A Synopsis of Accounting for Business Combinations

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A SYNOPSIS OF ACCOUNTING FOR BUSINESS COMBINATIONS,
INTANGIBLES AND GOODWILL IMPAIRMENT

INTRODUCTION

During the 1980's and 1990's a great number of business mergers and acquisitions took place. The generally accepted accounting principles to record the initial transaction and to account for the acquired assets during their estimated useful lives this were well established.

Over time however, users of financial statements began to question whether those principles and practices accurately reflected the market realities regarding the assets, their useful lives and their contribution to a company's value. In addition, intangible assets have become increasingly more important as an economic resource.

It was apparent that users of financial statements did not accept that goodwill amortization expense provided useful information. They realized that treating goodwill as a wasting asset whose value deteriorates predictably over a fixed period of time ignored the economic realities. Goodwill, in fact, can be replenished and increased in value; alternatively, the value of goodwill can decrease precipitously in a short period of time.

During the 1970’s the FASB had an active project on its agenda to reexamine the accounting for business combinations and acquired intangible assets. However, action on the project was deferred until, in 1981, the Board removed the project from its agenda entirely, to focus on higher priority projects.

In 1986 the Financial Accounting Standards Board (FASB) included the project on business combinations on its agenda. The purpose was to “improve the transparency of accounting and reporting of business combinations, including the accounting for goodwill and other intangible assets.” The FASB’s study confirmed that users of financial statements placed greater emphasis on the goodwill asset reported on the balance sheet, rather than an allocation of goodwill amortization expense reported on the income statement. This project resulted in FASB 141 – Business Combinations, and FASB 142 - Goodwill and Other Intangible Assets.

This emphasis on asset valuation rather than expense recognition reflected the FASB’s evolving emphasis on fair value measurement of assets and liabilities. The FASB achieved their two stated goals, that:

• All business combinations be accounted for in the same manner • Goodwill and intangible assets are accounted for in a manner that reflects economic reality.

Another reason the Board undertook the project is because “many perceived the differences in the pooling-of-interests method and purchase method to have affected competition in markets for mergers and acquisitions. Entities that could not meet all of the conditions for applying the pooling method believed that they faced an unlevel playing field in competing for targets with entities that could apply that method.”

This “unlevel playing field” was perceived to extend internationally, as well. “Cross-border differences in accounting standards for business combinations and the rapidly accelerating movement of capital flows globally heightened the need for accounting standards to be comparable internationally.” Thus the Canadian equivalent of FASB conducted a similar project concurrently with FASB.

The FASB’s project culminated in two new pronouncements, SFAS 141, Business Combinations, and SFAS 142, Goodwill and Other Intangible Assets.

FAS 141 – Business Combinations

FAS 141 supersedes APB Opinion 16, Business Combinations. Under APB 16, business combinations were accounted for using either the pooling-of-interests method[1] or the purchase method. The pooling-of-interests method was required when twelve specified criteria were met; otherwise the purchase method was required. However, the twelve criteria did not distinguish transactions that were economically dissimilar and thus similar business combinations were accounted for using different methods, and producing...
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