FAS 142

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 Intangible Asset.

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.