>>'Goodwill' accounting rules are hitting corporations hard
NEW YORK — Still smarting from the recession and the Sept. 11 attacks, many of America's large corporations are taking another financial hit, thanks to new accounting rules forcing them to write billions off their books for money lost on past merger and acquisition deals.
Companies used to acknowledge the erosion in small increments over periods lasting up to 40 years under a technique known as amortization of goodwill.
But regulators required companies to stop amortizing goodwill this year, and the change is resulting in hefty losses for many companies reporting the writedowns for the first time in their first-quarter earnings statements.
Wednesday afternoon, AOL Time Warner announced the biggest writedown so far under the accounting changes — a one-time balance-sheet charge of $54.24 billion reflecting the company's market-value decline since it was announced in January 2000 that America Online and Time Warner would merge in a $106 billion deal.
The massive charge, however, didn't shock experts who follow the company because it had already been announced. And for AOL Time Warner and other companies affected by the accounting-rule changes, the writedowns amount to paper losses generally anticipated by analysts.
The rule changes were made by the Financial Accounting Standards Board (FASB), which develops private-sector accounting rules recognized by the Securities and Exchange Commission.
Critics said the old rules governing accounting for mergers and acquisitions allowed companies to understate the value of their purchases and inflate earnings, said Itzhak Sharav, an accounting professor at Columbia University's business school.
Timing of change hurts
But the changes are hitting many companies hard now because of the timing under which they are taking effect. That's because the value of many acquisitions U.S. corporations made in the late 1990s and in 2000 plunged last year in a recession economy.
Underlying the changes is the accounting concept of goodwill.
When one company buys another, there's always a book value to the acquisition — the firm's assets minus its debts.
But goodwill comes into play because there are a host of intangible assets that make the value of the acquisition worth more than the whole of its identifiable parts, said Kim Petrone, FASB's director of planning, development and support activities.
It could be that the company being bought has valuable locations and employees or strong customer loyalty. Also, acquiring companies usually pay more than the value of what they are buying to ensure that the deal goes through.
"Goodwill is the difference between what you paid and the fair value of the underlying liabilities and assets of what you bought," Petrone said.
Under the old rules, goodwill was considered a "wasting asset" that declined in value over time and had to be depreciated, which cuts into companies' earnings a little bit each quarter.
But under the new rules, goodwill isn't necessarily a wasting asset.
"Those may be more valuable assets now. It's better accounting in the sense that it more accurately reflects the value of each acquisition," said April Klein, an accounting professor at New York University's Stern School of Business.
The new rules let companies leave the value of their goodwill as is on their books unless it falls — under another accounting term called "impairment."
"If you bought the company and paid a fair price there's no reason to write it down," Klein said. The AOL Time Warner merger "created all this goodwill, but there's an impairment because they paid more than it's worth. Who knew the Internet bubble would burst, but they have to write it down."
Merger costs catching up
The problem is magnified for companies now because of the mergers and acquisitions craze of the 1990s that saw huge acquisition deals for ever-increasing prices. Many were in the technology sector, which crashed hard in 2000 and 2001, erasing much of the goodwill. But companies in other sectors aren't immune to the accounting rule changes.
For example, supermarket giant Safeway this month recognized a $700 million setback on major acquisitions in Illinois and Texas, saddling the Pleasanton, Calif.-based grocer with a substantial first-quarter loss.
While writedowns hurt many companies' earnings this year, they should boost earnings in the long run as long as the companies don't have to take additional impairment charges, said Dan Noll, director of accounting standards for the American Institute of Certified Public Accountants.
"If you don't have to expense that over time, your net income is going to be higher," he said. "Bottom-line net profit will look better."
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