GB791 Unit 3 Standard Setting Analysis Example

From Twenty Years to None: A Unit 3 Standard Setting Analysis of Goodwill Accounting, 1999 to 2001

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Purdue University Global

GB791: Advanced Topics in Accounting

Unit 3 Standard Setting Analysis

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[Date]

The analysis is based on the published record of real standard setting; its interpretation is the candidate's.

The Baseline: Amortization and Pooling

From 1970 until 2001, two opinions of the Accounting Principles Board governed business combinations in the United States. APB Opinion 16 allowed two methods. Under purchase accounting, the acquirer recorded the target's assets at fair value and recognized any excess of the price paid as goodwill. Under pooling of interests, available when a combination met a list of conditions, chiefly an exchange of shares, the two companies simply added their book values together, and no goodwill appeared. APB Opinion 17 required goodwill recognized under purchase accounting to be amortized over its estimated life, with a maximum of forty years (Accounting Principles Board, 1970).

The combination mattered. Because pooling produced no goodwill and therefore no amortization, it allowed a company to report higher earnings after a merger than purchase accounting would. Companies structured transactions to qualify for pooling, sometimes at real cost, and many of the large stock-for-stock mergers of the 1990s used it.

The 1999 Exposure Draft

In September 1999, the FASB issued an exposure draft on business combinations and intangible assets. It proposed two major changes. Pooling of interests would be eliminated, so that every combination would use the purchase method. And the maximum amortization period for goodwill would be reduced from forty years to twenty. The Board's reasoning, as stated in the draft, was that goodwill is an asset that is consumed over time and that its cost should therefore be matched against the revenue it helps produce, and that forty years was longer than goodwill's useful life could reasonably be estimated.

The draft also proposed that goodwill amortization be presented on the income statement net of tax as a separate line, a concession to companies that worried about the effect on reported earnings.

The 2001 Revised Exposure Draft

In February 2001, the Board issued a revised exposure draft that reversed its position on amortization. Pooling would still be eliminated. But goodwill would no longer be amortized. Instead, it would be tested periodically for impairment and written down only when its carrying amount exceeded its implied fair value. The final standards, Statement 141 on business combinations and Statement 142 on goodwill and other intangible assets, were issued in June 2001 and adopted the revised approach (Financial Accounting Standards Board, 2001).

The revised draft's reasoning differed from the 1999 rationale. Where the earlier draft had argued that goodwill is consumed and should be matched against revenue, the revised draft argued that straight-line amortization over an arbitrary period gives users little information, and that an impairment test, though dependent on estimates, would better reflect the economics of goodwill.

What Changed Between the Drafts

The arguments for and against amortization were not new in 2001. Both had been made in comment letters on the 1999 draft and at the public hearings that followed. What changed was the pressure surrounding the proposal to eliminate pooling.

Ramanna (2008) studied this period and documented the political record. Companies that used pooling heavily, together with their representatives in Congress, opposed its elimination. Bills that would have blocked or delayed the change were introduced, and members of Congress wrote to the Board. The opposition was concentrated among firms in industries that grew by acquisition and paid in stock, and Ramanna found that political action committee contributions from those firms were associated with congressional opposition to the FASB's proposal. In that setting, the shift to nonamortization had a clear effect: it offered companies that would lose pooling a different way to avoid charges against earnings. Under the impairment approach, goodwill would remain on the balance sheet without regular amortization, and earnings would be reduced only when an impairment was recognized.

Ramanna (2008) also argued that the impairment approach gave managers discretion, because the fair value of a reporting unit is difficult to verify. That discretion was part of what made the compromise acceptable to opponents.

The Board traded the end of pooling for the end of amortization, and the evidence suggests the trade was shaped as much by who objected as by what they argued.

Reading the Record Carefully

The record supports an interpretation, not a proof. The Board's public documents give conceptual reasons for the change, and some members held those views from the start. It is possible that the reversal reflected a genuine change of mind among members persuaded by comment letters. The political interpretation rests on timing, on the pattern of opposition and on the fact that nonamortization specifically answered the objections of the firms most affected. A careful analysis says that the political pressure plausibly explains why the conceptual argument for impairment prevailed in 2001 when it had not in 1999.

What the Case Suggests About Standard Setting

Two accounts of standard setting compete in the literature. One treats the Board as a body that weighs conceptual arguments and adopts the rule that best serves users of financial statements. The other treats standard setting as a political process in which affected parties, and the legislators they support, shape outcomes. The goodwill reversal is useful because it allows the two accounts to be compared on one decision. The conceptual account explains why impairment testing had supporters in 1999. The political account explains why those supporters prevailed in 2001 rather than earlier, and why the change came packaged with the end of pooling. The case does not show that the Board abandoned its conceptual framework; it shows that the framework left enough room for more than one defensible answer, and that pressure helped decide which answer was chosen.

The Rule Since 2001

Goodwill accounting has continued to change. In 2014, the Board allowed private companies to amortize goodwill over ten years or less, responding to complaints that the impairment test was costly for them and of little use to their lenders. In 2017, it simplified the impairment test for all companies by dropping the old second step, the exercise of reallocating a reporting unit's fair value as if it had just been acquired, so that impairment is now measured as the excess of a reporting unit's carrying amount over its fair value. In 2019, the Board issued an invitation to comment asking whether public companies should return to amortization. After deliberations, it took the project off its agenda in 2022, leaving the public company rule as it was.

The pattern of the past two decades is that the costs of the impairment approach were felt most by private companies, which received relief, while public companies remained under the 2001 rule. Whether that rule reflects the best measurement of goodwill or the compromise reached in 2001 is a question the record since then has not settled.

References

Accounting Principles Board. (1970). Intangible assets (APB Opinion No. 17). American Institute of Certified Public Accountants.

Financial Accounting Standards Board. (2001). Goodwill and other intangible assets (Statement of Financial Accounting Standards No. 142).

Ramanna, K. (2008). The implications of unverifiable fair-value accounting: Evidence from the political economy of goodwill accounting. Journal of Accounting and Economics, 45(2-3), 253-281. https://doi.org/10.1016/j.jacceco.2007.11.006