SFAS No.141, 142, and Taiwan SFAS Rule 35 on Asset Impairment Yea-Mow Chen, Ph.D., AVA. San Francisco State University March 21, 2005
Outline Introduction SFAS 141: Determining Goodwill and Other Intangible Assets SFAS 142:Impairment of Goodwill and Other Intangible Assets Taiwan’s SFAS No. 35 Asset Impairment 5. Valuation of Goodwill and Other Intangible Assets
Introduction SEC’s concerns on overvalued non-amortized intangible assets and goodwill: The SEC is very concerned that the assets are recorded at their fair value on the financial statements. Company management should be concerned that overvaluation of non-amortizable assets increased the potential of being subject to impairment losses.
Introduction How severe is the overvaluation problem? As of September 30, 2001, there were 409 publicly listed companies with reported goodwill of $10m or more and whose shares were trading at discounts to their book values. The goodwill of 228 companies was potentially totally impaired, and another 95 companies had potential impairment in excess of 50%. The implied impairment would exceed $1b for 14 companies, would range from $1b to $100m for 108 companies, and would range from $100m to $10m for 261 companies. (Source: Mercer, Crow, and Patton, “Goodwill Valuation Under SFAS 142”, the CPA Journal, 2002)
Introduction If an asset’s value is impaired, how should the impaired value be taken into account? What is the appropriate way for calculating values impaired? Many companies carry large amount of tangible and intangible assets with volatile prices, how should their values be appraised?
Section 2: SFAS No. 141, Goodwill and Other Intangible Assets in a Business Combination
Statement 141: Business Combinations • All business combinations initiated after June 30, 2001 must use the PURCHASE METHOD • Pooling-of-Interests method is no longer permitted
Statement 141: Business Combinations • Requires disclosure of the primary reasons for a business combination and the allocation of the purchase price paid to the assets acquired and liabilities assumed by major balance sheet caption.
Statement 141: Business Combinations • Application of the purchase method requires identification of all assets of the acquiring enterprise, both tangible and intangible. • Any excess of the cost of an acquired entity over the net amounts assigned to the tangible and intangible assets acquired and liabilities assumed will be classified as goodwill.
Statement 141: Business Combinations • Fair Value is defined in SFAS No. 141 & 142 as “The amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale.” • It is more of an “Investment Value” concept as the benefits of synergies and attributes of the specific buyer and specific seller are included. • The ability of a controlling shareholder to benefit from synergies and other intangible assets that arise from control might cause the fair value of a reporting unit as a whole to exceed its market capitalization.
Intangible Asset Recognition • An intangible asset shall be recognized as an asset apart from goodwill: • If it arises from contractual or other legal rights • If it is separable; that is, it is capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented or exchanged.
Intangible Asset Recognition • An acquired intangible asset (other than goodwill) with an indefinite useful economic life should not be amortized (regardless of whether it has an observable market) until its life is determined to be no longer indefinite • If no legal, regulatory, contractual, competitive, economic, or other factors limit the useful life of an asset, the useful life of that asset should be considered indefinite.
Intangible Asset Recognition • “The accounting for a recognized intangible asset is based on its useful life to the reporting entity. An intangible asset with a finite useful life is amortized; an intangible asset with an indefinite useful life is not amortized. The useful life of an intangible asset to an entity is the period over which the asset is expected to contribute directly or indirectly to the future cash flows of that entity.”
Intangible Asset Recognition • A number of pertinent factors that should be considered in deciding the useful life of an asset: • Expected use of the asset by the entity • Legal, regulatory, contractual limits to useful life • Ability to renew/extend contractual or legal life • Effects of obsolescence, demand, competition and other economic factors • Level of maintenance expenditures required to realize expected future cash flows • Useful life of another asset (or asset group) to which useful life of intangible relates
Intangible Asset Recognition • Separable intangible assets that have finite lives will continue to be amortized over their useful lives. • A recognized intangible asset that is not amortized must be tested for impairment annually, and on an interim basis if an event or circumstance occurring between annual tests indicates that the asset might be impaired.
Intangible Asset Recognition • The FASB has classified intangible assets into five categories: • 1. Marketing-related intangible assets • 2. Customer-related intangible assets • 3. Artistic-related intangible assets • 4. Contract-based intangible assets • 5. Technology-based intangible assets
Marketing-Related Intangible Assets Trademarks, trade names Service marks, collective marks, certification marks Trade dress (unique color, shape or package design) Newspaper mastheads Internet domain names Noncompetition agreements
Customer-Related Intangible Assets Customer Lists Order or Production Backlog Customer Contracts and Related Customer Relationships Non-Contractual Customer Relationships
Artistic-Related Intangible Assets Plays, operas, ballets Books, magazines, newspapers, other literary works Musical works such as compositions, song lyrics, advertising jingles Pictures, photographs Video and audiovisual material, including motion pictures, music videos, television programs
Contract-Based Intangible Assets Licensing, royalty, standstill agreements Advertising, construction, management, service or supply contracts Lease agreements Construction agreements Franchise agreements Operating and broadcast rights Use rights such as drilling, water, mineral, timber cutting and route authorities Servicing contracts such as mortgage servicing contracts Employment contracts
Technology-Based Intangible Assets Patented technology Computer software and mask works Unpatented technology Databases, including title plants Trade secrets, such as secret formulas, processes, recipes
Allocation of Purchase Price • Goodwill equates with the residual intangible asset that generates earnings in excess of a normal return on all the other tangible and intangible assets. • The present value of future cash flows contributing to goodwill at the time of acquisition can be calculated by summing the future excess earnings, then discounting to present value.
Allocation of Purchase Price • Assuming all of the tangible and intangible assets have been identified and valued at the acquisition date, this process is simplified by use of the residual method. Under the residual method, the present value of the future excess earnings, or goodwill, is calculated by subtracting from the adjusted purchased price the fair value of all the identified tangible and intangible assets. The remainder or residual amount equates with goodwill.
Allocation of Purchase Price • Valuation of Goodwill as of Dec. 31, 2005 • ____________________________________________________________________ • Cash and Acquisition costs $80,000 • Debt-free Current Liabilities 15,000 • Current Maturities of Long-Term Debt 10,000 • Long-term Debt 45,000 • Adjusted Purchase Price $150,000 • Less: Fair Value of Current Assets (25,000) • Less: Fair Value of Tangible Assets (8,000) • Less: Fair Value of Intangible Assets • Software (10,000) • Customer Base (5,000) • Trade Name (12,000) • Noncompete Agreement (6,000) • Technology (30,000) • In-Process Research and Development (4,000) • __________ • Residual Goodwill $30,000 • ____________________________________________________________________
Allocation of Purchase Price • Target Company – Valuation Summary as of Dec. 31, 2005 • Fair Value • ___________________________________________________________________________ • Cash $20,000 • Marketable Securities 5,000 • Accounts Receivable 15,000 • Inventory 8,000 • Prepaid Expenses 2,000 • Land and Buildings 30,000 • Machinery and Equipment, Net 20,000 • Total Current and Tangible Assets $100,000 • Software 15,000 • Customer Base 12,000 • Trade Name 8,000 • Noncompete Agreement 5,000 • Technology 30,000 • In-Process Research and Development 4,000 • Assemble Workforce 1,500 • Total Intangible Assets $75,500 • Goodwill (excluding assemble workforce) $40,000 • Total Assets $215,500 • __________________________________________________________________________-
Section 3: SFAS No. 142, Impairment of Goodwill and Other Intangible Assets
Statement 142: Goodwill and Other Intangible Assets • This Statement addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. • This Statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements.
Statement 142: Goodwill and Other Intangible Assets • Goodwill and intangible assets that have indefinite useful lives will not be amortized but rather will be tested at least annually for impairment. • Intangible assets that have finite lives will continue to be amortized over their useful lives, but without the constraint of an arbitrary ceiling.
Statement 142: Goodwill and Other Intangible Assets • Goodwill will be tested for impairment at least annually using a two-step process that begins with an estimation of the fair value of a reporting unit. • The first step is a screen for potential impairment, and • The second step measures the amount of impairment, if any.
Statement 142: Goodwill and Other Intangible Assets • This statement requires disclosure of information about goodwill and other intangible assets in the years subsequent to their acquisition. Information to be disclosed: • The changes in the carrying amount of goodwill from period to period, • The carrying amount of intangible assets by major intangible asset class for those assets subject of amortization and for those not subject to amortization, and • The estimated intangible asset amortization expense for the next five years.
Statement 142: Goodwill and Other Intangible Assets • The provisions of this Statement are required to be applied starting with fiscal year beginning after December 15,2001. • This Statement is required to be applied at the beginning of an entity’s fiscal year and to be applied to all goodwill and other intangible assets recognized in its financial statements at that date.
Impairment of Goodwill and Other Intangible Assets • SFAS No. 142 mandates that goodwill and intangible assets without a defined live shall not be amortized over the defined period; rather they must be tested for impairment at least annually at the “reporting unit” level.
Impairment of Goodwill and Other Intangible Assets • All acquired goodwill should be assigned to reporting units. This will critically depend on the assignment of other acquired assets and assumed liabilities. • The amount of goodwill allocated to a reporting unit is contingent upon the expected benefits from the synergies of the combination. This goodwill allocation is required even though other assets or liabilities of the acquired entity may not be assigned to that reporting unit.
Impairment of Goodwill and Other Intangible Assets • The measurement of the fair value of intangibles and goodwill can be performed at any time during the fiscal year as long as the timing is consistent from year to year.
Impairment of Goodwill and Other Intangible Assets • The annual impairment test is to be accelerated and goodwill of a reporting unit should be tested for impairment on an interim basis if an event occurs that would more likely reduce the fair value of a reporting unit below its carrying value.
Impairment of Goodwill and Other Intangible Assets • Impairment Test Triggering Events: • A significant adverse change in legal factors or in the business climate • An adverse action or assessment by a regulator • Unanticipated competition • A loss of key personnel • A more-likely-than-not expectation that a reporting unit will be sold or otherwise disposed of • The testing for recoverability under SFSA No. 144 of a significant asset group within a reporting unit • Recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of re reporting unit
Goodwill Impairment Test • The Two-Step Impairment Test: • Compare estimated fair value of each reporting unit to the carrying amount of the unit. • If FV > Carrying Amount, no need to perform Step 2 • If FV < Carrying amount, then Step 2.
Goodwill Impairment Test • If the carrying amount of a reporting unit goodwill exceed the implied fair value of that goodwill, then an impairment loss must be recognized for an amount equal to that excess. • In order to determine the implies fair value of the goodwill, all assets must be valued. • The impairment loss cannot exceed the carrying amount of the goodwill. Only the value of goodwill is adjusted through this process. • The adjusted carrying amount of goodwill will be its new accounting basis. • Goodwill cannot be increased to its original carrying amount in the future. Once written down, it stays down.
Goodwill Impairment Test • Ex: Assume a company has a reporting unit with a fair value of $10,000,000 including goodwill of $3,000,000. further assume that the relative fair values of the assets have been valued and recorded on the books of the acquirer as: • ______________________________________________ • Recognized tangible assets $5,000,000 • Recognized identifiable intangible 2,000,000 assets (with definite life) • Goodwill 3,000,000 • ========== • $10,000,000 • ______________________________________________
Goodwill Impairment Test • After one year assume the carrying amount of certain assets after amortization are: • ______________________________________________ • Recognized tangible assets $3,500,000 • Recognized identifiable intangible 1,500,000 assets (with definite life) • ______________________________________________
Goodwill Impairment Test • Assume that an impairment test is performed at this time one year later and the fair value of the reporting unit is $9,000,000. A new asset allocation must be performed to determine the new goodwill amount: • ______________________________________________ • Recognized tangible assets $3,800,000 • Unrecognized tangible assets 1,000,000 • Recognized identifiable intangible assets 1,400,000 • Unrecognized identifiable intangible assets 800,000 • Goodwill 2,000,000 • ___________ • Fair Value of the reporting unit $9,000,000 • ______________________________________________
Section 4: Taiwan’s SFAS No. 35 on Asset Impairment