Accounting for business combinations and acquisition goodwill changed in 2001 when the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 141, Business Combinations (SFAS No. 141) and Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS No. 142). (1) Elimination of the pooling-of-interests method, new guidance on identifying intangible assets, elimination of goodwill amortization and required impairment testing for goodwill and other intangibles are some of the key changes included in these two new standards. One of the most important changes bank acquirers must now address is annual impairment testing for all intangibles that are not subject to amortization. These intangibles include goodwill and any other intangibles that "arise from contractual or other legal rights" or are "separable from the acquired entity" (SFAS No. 141 [paragraph] 39). The impairment testing for these intangibles, required by SFAS No. 142 [paragraphs] 17 and 26, may result in the recognition of impairment losses. These impairment losses reduce net income and the carrying value of assets. Understanding how this testing works and what makes one vulnerable to these impairment losses can help banks make appropriate strategic decisions about goodwill and other intangible assets.
Banks and other companies with recognized goodwill from purchase acquisitions before SFAS No. 141 and SFAS No. 142 have already had to transition to the new SFAS No. 142 rules for goodwill impairment testing. (2) However, because many bank acquisitions were previously accounted for using the pooling-of-interests method, in which goodwill and other previously unrecognized intangible assets are not recognized at acquisition, current bank acquirers may be less familiar with the purchase accounting method and its treatment of intangible assets. Also, because goodwill had been amortized under the old accounting rules, acquirers' initial goodwill impairment tests may not have resulted in recognition of impairment losses. Bank acquisition activity has increased during 2003 and 2004 after a slump in mergers in the early 2000s, according to Martin and Bos, (3) and this trend is expected to continue. These factors emphasize the importance to bank executives of understanding these rules before completing new acquisitions.
For goodwill and intangibles purchased in a business combination, vulnerability to impairment losses is linked to the initial valuation of those assets that occurs at acquisition when the purchase accounting method is used. Although generally accepted accounting principles (GAAP) did not require detailed disclosure of the initial valuation of goodwill and other purchased intangibles until the FASB issued SFAS No. 141 ([paragraphs] 51-52), this valuation information is available in pro forma balance sheets that acquiring banks are required to file with bank regulators for approval of the acquisition transaction. Analysis of these valuation data in pro forma balance sheets of past purchase acquisitions provides useful insights into the initial valuation process and illustrates the implications that valuation decisions have on future impairment testing.
This article summarizes the current accounting rules for goodwill and other intangible assets acquired in a business combination under SFAS No. 141 and SFAS No. 142. It discusses...
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