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RD Intangibles

• San Francisco Academy
• Thursday, February 19, 2004
• Professor Paul Zarowin, PhD
• New York University
• Stern School of Business
• KMEC 10-90
• 44 West 4th Street
• New York, NY 10012
• Tel [phone] / Fax [phone]
• pzarowin_at_stern.nyu.edu

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Presentation Outline

• 1. Introduction
• 2. The problem/issue
• 3. How we got here FASB and barriers to change
• 4. Capital market consequences
• 5. Solutions
• 6. Management accounting issues
• 7. New Accounting Rules
• 8. Summary

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1. Introduction
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2. The Problem/Issue

• Growth in RD
• BAD Accounting
• Paucity of RD disclosures
• hinders evaluation
• SUMMARY Bad Accounting and Insufficient
  Disclosure,
• when good accounting and more disclosure are
  needed most

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Economy-Wide Total RD Expenses Over Total Sales
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Economy-Wide Aggregate RD Expenses
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Economy-Wide Aggregate Market-to-Book Ratio
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3.How we got here-standard setting/barriers to
change
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4. Capital Market Consequences of the Problem
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5. Solutions - what to do?!
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6. Management accounting/internal control issues
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7. New Accounting Rules
Purchase Method for Acquisitions and Goodwill
Impairment
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Accounting Rules - Acquisitions

• Pooling of interest versus purchase.
• The purchase method led to Goodwill, which had
  to be amortized over a period not to exceed 40
  years.
• Companies tried avoiding the purchase method
  because future earnings were negatively impacted.
• The new accounting rules eliminated pooling and
  required purchase for all acquisitions.

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Example
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New Accounting Rules

• Upon acquisition, break the excess of acquisition
  price over fair market value of assets purchased
  into specifically-identifiable intangible assets.
• The remainder is goodwill.
• Goodwill is not to be amortized, but has to be
  tested for impairment in value.
• Test annually and whenever conditions may
  warrant.
• Write down goodwill if impaired.

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Amortization and Impairment

• Assess whether intangible assets have finite or
  indefinite lives.
• Finite-life intangible assets should be
  amortized, typically on a straight-line basis.
• Other intangible assets are subject to (at least)
  annual impairment testing
• If impaired, asset write-down is required with a
  negative effect on income in the same period.

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Impairment Test

• Intangible assets subject to amortization should
  be reviewed according to SFAS No. 121, i.e., if
  the carrying amount exceeds fair value and is not
  recoverable, write the asset down.
• Undiscounted cash flows are less than carrying
  amount.
• Goodwill Compare the fair value of the reporting
  unit to its carrying amount (including goodwill).
  If carrying amount is higher, goodwill is likely
  to have impaired. Fair value is the amount that
  can be obtained in a sale of the reporting unit.
  Best evidence is market prices. Otherwise, use
  comparables, present value techniques.

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Impairment Amount

• Allocate the fair value (as determined before) to
  tangible and intangible assets of the unit,
  excluding goodwill.
• The excess of the fair value of the reporting
  unit over the amount assigned to its individual
  assets and liabilities is the implied fair value
  of goodwill.
• Goodwill should be written down to the implied
  fair value or zero, whichever is greater.

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Example- Wellman (WLM)

• The company manufactures and markets polyester
  products and PET resins. It also recycles PET
  plastics.
• In the first quarter of 2002, the company adopted
  SFAS No. 142. The adoption resulted in a charge
  against income of 197 million!
• The earnings from continuing operations were 5.6
  million, on sales of 239.4 million.
• Stockholders equity declined from 612.7 at the
  beginning of the quarter to 397.0 at the end.
• Goodwill declined from 230.5 million to 33.3
  million at the end of the quarter.

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Example- Wellman (WLM)

• The company used the two-step process first
  testing for impairment in its reporting units,
  and then reducing the goodwill to its implied
  value in the Fibers and Recycled Products Group,
  which accounted for about 48 of quarterly
  revenues.
• The fair value was based on the present value of
  estimated future discounted cash flows.
• The entire goodwill related to this segment was
  written off.
• Goodwill in the other segment was left intact,
  with no amortization charge.
• Goodwill amortization in Q1/01 was 2.1 million.
• Other assets which were intended to be sold were
  written down to fair value less than cost of
  disposal (another charge of 19 million to
  earnings), consistent with SFAS No. 144.
• Net Earnings from continuing operations in the
  second quarter of 2002 were 12.8 million.

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8. Summary