Statement of Financial Accounting Standards No. 142 Term Paper

Executive Summary

The chosen statement to write this paper is ‘Statement of Financial Accounting Standards no. 142- Goodwill and Other Intangible Assets’. The standard was introduced in December 2001 superseding APB opinion no. 17. The objective was to provide maximum disclosure with regard to goodwill and other intangibles to the financial statement users. The statement straight away debarred amortization of goodwill and other intangible which are longer- lived and have indefinite useful life. In order to examine the practical applicability of the directions and suggestions of statement no. 142, the Annual Report 2008 of ‘Wal- Mart Stores Inc.’ was selected. On a critical analysis of the way goodwill and other intangibles were dealt in the financial statements of Wal- Mart, it was found that Wal- Mart has normally followed all the directions and guidance of Statement no 142, except in the area of presentation of intangible assets. Those have not been shown as separate line items in the balance sheet. Instead those have been clubbed with other long- lived assets. However, goodwill has been shown properly as a separate line item.

Introduction

Statement no.142, one of the statements issued by FASB dealing with Goodwill and other Intangible assets has been selected for this write up in order to evaluate its practical applicability. A critical analysis of the relevant portion of financial statements appearing in Annual report 2008 of ‘Wal- Mart Stores Inc.’have been made to observe the impact of statement no. 142 on the financial statement of Wal- Mart. Analysis have been made basically with regard to initial recognition of goodwill and other intangible assets, accounting for intangible assets other than goodwill, accounting for goodwill, and presentation in financial statements of these assets, keeping in view the applicability of provisions and directions of statement no. 142.

Purpose

SFAS 142 was issued to provide better information of Intangibles to the financial statement users. Though Goodwill is also an Intangible asset, but in SFAS 142 the term Intangible Assets has been used for intangibles other than Goodwill. SFAS 142 superseded APB Opinion no. 17, and is effective for financial statements issued after December 2001. It lays down the accounting treatment of Intangible assets acquired with other assets otherwise than under a business combination, as well as for Goodwill and Intangible assets after those have been initially recognized in the financial statements.

SFAS 142 differs from APB Opinion No. 17 in following ways:

• APB 17 treated the Goodwill acquired upon integration of entities as a stand alone transactions as it approach was transaction based, where as SFAS 142 bases the accounting of Goodwill treating the combined entity separate from units integrated into it. Those units are known as reporting units.
• APB 17 treated Goodwill and other intangibles as wasting assets and fixed a ceiling of 40 years to amortize these assets. However, useful lives of these assets have been treated by SFAS 142 as indefinite and those are not amortized but tested for impairments. Intangible assets having finite useful life will continue to be amortized.
• SFAS 142 provides very specific two step method of testing impairment on goodwill on annual basis. In first step it is decided whether goodwill requires impairment and second step the impairment of goodwill is valued. Similarly other intangibles of infinite useful lives will also be tested for impairment.
• SFAS also requires complete disclosure of Goodwill and other intangible with regard to calculations of their carrying value and other aspects impairments.

The purpose of SFAS 142 is to enhance financial statement disclosures impairments and other aspects of goodwill and other intangibles, so that users are better equipped to assess future profitability and cash flow of the entity.

Usefulness

Reporting effect of SFAS 142 is seen the Notes to Financial Statements of the companies. Normally a separate paragraph in the notes provides details about how the company has dealt with its Goodwill and intangible assets. The notes provide detailed disclosure about the impaired value of such intangibles and goodwill with reasons for such change in the value. To give an example, the Annual report 2008 of Wal-Mart Stores Inc., note titled ‘Goodwill and Other Acquired Intangible Assets’ at pages 32-33 of the report clearly cite the reason for change in good will since 2007 when it states that:

“The change in the international segment’s Goodwill since fiscal 2007 resulted primary from the acquisition of controlling interest in Bounteous Company Ltd.(“BCL”), the tender offer to acquire the remaining outstanding common and preferred shares of our Japanese subsidiary, the Seiyu (“Seiyu”), and foreign exchange fluctuations.”

The disclosure made by Wal-Mart in the notes providing reasons for change value of goodwill is an ample proof of following accounting process as suggested by SFAS142. Not only the financial statements of Wal-Mart carry depict strict compliance of the standard but the users of the statement need no further explanations when they view the changes in the value goodwill and other intangible assets.

Accordingly it can be said that companies are using SFAS 142 in the letter and spirit of the standard and the objective of providing the users of financial statements with detailed information about Goodwill and intangibles is being properly served.

Practical Application

The chosen real organization to assess the applicability of the statement no.142 in its financial statements is Wal- Mart Stores Inc. The application of relevant standard has been analyzed with reference to company’s annual report 2008 under following issues:

Initial Recognition and Measurement of Intangible Assets and Goodwill

On the issue of initial recognition clause no. 9 of the statement no.142 states that “An intangible asset that is acquired either individually or with a group of other assets (but not those acquired in a business combination) shall be initially recognized and measured based on its fair value….The cost of group of asset acquired in a transaction other than a business combination shall be allocated to the individual assets acquired based on their relative fair values and shall not give rise to goodwill.”

It may be noted that standard is not applicable to intangibles acquired under a combination; and also when intangible are acquired with group of other assets, total fair value of acquisition cost shall be shared among the assets acquired on basis of each asset’s fair value so that no goodwill results.

The treatment provided by Wal Mart on acquiring goodwill and intangible asset during 2007-08, as per notes on ‘goodwill and other intangibles’ in its annual report 2008 is that:

“Goodwill represents the excess of purchase price over the fair value of net assets acquired, and is allocated to the appropriate reporting unit acquired.”

This shows that Wal- Mart has not acquired any goodwill or intangibles to which the provisions of Statement no 142 are applicable. But acquisition of Goodwill was there during the year. Wal- Mart acquired 35% interest in BCL, but that was under a combination scheme with BCL, and therefore accounting was not as per provisions of SFAS no. 142. Wal Mart rightly complied with relevant standard (SFAS no.141) where Goodwill was resulted difference between purchase price and fair value of assets acquired, as is clear from portion of note no. 6 to financial statements reproduced as under:

“After closing the acquisition, the company began consolidating BCL using a December 31 fiscal year end. The company’s Consolidated Statements for fiscal year 2008 include the results of BCL for the period commencing upon the acquisition of The Company’s interest in BCL and ending with December 31, 2007. BCL’s results of operation were not material to the company. Assets recorded in acquisition were approximately $1.6 billion, included approximately $1.1 billion in goodwill, and liabilities assumed were approximately $1.0 billion. The Consolidated Financial Statements of BCL, as well as the allocation of purchase price, are prelimnary.”

Hence it can be said that Wal-Mart very correctly did not applied SFAS 142 on a combination transaction.

Accounting for Intangible Assets

SFAS 142 prescribes the following rules with regard to accounting for intangibles:

• Intangibles with indefinite useful life will not be amortized. Only the intangible assets with definite useful life will be amortized.
• The useful life of intangible asset shall be determined with reference to factors like expected use of intangible asset, expected useful of other assets or group of assets to which the intangible asset may be related, legal, regulatory, and contractual provisions with regard to initial acquisition or subsequent renewal or extension of the use, effects of obsolescence, demand, and other economic factors, and expenditure to maintain expected cash flows.

• Amortization method to be adopted for intangible assets with definite useful life would be such that reflect the pattern in which economic benefits from such intangible assets are utilized by the entity.
• Intangibles assets with indefinite useful life will be tested for impairment and impairment loss be recognized when fair value of the asset is less than carrying value of such asset.

However, based on guidance in Statement No. 142, there are three questions that need to be asked to determine the appropriate useful life:

1. “Does the company intend and have the ability to renew or extend the contract?,
2. Are there substantial costs associated with the renewal/ extension?,
3. Will there be material modifications to the existing terms and conditions?” (Jennifer M. Mueller, December 2004).

The above rules of SFAS 142 with regard to amortization and testing for impairment of intangible assets have been treated by Wal- Mart as stated in notes at page 32-33 of annual report 2008 of the company. The notes states as under:

“Goodwill and other indefinite- lived acquired intangible assets are not amortized; rather they are evaluated for impairment annually or whenever events or changes in circumstances indicate that the value of the asset may be impaired. Definite- lived other acquired intangibles are considered long- lived assets and are amortized on a straight- line basis over the periods that expected benefits will be provided.”

It may be noted that Wal- Mart is making clear distinction between definite- lived intangible assets and indefinite- lived intangible assets. The method of amortiztisation followed by the Wal- Mart is based on the principle of economic benefit enjoyed by the entity.

Further it may be pointed out that entity has determine the useful life of intangible assets on annual basis, and if after determining the indefinite life of an intangible, it is found that such intangible asset has definite useful life, then “remaining carrying amount of the intangible asset shall be amortized prospectively over the revised remaining life. However, Wal- Mart had no such situation where once determined indefinite life intangible asset has turned to be intangible with definite live on a later valuation.

Accounting for Goodwill

Statement no. 142 determines that Goodwill will not be amortized but tested for impairment. This is departure from earlier policy of amortization for 40 years as per APB Opinion no. 17. The immediate effect of this testing would be that when no impairment is found, that when fair value equals carrying value, earnings of the entity would go up by amortization amount.

Statement No. 142 has prescribed two step impairment tests for goodwill. In the first step an identification of probable impairment of goodwill is predicted by comparing fair value of a reporting unit with carrying value and impairment in goodwill is identified. If fair value exceeds carrying value of goodwill of reporting unit, there is no impairment and no need to go in for second stem. Impairment exists when fair value is less than carrying amount.

The notes to financial statement makes it clear that Wal- Mart tests the goodwill and other intangibles for impairment on annual basis, as we find similar disclosure in notes of earlier annual reports of Wal- Mart Store Inc. So the first step is being religiously followed by Wal-Mart in determining impairment in the value of goodwill and other intangible assets.

It is pertinent to point out here that accounting firms performing company’s audit are prohibited from carrying the impairment tests.

In the second step impairment is actually measured as per the guidance provided in Statement no. 142. “FASB 142 provides for a number of acceptable methods for determining the fair market value of reporting units and assets being tested for possible impairment. These methods include an income approach employing discounted cash flow projections; comparing recent sales of comparable assets; the application of industry standard multiples for revenue or cash flows; or indeed , virtually any method generally recognized as appropriate in an industry. In some cases, one of these methods may be employed as the primary valuation approach with validation by other methods.” (Bond & Pecaro, May 2002).

Wal- Mart is certainly following a prescribed procedure or method of fair value valuation after identifying the impairment in Goodwill, which is its main intangible asset. Notes at page 33 of Annual Report 2008 of Wal- Mart states very clearly the method adopted for determining the impairments. It states as under:

“Fair value is measured based on a discounted cash flow method or relative market based approach. The analyses require significant management judgment to evaluate the capacity of an acquired business to perform within projections. Historically, the company has generated sufficient returns to recover the cost of goodwill.”

The above statement from the accounts of Wal- Mart shows that the company is using discounted cash flow method to evaluate the fair market value of reporting unit. The company after determining the fair value of reporting unit evaluates the fair value of goodwill in order to compare it with carrying value. This comparison actually determines the impairment, which is then written of.

Financial statement presentations

Statement no. 142 requires that all intangible assets should be aggregated and presented in a separate line the balance sheet of entity. However individual intangible assets or class of intangible assets may also be presented as separate line items in the balance sheet.

The presentation style adopted by Wal- Mart is not as per directions of statement no. 142. Those are neither clubbed together and presented as separate line item nor presented as individual separate line items or as classes of intangibles as separate line items. As per notes to the financial statements in the annual report 2008, “Definite-lived other acquired intangible assets are considered long lived assets”. In other word those are clubbed together with other long- lived assets.

As far as Goodwill is consider clause 43 of Statement no. 142 suggests as under:

• Goodwill to be presented as a separate line item in the statement pf financial position,
• The total of goodwill impairment losses should also be presented as separate line item in income statement become income for continuing operations, unless it is associated with discontinued operations. In that case such goodwill impairment losses will be shown along with the results of discontinued operations.

Wal- Mart has rightly shown Goodwill as separate line item in the balance sheet. It appears there are no impairment losses, as there is no mention of such separate line item in income statement.

References

Wal-Mart. 2008 Annual Report, page 33. Web.

Statement of Financial Accounting Standards 142, Initial recognition and measurement of Intangible Assets, Clause 9. Web.

Jennifer M. Mueller, Amortization of Certain Intangible Assets, Online Journal of Accountancy, 2004. Web.

Bond & Pecaro, Implementing the Guidelines: FASB Statement 142, 2002. Web.