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In late July, New Economy darling JDS Uniphase made public a breathtaking $45 billion write-down of goodwill. And JDS is not the only high-tech company to reduce by billions of dollars the value of the goodwill it carries on its books. Others include Nortel Networks, $12.3 billion; VeriSign, $9.9 billion; and Qwest, $3.5 billion. The economic downturn is a major explanation for these sudden losses, but it’s not the only one. Companies may also have anticipated the imminent adoption of new accounting standards. These standards will have an important impact on how businesses record and recognize intangible assets, such as intellectual property. In our increasingly knowledge-based economy, intangibles are a significant portion of the assets acquired in the typical business combination. Therefore, better information about these assets has become more vital to the market. In response, the Financial Accounting Standards Board issued two new statements in July: FASB 141, “Business Combinations,” and FASB 142, “Goodwill and Intangible Assets.” Intangible assets, apart from goodwill, are assets that arise from contractual or legal rights or that are otherwise separately identifiable. Examples of separately identifiable intangibles include patents, trade and service marks, trade secrets, and licensing agreements. MORE GOODWILL Statement 141 reflects the conclusion that for accounting purposes, virtually all business combinations should be viewed as acquisitions (rather than mergers). Thus, the “pooling of interests” method to value business combinations is no longer allowed. Instead, all acquisitions made after June 30, 2001, must be accounted for using the purchase method. Under the purchase method, the price of an acquired entity is recorded on the acquiring company’s books as the combined fair values of all the acquired tangible assets and identifiable intangible assets. To the extent the price paid exceeds those fair values, it is accounted for as goodwill. In contrast, the pooling-of-interests method does not create goodwill. Therefore, this change in FASB standards will cause more goodwill to be recorded on the books. IMPAIRED TESTING Statement 142 deals with how new goodwill and identifiable intangibles will be accounted for after they have been initially recognized in the acquiring company’s financial statements. Previously, goodwill and other intangibles were deemed to be wasting assets with finite lives and were amortized annually over a maximum of 40 years. Statement 142, which goes into effect for most companies no later than Jan. 1, 2002, takes a very different approach. Under Statement 142, only those intangible assets that have finite lives will be amortized. Goodwill and other identified intangibles with indefinite lives will instead be tested annually for impairment. The test for impairment will be based on a comparison of the current fair values of those assets with their previously reported values. In the years after acquisition, Statement 142 requires various disclosures, including information about changes in the amount of goodwill, changes in the amount of intangible assets, and estimates of intangible asset amortization for the next five years. The bad news here is obvious from JDS Uniphase’s experience: The rapid loss in value of certain intangible assets will all too quickly hit a company’s reported earnings. And the necessary write-offs may all too publicly reveal that an acquisition is not paying off. But not every business anticipates unhappy revelations. Many companies — including AOL/Time Warner and Procter & Gamble — have announced that earnings will be positively affected as a result of no longer needing to amortize goodwill. And investors should certainly benefit from the additional disclosures. In general, the new FASB rules will force companies to more fully account for all intangibles, including IP assets. Attorneys who advise on the structuring of transactions will want to pay more attention to how tangible and intangible assets are valued and allocated. They may need more help from accountants and other valuation professionals. Attorneys should also bear in mind that increased disclosure can mean increased exposure to shareholder actions. Joseph S. Estabrook is a principal and Carl F. Miller is a senior manager in the Washington, D.C., office of Ellin & Tucker. Both have experience in valuing intangible assets and providing valuation consulting services to attorneys and their clients. Ellin & Tucker is an accounting and business consulting firm with offices in Washington, D.C., and Baltimore.

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