Visualising Intangibles: Measuring and Reporting in the Knowledge Economy

Stefano Zambon, Giuseppe Marzo

• Publisher: Routledge
• Year: 2016
• Print ISBN: 9780754646280
• eBook ISBN: 9781317001140
• Topic: Business
• Subtopic: Business General
• Index: Business

Despite the now widely recognized importance of intangible assets and intellectual capital, they still appear to be poorly understood by both academics and practitioners. Indeed, the necessity for adopting a fresh approach to their reporting, measurement and management is today generally clear and accepted. This book gives room to new perspectives which broaden the scope and depth of the investigation, whilst also opening up innovative methods and opportunities for practice.

PART 1
MEASUREMENT AND REPORTING ISSUES

Chapter 1

Regulatory Changes in Accounting for Goodwill and Intangible Assets: A Study of Their First Impact on European Companies Listed on US Markets

Stefano Zambon and Vania Crosara
University of Ferrara

Introduction: SFAS 141 and 142 as the Culmination of the FASB Business Combination Project

In recent years, the importance of intangible assets within companies has notably increased and this has produced the need for a better disclosure about this type of resources. At the same time, last few years have been characterised by a strong wave of mergers and acquisitions that has sharpened the problem of accounting for intangibles, which constitutes an increasing portion of the assets acquired in this kind of transactions.

Several institutions raised the problem of changing the accounting rules in this field. Definitively, the issuance in July 2001 by the US Financial Accounting Standards

Board (FASB) of the Statements of Financial Accounting Standard (SFAS) 141 “Business Combinations” and 142 “Goodwill and Other Intangible Assets” marked an important step in this direction. After, several other accounting institutions followed FASB’s example. These Statements are among the most significant pronouncements issued by the FASB in many years and reflect the culmination of a project, which has begun in the second half of the ‘90s, aiming at reforming the accounting treatment of business combinations (Mard et al. 2002).

The purpose of the FASB’s work was to increase reliability of financial data and comparability of annual reports released by companies. The starting point was the possibility to account for business combinations using one of the two then allowed methods: the purchase method or the pooling-of-interests method (even though the use of the second was permitted only when certain criteria were met). Consequently, similar transactions might have been recorded in two different ways, reducing the comparability of financial statements. Therefore, the first aim was the abolition of one of the two methods: in this respect, FASB decided that business combination had to be accounted for using only the purchase method, thus prohibiting the adoption of the pooling-of-interests. Another important step was to revise the requirements contained in APB Opinions no. 16 and 17 about the identification and the recognition of intangible assets and their accounting treatment, so to enhance consistency in the application of these standards. Finally, FASB decided that useful lives of certain intangible assets could be indefinite and that amortisation of those assets would not be representationally faithful.

These were the three main points with which the Exposure Draft issued by the FASB in February 2001 for illustrating the new accounting model dealt. In response, FASB received several comment letters, which brought some changes about:

• the reporting level at which to measure goodwill impairment. The FASB revised the definition of “reporting unit” (the level within the consolidated business at which goodwill impairment is measured) to a higher level, which reduced the potential number of reporting units and the extent of goodwill impairment testing;

• the timing and the mechanism of the impairment test. SFAS 142 requires an at least annually impairment test instead of the application of the indicator-based approach proposed in February 2001 Exposure Draft. Furthermore, for goodwill a two-step impairment test approach has been introduced; and

• effective date. The ED required the immediate adoption of both SFAS after their final issuing. Instead, general rules are that SFAS 141 is effective for business combination initiated on or after July 1, 2001 and SFAS 142 for years beginning after December 15, 2001.

In July 2001, with an unanimous approval, FASB issued the above mentioned SFAS 141 “Business Combinations” and SFAS 142 “Goodwill and Other Intangible Assets”, which superseded APB Opinions no. 16 and 17, respectively. The extent of the consequences of these two accounting standards is wide, as they brought about strong innovation in accounting for intangibles (especially goodwill) acquired individually, in group or in a business combination. They aim to represent an updated answer to the need for a better disclosure about these resources and an increased comparability of accounting documents. Through their application, the representation of the investments made in an acquired entity has improved, since purchase method records transactions on the basis of exchange value, and disclosure about the operation carried out has increased, this potentially helping to better understand the economic effect of the event and to better assess company future profitability and cash flows. More in general, SFAS 141 and 142 intended to produce a greater reliability of the financial results, in compliance with the concept of representation faithfulness contained in the FASB’s Statement of Financial Accounting Concepts no. 2 on “Qualitative Characteristics of Accounting Information”.

In the light of the above regulatory changes, the aim of this study is to analyse the way European companies listed on US financial markets (Nyse and Nasdaq) reacted to the issuing of SFAS 141 and 142 and, when they had already adopted these standards, to measure the impact of their application on company net income and shareholders’ equity.

The importance of this topic is linked to the relevance of US GAAP for European companies. Actually, these companies listed in the USA have to compulsory prepare their consolidated accounts in compliance with US GAAP or, alternatively, to present a reconciliation statement (contained in the so-called Form 20-F) between American accounting principles and their domestic GAAP, as requested by the US Securities and Exchange Commission (SEC) to foreign registrants listing their securities on Nyse and Nasdaq. Thus, in 2002-03 European companies had to face for the first time the application of the two new American SFAS. Moreover, the importance of this issue is linked to the change in EU regulatory framework (EU Regulation no. 1606/2002), which prescribes European listed companies to prepare their consolidated accounts in accordance to International Financial Reporting Standards (IFRS) from 2005 onwards. As in last few years a progressive alignment between US GAAP and IFRS has begun, European companies have now to deal with IFRS 3 on business combinations, which closely resembles to the US standards. Indeed, it can then be said that the US rules have subtly influenced accounting for intangible assets also vis-à-vis the other European companies (see Zambon and Dick 1998).

The paper is articulated as follows. In the following section, an analysis of the two SFAS will be proposed. A rather detailed overview of their content will be provided and their major innovations highlighted, also in comparison with the principles they supersede. Then, the empirical analysis will be presented. It is based on Forms 20-F released by European companies: at first, a qualitative study will be conducted in order to assess the behaviour of the analysed companies in respect of SFAS 141 and 142. After, both global and partial comparability indexes will be calculated to measure the quantitative effect of the two SFAS on net income and shareholders’ equity of European companies listed on US markets. The last section will be dedicated to drawing some conclusions. Findings about the examined issues will be discussed, offering a few interpretations and comments. Some further suggestions for a future development of this study will be provided.

A Presentation of SFAS 141 and 142

An overview of SFAS 141 and SFAS 142

SFAS 141 on “Business Combinations” Statement 141 has been issued by the FASB in order to produce relevant changes in the method of accounting for business combinations as well as in the classification of intangibles and in their recognition apart from goodwill. On the one hand, it prescribes this type of transactions to be accounted for only by using the purchase method; on the other hand, it sets criteria that intangibles must respect for their recognition apart from goodwill.

This statement supersedes APB Opinion no. 16 on “Business Combination” issued in 1970 and amends or supersedes a number of its subsequent interpretations. APB Opinion no. 16 allowed companies to record business combinations using one of the two methods: the purchase method or the pooling-of-interests method. Even though the use of the pooling-of-interests method was permitted only if certain criteria were satisfied, the possibility to account for identical transactions in different manner reduced the comparability of company financial statements.

In spite of the important changes introduced, it has to be noted that many of the previous prescriptions remained the same, like the criteria to be followed by companies to determine the cost of the acquired entity and to allocate it to assets acquired and liabilities assumed, as well as accounting for contingent considerations and pre-acquisition contingencies.

The FASB choice to account for all business combinations according the purchase method, determines the need to always treat this kind of transactions as acquisitions, and then to identify an acquirer entity and to calculate a goodwill as the excess of the cost over the net amounts of assets acquired and liabilities assumed.

Another important innovation introduced by SFAS 141 regards the separate recognition of intangible assets apart from goodwill. This is the most important change in the allocation of the business combination cost. It is prescribed that intangible assets have to meet one of the two criteria set for their separate recognition, otherwise their value must be included in goodwill. These criteria are:

• the contractual-legal criterion. The intangible asset has to arise from a contract or a legal right, regardless if that contract or that right can be transferred separately from the entity acquired or from other rights and obligations;

• the separability criterion. If the intangible assets does not arise from a contract or from a legal right, it can be recognised apart from goodwill only if it is separable. This means that it can be divided or separated by the acquired entity and can be sold, exchanged, transferred or rented. Even when an intangible asset cannot be sold, transferred, exchanged, rented individually, it is to be considered separable if it can be part of a transaction together with a related contract, asset or liability.

To help companies to better allocate the cost of the business combination, SFAS 141 provides a list of examples of intangible asset that meet these two criteria and are therefore to be accounted for as assets apart from goodwill. This guidance identifies five categories of intangible assets:

• Market-related intangible assets;

• Customer-related intangible assets;

• Artistic-related intangible assets;

• Contract-related intangible assets; and

• Technology-related intangible assets.

This is not an exhaustive classification and inside each category various intangibles can be included. As for the amortisation of these intangibles and the impairment methods, rules are given in SFAS 142.

It is interesting to point out that the value of the assembled workforce of “at-will”¹ employees acquired in a business combination does not meet the two prescribed criteria for the separate recognition and should therefore be included in the amount recorded as goodwill. This is based on the FASB’s view of the need to limit the appreciation of the intellectual capital that underlies the value of an assembled workforce.²

Finally, SFAS 141 requires companies to produce a more complete disclosure on the resulting business combination. Instructions regard both information to include in the annual financial statements and disclosure to be produced in the interim reports. In addition to the information that a company has to produce in the period in which a material business combination is carried out (general information about the operation), other several cases are indicated:

• when the amounts assigned to goodwill or other intangible assets are relevant in relation to the total cost of the operation during the period in which a material business combination is completed: SFAS 141 requires then specific information for goodwill, intangible assets subject to amortisation, and intangible assets not subject to amortisation (this information, together with general information about the business combination, is to be disclosed also when the operation is completed during the current year up to the date of the presentation of the nearest interim report);

• when a series of intangibles is not individually immaterial but material in the aggregate;

• when the company is a public business enterprise, supplemental information is to be disclosed in the notes to the financial statements on a pro-forma basis for the period in which a material business combination occurs;

• when an extraordinary gain due to the business combination occurs, information required by APB Opinion 30 is to be produced;

• when the allocation of the purchase price is preliminary and when contingent consideration is based on future earnings, companies have to produce the information required by the SEC.

Regarding to the information to be disclosed in the interim report, companies must provide it when the business combination is completed during the year up to the date of the nearest interim report.

As pointed out early, provisions of SFAS 141 apply to all business combinations initiated after June 30, 2001 and to all business combinations accounted for by the purchase method, whose acquisition date is July 1, 2001 or later (these provisions do not apply to business combinations between two or more mutual enterprises). It is therefore important to give a clear definition to the term “initiated”: SFAS refers to the definition provided by APB Opinion no. 16, for which a business combination is considered initiated at the date w...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• List of Figures
• List of Tables
• List of Appendices
• List of Contributors
• Introduction: Visualising the Invisible: Measuring and Reporting on Intangibles and Intellectual Capital
• PART 1 MEASUREMENT AND REPORTING ISSUES
• PART 2 DISCLOSURE ON INTANGIBLES: VALUE RELEVANCE, SCORING AND RATING
• PART 3 NEW PERSPECTIVES ON THE MEASUREMENT AND REPORTING OF INTANGIBLES
• Index