One Accounting Rule Change You Should Know About
Many credit managers find changes in financial accounting rules
uninteresting, and as a result tend to ignore information about changes
mandated by the Financial Accounting Standards Board [the FASB].
However, there is one new accounting rule that you should be aware
of because it is likely to have a significant affect on the financial
statements being reported by your customers. The new accounting rule
is Financial Accounting Standard 142 [FAS 142] -Goodwill and Other
This new rule addresses financial accounting and reporting for acquired goodwill
and other intangible assets. It was felt by the FASB and others that amortization
of goodwill was not consistent with the concept of representational faithfulness.
FAS 142 addresses how intangible assets that are acquired either individually
or with a group of other assets should be accounted for in financial statements
upon acquisition. This Statement also addresses how goodwill and other intangible
assets should be accounted for after they have been initially recognized in
the financial statements.
FAS #142 changes the subsequent accounting for goodwill and other intangible
assets in the following significant respect. Goodwill and intangible assets
that have indefinite useful lives will not be amortized over a theoretical
useful life. Instead, they will be tested at least annually for impairment.
If goodwill is impaired, the asset must be written down. This Statement provides
specific guidance for testing goodwill for impairment in order to determine
its fair value.
FAS 142 is responsible for the recordbreaking loss reported recently by AOL
Time Warner of $54 billion. Why? Because when an intangible asset [such as
goodwill recorded in an acquisition] is determined to be impaired, it is written
down to its "fair value." In the case of AOL Time Warner, this rule change
resulted in a one time, non-cash [extraordinary] loss in excess of $50 billion.
The question to be asked is this: Does this loss mean that AOL Time Warner
is not creditworthy. One answer is that if it were not for the change in accounting
rules, AOL Time Warner would have recorded a profit for the quarter rather
than a $54 billion loss!
Examples of the impact of FAS #142 abound. Other examples include:
Raytheon Co. reported that it may record a goodwill impairment
charge of $300 million to $900 million as a result of adopting
FAS 142, the new rule on the amortization of goodwill.
Brunswick announced recently it would take a second-quarter charge
of $25 million-to-$30 million on the adoption of FAS No. 142, to
cover the write-down of goodwill and other intangibles.
Worldcom recently announced that it expected its write down for
goodwill impairment to be between $15 billion to $20 billion.
What does this change mean for credit managers. It can mean significant,
even wild swings being reported in earnings from one quarter to the
next, or from one fiscal year to the next for certain customers.
Also, since net income or loss affects the retained earnings account
as listed in the equity section of the balance sheet, these broad
changes in earnings can also have a significant affect on a customer's
balance sheet. What is the risk? The risk is that the person analyzing
a customer's financial condition that does not understand the affect
of FAS #142 could misinterpret the reduction in profits and the impact
on the equity section of the balance sheet improperly. Specifically,
some creditors might reduce or even withdraw the customer's credit line
in the face of significant net losses being reported.