The debates at the Board's Norwalk, CT offices are in anticipation of a year-end final decision to eliminate the pooling-of-interests accounting method and in the process, recognize goodwill.

Jenkins and his staff have stated both to Congress and an alarmed industry that their objective is to evaluate the proposed standards thoroughly, yet aggressively. The end goal is to institute a purchase method standard that makes merger or business combinations accounting more accountable to investors, at a cost that in the long run helps - and does not harm - industry players.

In both trips to Washington, DC the chairman informed and educated lawmakers who have been lobbied by dot-come executives, tech firms and old-line manufacturers alike. All complain that eliminating pooling would discourage merger and acquisition activity, ultimately impacting the national economy. Jenkins' latest congressional appearance was on May 4th where he testified before the Subcommittee on Finance and Hazardous Materials.

Kimberly Petrone, a FASB staff member and project manager, also represented the Board in Washington and help write the September 1999 FASB Exposure Draft, eliminating the pooling method.

Petrone noted, "We are still listening to feedback and sorting through information. The idea is to first determine an acceptable way to treat goodwill, then determine how to proceed with the purchase versus pooling accounting methods."

At Issue: Goodwill
Many voices in industry are still fighting against recognizing goodwill on the merged balance sheet.

Goodwill is the amount paid above the "fair" value of the acquired company's assets. Because goodwill is notionally an asset, and assets wear out, goodwill must be amortized with a regular charge against earnings for some period of time. In theory, goodwill should equal the premium the buyer pays over and above the fair market value of all the acquired company's assets.

Acquirers seldom fix a value on the intangibles. Instead they appraise the tangible assets and dump everything else into goodwill. That makes goodwill critically important in deals involving knowledge companies, especially e-commerce firms, and pharmaceutical and biotech target firms, all of whom virtually owe their entire purchase price to intangibles, such as goodwill.

Accounting rules arbitrarily assign this catchall category a useful life that can be as long as 40 years, which then means that the value of goodwill must be amortized, or written off for that period. A dollar of amortization reduces reported earnings by a dollar. An acquiring company that acquires a lot of goodwill and who accounts for it on the balance sheet, is also acquiring a drag on future earnings.

Taking A Second Look
In an attempt to follow through on its promise to Congress and the investing public, the FASB hosted Trevor Harris, a professor of international business at Columbia Business School in late May and early June. In addition, an industry team with representatives from Morgan Stanley Dean Witter, Goldman Sachs & Co., Deloitte & Touche, PricewaterhouseCoopers, and Arthur Andersen also participated. Three days later they invited the Institute of Management Accountants to further discuss issues.

Harris and his team presented a 52-page presentation Accounting for Business Combinations: A Workable Solution. The central premise suggested redefining goodwill from an amortizable asset, as defined in paragraph 46 of the Exposure Draft, to a non-amortizable intangible asset, as defined in paragraph 40. This would cause goodwill to overcome the 20-year useful life presumption; be of a type that has an observable market; and be determined to have an indefinite useful economic life that is not otherwise limited.

The professor and the invited bankers and auditing executives introduced a residual income approach to valuing new merger deals and goodwill - a move they said would help the investing community and regulators " … understand the extent to which you have acquiring managers who are overspending. This method helps highlight what is going on and reveals how well management is managing."

Jenkins and the Board were supportive of the group's theories but proved to be realists.

"Is this something the auditors can do, or do they have to hire investment bankers," quipped Jenkins to laughter from the group. "I think this is useful, you're not just ignoring goodwill, but looking at this thing, step-by-step. You're pulling the discussion back to rates of growth, equity and things like that," he added.

Answering Jenkins, Paul Efron, Managing Director of Goldman Sachs said, "Will the auditor be able to do that...my answer is yes, it's a higher level of understanding of finance, but yes the auditor can record the deals at this level of sophistication."

Benefits of a Residual Income Approach Based on accounting measures so there is a direct link between goodwill and valuation Relates net asset values, earnings and reinvestment of free cash flow to valuation Corporate business plans usually exist for 3-5 years facilitating reliability, tests of valuations and goodwill Terminal values are constrained, carry smaller weights

The significance of the two-and-a-half hour discussion lay not only in its mathematical and theoretical sophistication, but also that leading industry practitioners were willing to support the recording of goodwill in some manner, and were shrewd enough to tie into FASB's existing Exposure Draft and its wording of impairment testing.

Summary of Recommendations Capitalize goodwill No systematic amortization of goodwill In general, do not split acquisition premium (excess of purchase price over tangible net asset value) into separate intangible assets Goodwill impairment test based on residual income valuation to prevent overstated asset value

Future Discussions
It has been the case with the FASB since the beginning of the debate that merging companies stop ignoring goodwill. It is not clear if the redefining of goodwill as a non-amortizable, intangible to be tested annually, is good enough.

"This was very instructional and very useful, regardless of the outcome of what we do," commented Jenkins. "This is good, you brought in impairment as part of the discussion."

It is possible the FASB will stick to its contention that only in the purchase method of accounting, where goodwill is an amortizable intangible, that it is fairly and accurately noted. Here the acquiring company records the net assets of the acquired company at the price paid, including any intangible assets to the extent they can be separately identified and reliably measured. The excess of the price paid over the fair value of the acquired company's net assets is recorded as goodwill, which is subsequently amortized and charged against earnings over time.

The FASB is considering a number of other options. They include cutting the goodwill write-off period to ten years (or possibly 20 years if companies could make the case for the longer period) from the current 40-year term. In addition there is the argument to preserve the "as is" current scenario with a 40-year write-off period. Many industry players say they would favor a one-time goodwill charge-off.