New Goodwill Guidelines: impact on financial ratios. (Accounting Issues).

In this companion article to "New Goodwill Guidelines: Some Implications for Bankers," Kilpatrick and Wilburn describe what effect new FASB rules have on financial ratios and provide examples using Coca-Cola Company and AOL Time Warner, Inc.

Big changes came to how companies account for mergers and acquisitions when the FASB issued Statement of Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets." It's been 19 months since then, and bankers are still trying to figure it all out as they use financial statements and ratios to analyze and evaluate a company.

The goal of these rules is to increase comparability in accounting for similar business transactions and to improve the transparency of information reported for goodwill. SFAS No. 141, which eliminates the "pooling-of-interests" method of accounting for business combinations, affects combinations entered into after June 30, 2001. SFAS No. 142, which eliminates amortization of goodwill and other indefinite-lived intangibles and instead requires these assets to be tested for impairment in value, is effective for fiscal years beginning after December 15, 2001 and for new business combinations occurring after June 30, 2001.

The effects of adopting the new goodwill accounting rules can be dramatic. AOL Time Warner reported a $54 billion goodwill impairment loss (which had a pre-adoption balance of $127 billion) and estimates a reduction in annual amortization expense of approximately $6.4 billion. On the less dramatic side, Coca-Cola Company reported a goodwill impairment loss of $926 million upon adopting SFAS No. 142 and estimates a reduction in annual amortization of approximately $210 million.

Effects on Financial Statements and Ratios

The adoption of SFAS No. 142 requires that an initial impairment assessment be performed on all goodwill as well as those intangible assets with indefinite …