Roundtable Meeting and Discussion of "Accounting for Goodwill"

We hold these truths to be self-evident:

• A business combination effected with stock differs from an all-cash transaction.

• This does not mean that different accounting treatment is justified, just that there is a difference.

• In most transactions a substantial portion of the intangibles acquired can be identified: e.g. assembled work force, including management; customer list; in-process R&D; distribution channels, both domestic and foreign; patented or unpatented technology; products or services established in the marketplace including brand names.

• The remainder of the purchase price is a true residual: Goodwill

• Unless accounting treatment for the identifiable intangibles is consistent with that of the residual Goodwill, most acquirers will choose to minimize the former and maximize the latter.

• Some of the identifiable intangible assets have short lives, some medium term lives, some long lives, and some do not depreciate at all, e.g., they appreciate.

• There is little, if any, correlation between the cost(s) incurred to develop certain intangibles, and the real intrinsic value of those same intangibles; compare Oil Drilling where an exploratory well can cost $10 million and find $5 billion worth of oil – or none!

• The basic accounting conundrum facing us, and the reason that there is no agreement on any single accounting solution, is that the basic accounting model (GAAP) deals with costs, and the Purchase Accounting proposals deal with values.

• At least in the next 15 years, we do not expect to see the basic accounting model change from historical cost to Fair Value.

• Therefore any solution to the accounting for both identifiable intangible assets and Goodwill is going to result in a ‘mix’ of accounting attributes. This may be good or it may be bad, but it does explain the problems that many people have with ‘arbitrary’ accounting rules, including amortization of Goodwill over any finite period.

• On the other hand, some solution has to be found.

• Intangible assets, including Goodwill, can be tested for impairment.

Our recommendations, while not ‘self-evident’, are as follows:

1. Require Purchase Accounting. There are so few true ‘Mergers of Equals’ it is not worth trying to ‘save’ Pooling Accounting.

2. Require Buyers to identify the assets acquired, including major categories of Intangibles.

3. Develop estimates of values for clearly identifiable intangible assets in just a few major categories:
   • Customer base or distribution channels

   • Assembled work force

   • Technology, both patented and unpatented

   • Established products/services including brand names

   • In-process Research and Development

   • Other, specific to acquired company or industry, such as licenses, core deposits and so forth

4. Develop estimates of lives of those assets that have expected lives shorter than 20 years, e.g., work force, customer base.

5. Write off those assets over expected life, but ‘below the line’ because this is a non-cash charge.

6. Having valued (and disclosed) the other identifiable assets, add them to the residual Goodwill.

7. Do not set up a pre-determined amortization period, unless the buyer wishes to do so, in which case the estimated lives should be used.

8. For the Identifiable Intangible assets plus Goodwill, mandate annual testing for Impairment.

9. Impairment tests, based on residual income or some other means of assessing future income and cash flows, are no more difficult than many other accounting estimates. Companies make these estimates. Appraisers make these studies. Auditors can review all the inherent assumptions for reasonableness.

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