Impacts of the Adoption of SFAS 142 Goodwill
Before SFAS 142 took effect in 2001, goodwill resulted from an acquisition, and it could be amortized for up to 40 years. Since amortization expenses were recorded in the income statement, they affected a company’s earnings. As a result, many companies used the maximum 40 years to minimize the effects of the amortization expenses on the income statements. What is more, management could intentionally inflate the goodwill value in the balance sheet by only taking a few depreciation expenses for each period. Issues arising from the old goodwill treatment could have an adverse effect on shareholders' value, especially those acquisitions driven by managerial ego or other reasons. As a result, investors had no knowledge whether the acquisitions were appropriate investments or not.
Section I
Since 2001, SFAS 142 has required companies to test their goodwill impairment by taking a fair-value approach, at least annually. Current economic situations affect the goodwill impairment charge. If it is a bad …show more content…
As SFAS 142 requires companies to take goodwill impairment tests at least annually, increased impairment losses can reduce the assets account in the balance sheet. According to the loan covenants, borrowing entities need to maintain a certain level of debt-to-total assets ratio to avoid triggering the technical defaults. Some covenants require the borrowing firm’s debt-to-total assets to not exceed 70%. Reduced total assets arising from goodwill impairment charge can result in an increase of the debt-to-total assets ratio. Firms that entered into a balance sheet-based covenant may not be able to meet their debt obligations if they maintain a high debt level and take significant goodwill impairment loss annually. Therefore, SFAS 142 may be a major issue for those firms with a lot of debts to
Before SFAS 142 took effect in 2001, goodwill resulted from an acquisition, and it could be amortized for up to 40 years. Since amortization expenses were recorded in the income statement, they affected a company’s earnings. As a result, many companies used the maximum 40 years to minimize the effects of the amortization expenses on the income statements. What is more, management could intentionally inflate the goodwill value in the balance sheet by only taking a few depreciation expenses for each period. Issues arising from the old goodwill treatment could have an adverse effect on shareholders' value, especially those acquisitions driven by managerial ego or other reasons. As a result, investors had no knowledge whether the acquisitions were appropriate investments or not.
Section I
Since 2001, SFAS 142 has required companies to test their goodwill impairment by taking a fair-value approach, at least annually. Current economic situations affect the goodwill impairment charge. If it is a bad …show more content…
As SFAS 142 requires companies to take goodwill impairment tests at least annually, increased impairment losses can reduce the assets account in the balance sheet. According to the loan covenants, borrowing entities need to maintain a certain level of debt-to-total assets ratio to avoid triggering the technical defaults. Some covenants require the borrowing firm’s debt-to-total assets to not exceed 70%. Reduced total assets arising from goodwill impairment charge can result in an increase of the debt-to-total assets ratio. Firms that entered into a balance sheet-based covenant may not be able to meet their debt obligations if they maintain a high debt level and take significant goodwill impairment loss annually. Therefore, SFAS 142 may be a major issue for those firms with a lot of debts to