Dr. Stanley Jay Feldman, Chairman of Axiom Valuation Solutions and Associate Professor of Finance, has authored a working paper describing key uncertainties and challenges to business valuation analysts created by recent accounting rule changes by the Financial Accounting Standards Board (FASB).

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04.28.2004 - This is a revised version of an earlier paper dated May 2002. This version is essentially equivalent to the earlier paper, although the examples used were amended to improve clarity and understanding of what is a difficult and complex subject.

Summary

Financial Accounting Standard (FAS) 142 requires that goodwill emerging from acquisitions be tested to determine whether it has been impaired. Prior to FAS 142, goodwill was amortized over as many as forty years with the amortized amount deducted from net income. FAS 142 requires firms to effectively undertake a market test to see if goodwill has been impaired. This test is completed in two steps. The first simply requires a revaluing of the reporting unit. If this value is equal to or greater than the unit’s carrying value then goodwill has not been impaired. On the other hand, if the calculated value is less than the unit’s carrying value, then step 2 must be undertaken. The purpose of step 2 is to assign the value of the reporting unit to its identified and recognized assets and liabilities. These assets are valued as standalone entities. The sum of recognized asset values less the market value of liabilities is the fair market value of net assets. The difference between the fair market value of the reporting unit and the fair market value of net assets is the implied fair market value of goodwill. If this value is less than the carrying value of goodwill, then the difference is equal to the value of goodwill impairment loss.

The purpose of FAS 141 and FAS 142 is to provide investors with better financial information as to the success of past acquisitions. In the process of doing this, the FASB has forced firms to deal with a number of thorny and, in some cases, unresolved valuation issues. These issues include:

• Valuing the reporting unit from the perspective of hypothetical new buyer or from the perspective of the acquiring firm implementing its strategy for deploying the acquired assets.
• Applying a marketability discount to the value of a reporting unit when the unit no longer has equity trading in a liquid market.
• Estimating the proper cost of capital when the discounted cash flow approach is used to value the reporting unit.