In June 2001 (revised in 2007 and again in 2009 to ASC Standards), the Financial Accounting Standards Board (FASB) issued its final statement regarding the accounting for purchased assets (SFAS 141, now ASC 805) and testing for goodwill impairment (SFAS 142, now ASC 350).
Purchase Price Allocation – For all transactions of acquired businesses (or a group of assets) closed after June 30, 2001, SFAS 141 (now ASC 805) eliminates pooling-of-interests in favor of the purchase accounting method. Under SFAS 141, acquired goodwill and other assets acquired as a result of business combinations must be stated at its fair value and identified separately from other identifiable financial, intangible and tangible assets, the fair value of which is recognized and separately stated. A short list of the different type of tangible and intangible assets to which these rules apply is stated below.
Goodwill Impairment – Additionally, under SFAS 142 (now ASC 350), it is required to annually test goodwill and other intangible assets for possible impairment. In Step One of this process, a test is made of the assets of a reporting unit against its carried accounting value for possible impairment. If the reporting unit’s accounting value is greater than its fair value, indicating possible asset impairment, then Step Two, further analysis to determine value, is engaged. Step Two compares the implied fair value of the goodwill, intangible or tangible asset with the carrying value. For example, SFAS states that “the fair value of goodwill can be measured only as a residual and cannot be measured directly.” Essentially, in order to determine the implied fair value of the goodwill, all assets must be valued and where, appropriate, identified long-lived assets would be adjusted downward to reflect their fair value. If the carrying amount of a reporting unit’s goodwill exceeds the implied fair value of that goodwill, then a goodwill impairment loss must be recognized for an amount equal to that excess. The adjusted carrying amount of goodwill will be its new accounting basis.
In December 2007, the FASB again significantly changed the accounting for business combinations by issuing a revised statement, SFAS 141(R) (now ASC 805), Business Combinations. SFAS 141(R) applies a fair value model, where an acquirer measures identifiable assets, acquired liabilities assumed and any non-controlling interest at fair value as of the acquisition date. The fair value model creates new risks in accounting for intangible assets; among them is the subjective nature of valuing such assets.
- Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date.
- Goodwill is similarly defined as before, as an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.
- Intangible assets are defined as assets that lack physical substance. As used in SFAS 141(R), the term intangible asset excludes goodwill and financial assets.
Since estimates of fair values of assets acquired, liabilities assumed, and non-controlling interests are very subjective and are based on methodology and assumptions applied during the valuation process, effective for fiscal years beginning after November 15, 2008, the measurement of intangible assets acquired in a business combination is governed by SFAS 157 (now ASC 820), Fair Value Measurements.
SFAS 157 (now ASC 820) defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants consummated at the measurement date. This is a hypothetical transaction, considered from the perspective of a market participant that holds an asset or owes a liability. An orderly transaction is not a forced transaction. It assumes exposure to the market for a period prior to the measurement date sufficient to allow for customary marketing activities.
SFAS 157 further states that the objective of a fair value measurement is to determine the price that would be received to sell the asset or paid to transfer the liability at the measurement date, rather than a purchase price or entry price. The fair value of the asset (or liability) is based on the assumptions that the market participants would use in pricing the asset, such as the condition and location of the asset and any restrictions on the sale or use of the asset at the measurement date. Market participants are, by definition, independent, fully informed of all the facts known or knowable and have the willingness and ability to complete the transaction. Related parties cannot be market participants under SFAS 157.
Lastly, SFAS 157 (now ASC 820) establishes a fair value hierarchy classified by reliability of the inputs:
- Level 1 inputs are quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.
- Level 2 inputs are quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, and values based on interest rates and yield curves observable at commonly quoted intervals, volatilities, prepayment speeds, loss severities, credit risks, and default rates.
- Level 3 inputs are the reporting entities own assumptions about those used by market participants in pricing the asset or liability (including assumptions about risk) based on the best information available.
Accredited Business Appraisals has over 30 seasoned years of experience appraising wide ranging and diverse asset types both tangible and intangible. Among these asset types to which Purchase Price Allocation and Goodwill Impairment applies and with which Accredited Business Appraisals has experience appraising are:
- Business Goodwill
- Furniture, Fixtures, Machinery and Equipment
- Real Estate – Commercial, Industrial and Multi-Family Residential
- Trademarks and Brand Names
- Royalty Based Assets
- Contracts in Place
- Trained Workforce in Place
Other Financial Reporting Changes:
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