On July 1 st 2001, the FASB released the Statement of Financial Accounting Standards (SFAS) No. 141: Business Combinations and No. 142: Goodwill and Other Intangible Assets, which respectively replaced APB No. 16 Business Combinations and APB No. 17 Intangible Assets, both dating from the early 1970s. SFAS 141 and 142 fundamentally changed the accounting for goodwill, moving from a historical cost approach to a fair value-based accounting method (Lhaopadchan, 2010). The two most significant changes were the elimination of the pooling of interests method of accounting for a business combination, and the shift in accounting for goodwill from the amortization approach to an impairment testing approach (Massoud and Raiborn, 2003).
Prior to SFAS 141, firms were able to choose between two methods when accounting for an acquisition: the ‘pooling of interests method’ or the ‘purchase method’. The main difference is that the purchase method recognizes all additional intangible assets, including any goodwill acquired, while the pooling of interests method does not recognize any intangible assets or goodwill besides those that were already recorded by the acquired firm (Jerman and Manzin, 2008). As a consequence, almost identical transactions were accounted for using different methods, with managers showing a clear preference for the pooling of interests method (Van de Poel et al., 2009).
Hence, the financial results of firms were difficult to compare because of the different methods available to record
a business combination. The elimination of the pooling of interests method by SFAS 141 resulted in all transactions being accounted for using the purchase method. This improved the comparability of information on business combinations provided in financial reports (SFAS 141, 2001).
The second major change of SFAS 142, as compared to APB 17, is that the standard takes a different approach on how to account for intangible assets and goodwill subsequent to their initial recognition. The goodwill amortization approach was eliminated and instead firms are required to, at least annually, undertake a two-stage impairment test to evaluate their goodwill balance. The first step is to determine whether an impairment exists, by comparing the fair value of a reporting unit with its book value. Next, when the value of goodwill is considered to be below its current book value, an impairment loss has to be recognized in income from continuing operations, and goodwill has to be written down. The FASB states that these changes in accounting for goodwill improve the financial reporting quality, because the financial statements of acquiring entities will better reflect the underlying economic value of the intangible assets and goodwill. Financial statement users will be better able to understand the investments in these assets and the subsequent performance of investments (SFAS 142, 2001). These suggested improvements are supported by studies of Massoud and Raiborn, (2003), Sevin et al. (2007), and Baldi (2009), however some critical notes can be made. As recognized by the FASB itself, there may be more volatility in reported income than under the previous standards, because impairment losses are likely to occur irregularly and in varying amounts (SFAS 142, 2001). Managers often do not appreciate earnings volatility and therefore may have an incentive to choose a convenient time to recognize impairment losses (Jahmani et al., 2010). In addition, SFAS 142 provides managers with more flexibility in determining the fair value of goodwill, the existence, and the amount of a goodwill impairment (Beatty and Weber, 2006; Lhaopadchan, 2010).
US-GAAP – Provisions
US-GAAP – Measurement
Purchase Price Allocation
Allocation to reporting units
Impairment test US GAAP
Reversal of impairment
Substitution goodwill through internally generated goodwill
US-GAAP – Disclosure
Comparison IFRS vs US GAAP
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