I have received several inquiries recently about the new accounting rule mandated by the Financial Accounting Standard Board (FASB) and what effect, if any, it will have on analysis of the financial statements provided by customers in order to obtain credit. The new accounting rule is Financial Accounting Standard 142 (FAS 142), Goodwill and Other Intangible Assets.

There is no doubt that the rule change will have an effect on financial statements as companies adopt the rule. In fact, several organizations such as Raytheon and AOL Time Warner have already reported quarterly losses, where they would have reported profits, based on one-time adjustments to their intangible assets in accordance with FAS 142.

FAS 142 addresses financial accounting for and the reporting of acquired goodwill and other intangible assets such as copyrights and patents, etc. Under the new rule those intangible assets that have indefinite useful lives will no longer be amortized over theoretical useful life (previously up to forty years). Instead, they will be tested annually for to determine if the previous assigned value is still justified. If the value of the intangible asset is no longer justified then the asset is to be written down to its fair value. FAS 142 provides guidance for testing the intangible asset to determine its fair value.

The word intangible is defined as “incapable of being appraised at an actual or an approximate value.” When reviewing the balance sheet the savvy credit analyst will deduct intangible assets from total assets and the corresponding amount from net worth in order to determine a better representation of the equity section of the balance sheet. This also provides a more accurate result when calculating the overtrading and debt to equity ratios. The write down of the intangible to a “fair value” will have an effect on the equity section when retained earnings are carried over from the income statement to the balance sheet. Therefore, the credit analyst will need to pay particular attention to any reduction in earnings from previous statements to determine if the reduction is due to changes in operations or complying with FAS 142.

FAS 142 should not have any effect on balance sheet analysis unless, of course, the analyst is including intangible assets in their analysis.

I wish you well.

This information is provided as information only and not legal advice. Legal advice should be obtained from a competent, licensed attorney, in good standing with the state bar association.