Professor Brian Bushee The Wharton School of Business
Intangibles and Reserves The Shaw Group SOLUTION
Please refer to the attached Shaw Group case to answer the following questions. 1. What does the “Goodwill” from Shaw’s acquisitions represent (i.e., what are some of the economic assets that comprise this account)? Which intangible assets and liabilities does Shaw amortize over time? Which intangibles, if any, are not amortized? Shaw defines Goodwill as the “excess of the purchase price of acquisitions over the fair value of the net assets acquired” (Note 1). The net assets acquired include not only tangible assets and liabilities, such as accounts receivable and PP&E, but all separately identifiable and transferable intangible assets and liabilities. As indicated in Notes 1 and 4, these intangibles include “various licenses, patents, technology, and related processes;” customer relationships; contract asset and liability adjustments; and accrued contract loss reserves. Thus, Goodwill must include any intangibles that are not separately identifiable and transferable. These economic “assets” could include the value of human capital, growth opportunities, and expected synergies. Goodwill could also represent overpayment, as it is a plug between the purchase price and the fair value of all net assets acquired. Shaw amortizes technology intangibles over 15 years, patents over 10 years, and customer relationships over 10 years. Each of these intangibles is amortized on a straight-line basis. Contract assets and liabilities, as well as accrued contract losses, are amortized to contract costs over the lives of the contracts as work is performed on the contracts. Goodwill is no longer amortized (effective fiscal year 2002). Instead, Shaw performs annual Goodwill impairment reviews by reporting unit based on “a fair value concept.” 2. What do the Contract Liability Adjustments and Accrued Contract Loss Reserves represent? How does Shaw’s management estimate the fair value of these liabilities? At what point do these liabilities affect the income statement, and in which direction (increase or decrease)? Shaw performs work under a variety of contractual arrangements, including costreimbursable contracts (i.e., Shaw can pass all costs along to the customer), fixed-price contracts (i.e., Shaw charges the customer a negotiated fixed price and bears the costs or benefits of any cost overruns or shortfalls), and incentive/penalty provisions (e.g., extra costs or discounts for finishing projects by certain deadlines). The contracts generally run for two-to-four years.
Intangibles and Reserves: The Shaw Group Solution
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When Shaw makes an acquisition, they acquire a large number of contracts in progress and contract backlogs (i.e., contracts where the work has not started yet). Because these contracts are separately identifiable and transferable, SFAS No. 141 requires that they be recognized as separate assets and liabilities, recorded at their fair value at the date of acquisition. Shaw values these contracts using “a market-based discounted cash flow approach.” If the NPV of a contract is positive, it will be recorded as a contract asset adjustment. If the NPV is negative, it will be recorded as a liability adjustment. Note that these contract adjustments were created by two acquisitions. The August 2000 acquisition of Stone & Webster accounted for the additions to the reserve in 20001. The May 2002 acquisition of the IT Group accounted for the additions in 2002 and thereafter. Also, note that there is some uncertainty as to the amounts of the contract adjustments at the time of acquisition because the acquired companies are in bankruptcy. Thus, Shaw makes adjustments to the contract adjustments accounts for up to a year (or more) after the acquisition. The offset to these adjustments is a change in Goodwill. Contract assets and liabilities are amortized to contract costs (i.e., cost of revenues)...