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Intangible assets are an increasingly important economic resource for many businesses. Intangible assets have also become a greater portion of assets gained in an acquisition or business combination. Therefore, more useful information about intangible assets is needed for both those involved in the transaction and potential investors in the public community. Statement 142 replaces Accounting Principles Board (APB) Opinion No. 17, Intangible Assets in order to produce better information on which the public can rely.
APB Opinion No. 17 was issued in August of 1970 and involves intangible assets acquired from companies or individuals. The Opinion states that the cost of the acquisition of intangible assets should be classified as intangible assets. For intangible assets that are not easily identifiable, the Opinion states that the cost of developing these assets should be charged against income as they occur. However, intangible assets that are developed internally will not be added as an asset to the balance sheet according to Opinion 17. Finally, the Opinion’s policy on amortization is as follows: intangible assets should be amortized over the period of benefits; however amortization should not exceed forty years. Therefore, the theory behind this amortization rule is that the value of the intangible assets will disappear over the period of amortization.
“Statement 142 addresses the financial accounting and reporting acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, Intangible Assets.” The Statement was issued in June 2001 in order to improve and change policies of Opinion 17 for intangible assets, and to specify how to treat goodwill. The Statement discusses how assets that are gained upon acquisition, either individually or with a group of assets should be accounted for in financial statements. Upon acquisition intangible assets should be recorded at fair value on the balance sheet. (Fair value is the amount at which the asset can be sold in a current transaction between willing parties, such as a quoted market price. ) However, internally developed intangible assets should not be recognized on the balance sheet, and should be recognized as an expense when incurred (just as stated in Opinion 17).
The Statement says that intangible assets with a limited life should be amortized over the useful life period. The useful life of an intangible asset is the period in which that asset is expected to contribute to future cash flows of the entity. In order to determine the useful life many factors are to be considered: how long the entity is expecting to use the asset, how long a comparable asset has lasted in the company, and legal and economic factors, to name a few.
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The amount that should be amortized of the intangible asset should be the cost of the asset less any residual value. “The residual value of an intangible asset shall be assumed to be zero unless at the end of its useful life to the entity the asset is expected to continue to have a useful life to another entity and (a) the reporting entity has a commitment from a third party to purchase the asset at the end of its useful life or (b) the residual value can be determined by reference to an exchange transaction in an existing market for that asset and that market is expected to exist at the end of the asset’s useful life. (www.fasb.org/pdf/fas142.pdf)” Furthermore, the entity should annually test the intangible asset for the remaining useful life to determine if the period of amortization should be reevaluated or tested for impairment and no longer amortized if the asset is found to have an indefinite useful life. If an asset has an indefinite useful life it should be tested for impairment on an annual basis. Impairment loss exists if the fair value of the intangible asset is less than the carrying value. After the impairment loss is recognized, the new accounting basis of the asset becomes its adjusted carrying amount.
Statement 142 also reports on how to treat acquired goodwill. The Statement says that while goodwill should not be amortized, it should be annually tested for impairment. The asset is impaired if the fair value of the asset is deemed to be less than the carrying value. The next step is to evaluate the amount of the impairment loss. In order to measure the amount of the impairment, the implied fair value of the goodwill must be compared to the carrying amount of the goodwill. Implied fair value of goodwill is the fair value of the acquisition in excess of the amounts assigned to the assets and liabilities of the transaction. The impairment loss should be the amount in which the carrying amount exceeds the implied fair value. However, the loss recognized cannot exceed the carrying amount. After the impairment is recognized, the new accounting basis for the asset will be its adjusted carrying amount of goodwill. If the impairment test is not complete before the financial statements are issued and the impairment is probable , the loss should be noted in the notes of the financial statements.Tests of impairment may also be conducted if events occur within the year that may further reduce the fair value of the asset, such as ……………..
Note that the Statement does not refer to the accounting or reporting for assets acquired in a business combination (this issue is resolved in Statement 141). Users will also benefit from Statement 142 because they will be able to better track the performance of these intangible assets in their investment. In addition, the information will enhance the user’s ability to determine future cash flows of the company and to make well informed investment decisions.
The first key note difference between the Statement and the Opinion is that the goodwill and most intangible assets of an acquisition will not be amortized following the procedures of Statement 142. Therefore, the rates and manner at which assets will decrease in value will differ from the Opinion. As a result of this change, impairment losses will be less likely than under the of the Opinion. Opinion 17 also treated the acquiring company as a stand-alone company even though they integrated the acquired company into their operations, so the premium paid for goodwill was not accounted for properly. The Statement, however, looks at the companies in an integrated manner and determines accounting for goodwill based on the combined reporting units of the new hybrid. Another difference between the Opinion and the Statement is that the Opinion looks at intangible assets as those with a certain life period, i.e. they should be amortized with a ceiling of 40 years. On the other hand, the Statement tests goodwill and intangible assets with indefinite lives for impairment on an annual basis. Under guidance of FASB Concepts Statement No. 7, Using Cash Flow Information and Present Value in Accounting Measurements, the statement estimates the fair values used in testing both goodwill and other intangible assets for impairment which are not being amortized. The test includes a two-step process that first examines the fair value of the company and a test of potential impairment then there is a measure for the amount of impairment if any is found. The intangible assets which are presumed to have finite lives will be amortized, but not under a constrained ceiling. Finally, the Statement requires the disclosure of information in years subsequent to the acquisition of goodwill and other intangible assets. “Required disclosures include information about the changes in the carrying amount of goodwill from period to period (in the aggregate and by reportable segment), the carrying amount of intangible assets by major intangible asset classes for those assets subject to amortization and for those not subject to amortization, and the estimated intangible asset amortization expense for the next five years.” The Statement does carry forward some of the aspects of the Opinion. For instance, internally developed intangible asset treatment was kept the same in the Statement as it was taken from the Opinion. The Statement also keeps the requirement to expense the cost of certain research and development assets at the date of acquisition under requirements of FASB Statement No. 2, Accounting for Research and Development Costs, and FASB Interpretation No. 4, Applicability of FASB Statement No.2 to Business Combinations Accounted for by the Purchase Method.
An Atlanta, Georgia based company with over one hundred acquisitions relies heavily on this Statement and first adopted FAS 142 on January 1, 2002. The company chose to use its fiscal October month-end for the performance of the annual impairment test for goodwill and for the franchise license intangibles. Prior to this date, the company allocated all of the cost of an acquisition, which was in excess of what was allocated to working capital and tangible assets, to the franchise license intangible assets. Upon adoption of FAS 141 and FAS 142, the company considered whether to reallocate a portion of the franchise license intangible assets to goodwill. However, paragraph 61 of FAS 141 states that unless separate purchase price allocations had occurred at acquisition and separate accounting records were maintained for goodwill and intangible assets which were previously reported as a single amount under Opinion 17, companies should not change the amount of purchase price assigned to identifiable intangible assets acquired. Prior to the adoption the company had not kept separate records, no amount had been assigned to goodwill, valuations had not been performed and the excess purchase price had been assigned to franchise license assets. Therefore, the company did not change its historical purchase price allocation upon adoption of FAS 141 and 142.
The company began allocating a portion of the purchase price to goodwill subsequent to the adoption of FAS 141 for acquisitions occurring after June 30, 2001. The most significant acquisition was a month later for approximately $1.4 billion. Since July 1, 2001 the company has completed approximately 8 other acquisitions resulting in a total consideration of less then $200 million.
When the company adopted FAS 142 on January 1, 2002 the management made several significant assumptions. First, the reporting units for goodwill impairment testing would be at the operating segment level. Secondly, the franchise intangible assets have indefinite useful lives and should be grouped at the operating segment level for impairment testing. Finally, management agreed upon certain methods to value reporting units and franchise licenses in performing the annual impairment tests.