Question

If the FASB allowed companies to amortize goodwill over any period of time not to exceed 10 years, would it invalidate the comparability basics; one of the fundamental premises of accounting and financial statements? Why or why not in your opinion?

Answer 1

Answer - If the FASB allowed companies to amortize goodwill over any period of time not to exceed 10 years, would it invalidate the comparability basics - one of the fundamental premises of accounting and financial statement.

1) The key topic under discussion here is GOODWILL. Goodwill is an intangible asset that is created when one company purchases another company. For example - If a company having an asset of worth 100$ and liabilities of 20$ has a net worth of 80$ (100-20=80$). Now if this company having a net worth of 801$ is sold for 110$. Then the buyer who is paying over and above its worth, the extra 30$ is paying for company's record and reputation over the years, its repute in the market, the experienced gained over the years, the team of loyal and skilful employees created over the years, all of which are things that form an intangible asser for which extra 30$ in lumpsum was paid and this in the financial statements is called as 'GOODWILL'. The value which you paid over and above the net worth of the company to account for its non-physical but identifiable assets.

2) Now understand that although Goodwill is an intangible asset but still there is a significant difference between how the two are treated in accounts i.e. Goodwill and Other Intangible Assets (i.e. trademarks, patents etc.)

All Assets (including other Intangible aseets) have a tendency to wear off and therefore, we write them off every year against the profits of the company. But Goodwill is perceived to have an indefinite life. Thus, we dont write it off.

3) Now earlier what we used to do was- We used to evaluate Goodwill at the end of each year to check for impairment. For example - The year you bought the company, it had a great repute amongst its consumers. It had a strong foot hold. However, after a few years, a new entrant came in the market or the company got involved in some controversy and which impacted its reputation amongst consumers or the key personnel's left the organization etc.

The goodwill was required to be evaluated at year end to see if there has been any impairment. This annual impairment test was annual, it was required to be done each year. It was both time consuming and expensive.

4) Now FASB (Financial Accounting Standards Board) came up with an alternative that Goodwill can be amortized on a straight line basis over a period not exceeding 10 years. If there is an indication that the fair value might have decreased below its carrying amount in the balance sheet, then an impairment Charge is created in the balance sheet. If it is discovered that carrying amount also may not be recoverable then an Impairment Testing is performed.

So now the big question here is : Amortization Vs Impairment.

Now there is a certain section of group that is supporting amortization and their points are presented below :-

1) The impairment test is expensive and it is subjective in nature. Thus, small business prefer amortization to having impairment tests done annually with respect to the cost-benefit analysis of it as Amortization of Goodwill would be much less expensive than Impairment.

2) There is also an opinion that Amortization would reduce complexity off the balance sheet and also concerns that goodwill is often overstated in the financial statements.

3) Impairment tests are complex in nature and also very subjective.

However, there exists a point of view that emphasizes on Impairment of Goodwill only based on following points :-

1) Assessment of Goodwill annually gives users an information regarding how well the company has utilised the intangible and tangible resouces of the company and whether the unit still remains the cash-generating unit for future.

2) Annual impairment tests gives investors a better insight regarding the future aspects of the company and the fair asseessment regarding the performance of the units undertaken.

3) Also there is no method of estimating the useful life of GOODWILL hence, the estimate given of 10 years is nothing but an arbitrary number.

4) Since it is the investors or stakeholders for whom the financial statements are prepared, their need for value and comparability should be given priority and importance.

5) Also in today's time the intangibles are becoming even more important than before. In such a scenario, amortization is like taking a step back.

6) There is also a strong opinion that the relevance of financial statements would diminish for users as they heavily rely on the estimates calculated by the expert audit and financial professionals.

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Would it invalidate the comparability basics :-

1) The amortization of goodwill would affect the comparability basics of the financial statements. In order to keep this in mind FASB proposed that if the Company subsequently goes public , it may be required to recast prior periods as if the alternative had not been chosen to allow users to compare the financial statements performance.

2) Also a text from asc.fasb.org says  - "To achieve comparability among entities that elect to apply the accounting alternative, the PCC decided that the subsequent measurement, derecognition, other presentation matters, and disclosure requirements should be applied together and not individually. The PCC also decided that the accounting alternative, if elected, should apply to all existing goodwill and all new goodwill recognized after the effective date.'

3) Also the amortization would deviate the US system away from the International convergence. The debate regarding the same is ongoing. Hence, the comparison at International level would also be affected.

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Conclusion :-

A Globally consistent solution is the need of the hour. In a global world investors need consistent information to enable them to compare and make an informed decision. It should not be left to the investors to convert the information from a local GAAP or rules or laws and regulation and make the information comparable on an International level. FASB should reevaluate to see how the cost of impairment testing can be reduced for the businesses by simplyfying the Impairment mode, additional quantitave disclosures that can be provided in the financial statement to help aid the data to make it more useful for the investors who rely heavily on such bodies for fair and transparent information.

The magnitude of this change is far and wide and definitely deserves in depth discussion and debate.

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