The Financial Accounting Standards Board (FASB) has reconfirmed its proposal to require the purchase method of accounting for all business combinations and to eliminate the pooling-of-interests method.  But while earlier proposals would have required goodwill to be amortized to earnings over a period of up to 20 years, under the latest proposal, goodwill would only be written down if its value is impaired.

The Board also reconfirmed its plan to "grandfather" all business combinations taking place before the date of its final statement, which is expected to be issued in June of this year. Currently, under the purchase method, any amount by which the purchase price exceeds the fair market value of the seller’s assets is allocated to goodwill and other intangibles, which are amortized over their economic life, diluting the new entity’s earnings.  In a pooling transaction, the assets, liabilities, and equities of the combining companies are combined at their historic book values, and no goodwill is recorded.

The proposed statement recognizes that some of what is recorded as goodwill retains its value.  Under the statement, intangible assets created in a business combination would be tested periodically for impairment by comparing the fair value of such assets to their carrying amounts.  If the fair value is lower than the carrying amount, an impairment loss would be recognized.

The proposed statement would also affect combinations that produce negative goodwill, requiring a one-time extraordinary gain in place of amortizing the negative goodwill as ordinary income.  

Impact on Business Valuation
Price-to-earnings multiples will likely be affected.   Because amortization expense of goodwill (created by a business purchase or combination) will not automatically be required, the company’s net income will often be higher.  Therefore, when utilizing the market approach valuators will need to analyze the statement’s impact on a company’s financial statements and, if necessary, make normalization adjustments to comparable guideline and/or acquisition companies so that earnings multiples are consistent.

When utilizing the income approach, in converting discount rates from cash flow to net income and vice-versa, the valuator should consider the effect of the change in amortization expense.