Goodwill and Other Intangible Assets

Introduction

The Financial Accounting Standards Board – FASB establishes standards of financial accounting which help accountants, companies, auditors and other users of financial statements. FASB issues Statements of Financial Accounting Standards-SFAS.  FASB has so far issued 163 statements of standards. This paper will cover SFAS 142 which covers the accounting treatment of goodwill and other intangible assets. The areas covered throughout this paper are the Name and number of the standard, status, summary, reason for issuing, difference between standard and current practice, affect on the conceptual framework, objective of statement, scope of the statement and in the summary of the effects of the statement will be discussed (Financial Accounting Standards Board).

Name and Number of the Standard

The name of the standard is Goodwill and Other Intangible Assets and the number of the standard is SFAS 142 (Financial Accounting Standards Board).

Status of the Standard

The standard was issued in June 2001 and is effective on fiscal years starting after December 31, 2001 and the goodwill acquired in combinations of business shall not be amortized after June 30, 2001 (Financial Accounting Standards Board).

Summary

SFAS 142 is related to the accounting treatment of acquired goodwill and other intangible assets and replaces Opinion No.17 of the Accounting Principles Board. The statement sets the standard on how to record and treat goodwill or other intangible assets which are acquired separately or with a group of other assets. This acquisition does not cover those intangible assets which are acquired in business combinations such as mergers and acquisitions (Financial Accounting Standards Board).

Reasons for Issuing SFAS 142

The need for a better standard and guideline arose when the management of companies and the users of financial statements like research analysts pointed out the importance of intangible assets as a significant financial resource for many organizations and the fact that these intangible assets have an integral part in the acquired assets. It was also noted that the amortization expense of these intangible assets was not considered important in the analysis of investments (Financial Accounting Standards Board).

Difference Between Current Practice and SFAS 142

The major change in this standard is the way intangible assets are recorded and the treatment of amortization. It states how goodwill and other intangible assets shall be treated after they have been initially recorded at acquisition. The standard abolishes the amortization of goodwill and other intangible assets and states that the value of these assets shall not decrease and those of total assets. Due to this change their might be fluctuations in the income with respect to the previous standard as the impairment losses would probably occur at irregular intervals and in different amounts (Financial Accounting Standards Board).

Previously in acquisitions the acquired firm or business was treated as a separate entity and the amount of goodwill was not properly treated. This standard combines the acquirer and acquired firm and goodwill is based on units which are called reporting units. Current practice for the treatment of intangible assets recognized limited life of these assets and a limit of 40 years was set. The new standard recognizes that intangible assets can have a limitless life and that these assets would be checked for impairment each year and the intangible assets that have a limited life shall be amortized according to their respective lives.

Another problem with previous standards was the calculation and measurement of impairment of intangible assets. SFAS 142 states clear guidelines on how to test intangible assets for impairment. It states that goodwill shall be tested for impairment in a two step process, the first step being the testing the impairment and the second step to calculate the amount of impairment. The treatment of internally developed intangible assets remains unchanged as the previous standard which is to expense the cost of such intangible assets.

Affects on the Conceptual Framework

The establishment of this standard affects the conceptual framework in two areas. As mentioned earlier the standard has abolished the amortization of goodwill over a period of 40 years. The FASB arrived at the conclusion that the previous practice of amortization was not in line with SFAS 2 which includes the guidelines for truthfulness in representation of data and with the issue of this standard the practice has become more reliable. This standard will also affect SFAS 7 which lies down the guideline for cash flow information and present values in accounting.

The new standard entails the calculation and testing of intangible assets not being amortized. The amortization expense was previously included in the financial statements and now this would not be included in the income statement, balance sheet or the statement of cash flows. Previously the amortization for each year was calculated and recorded but this has changed to testing of impairment only.

Objective of SFAS 142

The objective of the new standard is to make the accounting treatment of intangible assets more consistent with other standards and to make the presentation of financial statements more transparent. On close study it can also be found that the objective of this standard is to develop uniformity between the life of the intangible assets and the periods of cash flows used to calculate the value of these assets (Reynolds American Inc). This means the consistency between SFAS 142 and SFAS 141. As discussed earlier another objective of the standard is the consistency between the calculation, recording and amortization of intangible assets with the truthful representation of data.

Scope of SFAS 142

SFAS 142 covers the treatment of intangible assets including goodwill which are acquired with a group of assets or separately. It provides the guidelines for testing the impairment of intangible assets specially goodwill. It states the testing of goodwill in two steps as discussed earlier. It also carries the same treatment for internally acquired intangible assets as that of the previous standard in opinion 17 of APB. It abolishes the calculation and recording of the amortization expense of the intangible assets.

Impact and Effects of the Statement

The direct impact of this statement has come in the accounting treatment of acquired intangible assets. This change has not only improved the way intangible assets are reported but has also helped the transparency in the representation of financial statements. The previous standard permits the amortization of intangible assets whereas this amortization of intangible assets has been stopped to comply with other standards.

As companies adopt this standard their cash flow and income statements would be directly affected and the analysis and valuations linked with these statements such as financial ratio analysis, capital budgeting and modeling. The changes in the standard are far reaching and provide a clear picture of treating intangible assets. There are also differing opinions of this standard which state that the standard does not indicate the method for estimating future values of intangible assets (Aranca).

Works Cited

Aranca. FAS 141 & FAS 142 Valuation. 2 Sep 2008. <http://irc409aweb.com/FAS-141-and-FAS-142.html> 18 May 2009.

Financial Accounting Standards Board. FASB Pronouncements and EITF Abstracts. 15 Jan. 2009. <http://www.fasb.org/st/#int25> 18 May 2009.

Financial Accounting Standards Board. Status of Statement No. 142. June 2001. <http://www.fasb.org/st/status/statpg142.shtml>  18 May 2009.

Financial Accounting Standards Board.  Summary of Statement No. 142. June 2006. <http://www.fasb.org/st/summary/stsum142.shtml> 18 May 2009.

Reynolds American Inc. Quarterly Report. Company report. Winston Salem: Reynolds American Inc, 2008.