The following article is adapted from reprinted from the M&A Tax Report, Vol. 7, No. 12, July 1999, Panel Publishers, New York, NY.
AMORTIZING GOODWILL: FASB, STILL AT IT AFTER ALL THESE YEARS
By Robert W. Wood, San Francisco
The Financial Accounting Standards Board ("FASB"), has long been stirring the pot in connection with its project on reforming the rules employed to account for business combinations. Once again, it has altered its position on the crucial issue of whether and how goodwill (arising in a purchase business combination) ought to be amortized. Remember that here we are talking about goodwill amortization for financial statement purposes, not tax purposes.
For purposes of the FASB rules, not surprisingly, goodwill is defined as the amount by which the purchase consideration exceeds the net fair value of the target's identifiable tangible and intangible assets. This method of calculation is known as the residual method. Previously, the FASB had decided that a rebuttable presumption should exist that goodwill would have to be amortized over periods not exceeding 10 years. In rare and extraordinary cases, goodwill would be eligible for amortization over a 20 year interval, but 10 years was considered the norm.
Now, however, FASB has once again shifted its stance: It dropped the 10 year rebuttable presumption in favor of a simpler approach in which goodwill would have to be amortized over periods not exceeding 20 years. This decision is, to put it mildly, somewhat troubling. It gives no credence to the well-rehearsed proposition, which was acknowledged by both the board members and the FASB staff, that some portion of goodwill (perhaps a large portion) is simply not a wasting asset, or alternatively, does not possess a determinable useful life. (As a result, so their theory goes, it should not be amortized at all!).
Theory and Taxes
Arguing about the appropriate theory for goodwill amortization can be a bit controversial. It can certainly be argued that goodwill should be subject to periodic testing for impairment. Support for this approach is provided by a good deal of experience in the tax arena. Until the 1993 enactment of Section 197 of the Internal Revenue Code, the IRS—supported almost uniformly by the courts—had rejected the ability to amortize goodwill (and other customer-based intangibles) on the ground that they did not possess the requisite determinable useful life. Section 197 wound up providing a uniform standard of 15 years, putting the IRS and taxpayers back in their respective corners at least for a while.
Notwithstanding the troubling nature of this new FASB position, all is not yet lost. The FASB will next deliberate how goodwill amortization ought to be displayed in the financial statements. The debate, which commenced on May 19, 1999, centered around two approaches. The good news is that either of which would likely be seen as acceptable by the business community.
A. Income Exclusion. The first approach would require that goodwill amortization be treated as an item of other comprehensive income and, therefore, excluded from net income. Under this approach, at worst, an enterprise would produce an income statement that reported net income (unencumbered by goodwill amortization) and "below the line," reported, sequentially, other comprehensive income. Finally, presumably at the bottom of the statement, it would report comprehensive income. This approach, would probably be the most favorable method as it would fully set out exactly the position of the amortization and would be easily spotted on financials.
B. Cash Earnings? Alternatively, there was some support for an approach that would seem to endorse the concept of cash earnings. An enterprise would calculate income before goodwill amortization and display a related per-share amount (cash earnings). It would then report goodwill amortization, net of tax, in a manner similar to that in which extraordinary items are currently displayed.
Finally, it would subtract the tax-effected goodwill amortization figure from the income before that goodwill amortization, to arrive at net income. Debate was quite heated on this display issue.
C. Line Item. Although one of the above two approaches seem viable and most likely to be adopted, there was a third approach which is not yet off the table. This third approach, at least if it gathered the necessary steam, would probably be highly unpopular. It would simply show goodwill amortization as a separate line item within income from continuing operations.
Conclusion There have long been (and perhaps long will be) debates about both the tax treatment and the accounting treatment of intangibles. Plus, even apart from the theoretical side, there are often factual disputes about the appropriate category for particular assets.
Amortizing Goodwill: FASB Still At It After All These Years, Vol. 7, No. 12, The M&A Tax Report (July 1999), p. 6.