, and the amount of any remaining goodwill. All charges taken within the first year after a company adopts the new approach may be written off as the result of an accounting change. After that, goodwill-impairment charges must be disclosed as an operating expense, and reflected as a hit to earnings.