Goodwill impairment testing - Merry Christmas

Its closing bell for 2008, (whew finally...) and this year in addition to the usual laundry list of closing activities for USGAAP related accounts, there is bound to be an extensive list of activities to be added to the closing checklist on the CFO's calendar.... "Impairment Testing"

Companies are under FAS 142 required to look for factors that may lead to goodwill or other intangible asset impairments at quarter ends but are mandatorily required to examine and assess whether a firms goodwill and intangible assets have been impaired at the year end. This is to be performed regardless of there being a triggering event.

A goodwill write-down is required when the impairment is deemed permanent — or not "recoverable within a reasonable amount of time". In accounting terms, if the stock price stays below carrying value for 60 days it generally means a triggering event. We are in that kind of situation now, in which many companies are experiencing depressed pricing for longer than 60 days, and not seeing much volatility on the upside,

Where there is smoke there is fire, well if plummeting stock and real estate prices weren't enough, significant cash flows have begun to dry up. These will make it a thorny and a rather intriguing time on the excel sheets for financial analysts drawing up their round of cash flows over the next 5 years for impairment analysis testing.

The testing process itself is onerous and can be thorny, as it includes running several valuation models, examining and reworking internal forecasts, gathering and digesting analysts' price targets, reviewing historical pricing, and crunching industry data. Whats more once all this is through on the excel sheets, the same needs to be convinced to the board, thanks to  SOX & as well as to the audit firms. Companies may need to plan additional time devoted to this activity.

Assuming after all the testing, there is a permanent impairment and a Company is required to book impairment losses, "USGAAP rules prevent impairment losses to be reversed in the future.

This means that if the year 2008 were to be the worst year for a decade, we will be stuck with these impairment losses sitting in the reserves in the years to come. This can however be overcome, once you either sell the business unit in which the goodwill loss has been booked or the easier way out convert your accounts to IFRS as IASB allows reversal......... 

Well converting to IFRS maybe an easier solution as you can offset your losses by booking DTA (deferred tax assets) on the impairment losses with the hope that these will reverse once you convert to IFRS.......but thats only when you can pass the going concern test in the first place.......blip..zzzbliiipppzzz

Merry Christmas to Goodwill testing (i have time until March 31 as my books close then..)

PS - i now beleive in the theory that fair value accounting will lead to naked short selling (read our earlier article)... with the losses to be posted in Jan 09...better we shy away from the markets..click here

Leases - Asset Retirement obligations and MLP's

Should asset retirement obligations or costs incurred by an entity at the time of retirement of a fixed asset in a lease be included in calculating the minimum lease payments...

Asset retirement obligations or ARO's are defined as legal obligations imposed on an entity to reimburse costs to a third party upon retirement of tangible long lived assets. The term retirement is defined as the other-than-temporary removal of long lived assets from service and includes sale, disposal of assets etc.

To illustrate this in simple terms

Assume a Chemical Company takes on lease a factory for a period of 10 years from the Govt, the Company has been obligated by the Govt to decommissions all hazardous machinery at factory at the end of the lease term. The costs which will be incurred to dispose of the hazardous machinery are commonly referred to as ARO's.

Accounting for the ARO's are primarily been zeroed in USGAAP's FAS 143, wherein Companies are required to estimate the fair value of the ARO at the time of retirement and account them at their present values.

This issue of Substance over form looks at whether costs in an ARO for a leased property should be included while calculating the minimum lease payments for a lease classification there impacting lease accounting under FAS 13 under US GAAP or AS 19 under IGAAP.

Let us take two cases where there is a ARO involved

Case 1 - Company leases a fully furnished office (with carpets, cubicles, Air conditioning etc) and has been contractually obligated to remove the furnishings at the expiry of the lease

Case 2 - Company leases a raw office and furnishes the office, the Company is obligated to remove all furnishings at the expiry of the lease and hand over the office in the same raw condition back to the lessor

In both the circumstances there is a cost which the Company will incur at the expiry of the lease, the question is whether these costs should be categorized as minimum lease payments of the leased office for determining the classification and accounting of the lease of the office.

GAAP by definition, defines lease as the right to use the asset, therefore only monies which are directly identifiable to that asset should be included in the minimum lease payments.  

Case 1 - As the Company leased a furnished office, and has to incur costs at the end of the lease term to dismantle the asset, the cost of the dismantling or ARO will be construed as a minimum lease payment as the rent for the leased property included the cost of the furnishings and that the assets belonged to the lessor.

On case 2, as the assets were constructed post the leasing of the office, the dismantling costs or the ARO should not be included as the costs are not linked to the lease payments of the office. Rather these should be accounted under FAS 143 under USGAAP, at present there is no such  requirement under Indian GAAP

Let us take an another example to illustrate this further

Company A (lessor) owns a petrol station that it leases to Company B (lessee). The property includes pre-existing underground fuel storage tanks that are required by the local government to be removed in ten years. Even though Company A leases the petrol station to another party, it remains legally obligated for removal of the underground storage tanks and must recognize an ARO pursuant to FAS 143.

If the lease agreement requires Company B to remove the underground storage tanks at the end of the lease term, the cost of removal would be included in the minimum lease payments and accounted for under GAAP for leases 

 As the concept of ARO is still not very understood in the Indian GAAP context, one must always look for such costs embedded in agreements lease as these could be covered under AS 19. 

Its an another example of an embedded lease - GAAP is in more ways than truly substance over form.

Read our earlier article on embedded leases by clicking here.

Going Concern - are you sure your firm will survive the next 12 months

A FEW months before XL Leisure Group, Britain’s third-largest tour operator, filed for bankruptcy in September, leaving thousands of holidaymakers stranded, it issued a set of accounts, signed off by its auditors, that gave no hint it was about to go bust. Such experiences haunt auditors as they grapple with year-end accounts in the cruellest economic climate most have ever experienced. “Companies and their auditors have got to get used to the idea that nothing is as it used to be,” comments Will Rainey, a partner at Ernst & Young, one of the big-four accounting firms.

The problem is that year-end accounts are prepared on the basis that a business is a “going concern”, ie, that it will operate for the foreseeable future, or at least 12 months after the reporting period. That judgment is made by the board of directors, and auditors have to agree with it.

The difficulty they face is that most companies fund their operations in part through borrowing, which can stretch from simple overdrafts to huge syndicated loans. Each year, auditors will often seek letters from their clients’ bankers reassuring them that they will renew lending facilities in the ordinary course of business. But this year many banks may well refuse to write those letters because they do not want to commit to new lending. It will lead to some difficult judgment calls on the availability of funding next year, Mr Rainey says.

According to international standards, directors and auditors usually have three options with accounts: they can prepare them on a going-concern basis, which is standard but might expose them to charges of negligence if they are wrong; if they do not believe the business is a going concern, they must prepare the accounts on a break-up basis; or they can express some doubts about the company’s future, but still prepare the accounts on the going-concern basis. (Britain’s Financial Reporting Council has suggested a fourth alternative, that would express “serious doubt” about the ability of the company to continue as a going concern. But auditors say this may add to confusion.)

The temptation this year will be to express some doubts about funding uncertainties, but auditors realise that if they do that too widely, the caveat will become meaningless. Steve Priddy, of the Association of Chartered Certified Accountants, says that the onus will be on directors to be frank about any worries, even when they consider the firm a going concern. But if banks do not want their most creditworthy clients to suffer, they should be a bit bolder, too. After all, many now have the explicit backing of their governments. So they can afford to be a bit more public-spirited in these peculiar times.

Source - the Economist 

Lease GAAP unusual questions- software licences can they be classified as leases

Various companies very often source software licenses from third parties for their operating systems and more often than not these are bundled together with AMC & software support contracts.

Contracts for core accounting and operating software typically run over a period of time say 3-5 years and many a times accountants take the annual cost  on the contract straight into SG&A.

Well for those companies who wish to improve their EBITDA or LBITDA (coined only for the recession "L"= losses), they can take recourse to lease accounting.

Wait a minute doesnt, lease accounting straight away exclude licenses from its scope under its very definition, co-incidentally all GAAP's (US/IASB/ICAI) have this written in their very first page, so where's the scope.

Well i scratched my head and could find all about two reasons

a) the exclusions cover licences on copyrights, trade licenses, oil exploration rights.... most of these licenses, typically have no shelf life and appreciate over a period of time or rather are intangibles with no finite life, these can be construed that lease GAAP excludes from its scope only those licenses, which dont have a shelf life and their values appreciate over a period of time.

b) SOP 98-1 (Accounting for cost of software- AICPA pronouncement) provides that companies must analogize to FAS 13 (Accounting for leases), whenever  an asset is acquired as a result of a software arrangement and must test for the 4 criteria to classify them as an operating or a financial lease.

ADBreak: if you wish to get constant GAAP updates on your mobile - SMS SARIN to 56070 or simply click on this link http://labs.google.co.in/smschannels/subscribe/GAAPupdates

Point (a) may or may not be that convincing but if you can analogize SOP 98-1 to your GAAP, then its worth a try.

Now that we have figured out that software licenses can be classified as leases, all you have to do is break down your value of the contract into cost of software licenses, cost of support and AMC (based on the fair value approach) or rather apply the rules on embedded leases (read my blog on embedded leases).

Its strange but when you sit down and compare GAAP'S across the world, most of the substance remains the same, though may vary in form.

IFRS amendments on Fair value - Its trinity's turn

With Neo (banks) and Smith (FASB) read earlier articles on fair value, its time to introduce TRINITY (IFRS)

With the FASB taking a lot of flak for its standard on FAS 157 and being forced to make some amendments, IASB in response also decided to make certain amendments to IFRS 7 and IAS 39.

The amendments to IAS 39 introduces the possibility of reclassification of investments  from a "held for sale" assets classification to a "held to maturity." 

• The switch eliminates the need to record the instruments at fair value (at market prices), and;
• instead allows companies to record these instruments at historical costs unless there is a permanent impairment. (explained with an example at the bottom of the blog)

Reclassifying the assets to held to maturity will be a big boost for banks, which now can continue to hold these investments at book value and only test for impairment rather than marking them to fair value prices in distressed market conditions.

The only glitch or rather advantage which firms applying IFRS will have over USGAAP, is that the reclassification can be done retroactively from July 1, 2008. This will give bank managements to essentially 'cherry-pick' which instruments to reclassify and, in some instances, avoid the recognition of markdowns on assets that declined in value since that date.

IAS 39 was deemed a stronger standard than FAS 115, for the fact it did not allow reclassification of investments. I feel that, the current move has given a silver lining to a lot of  companies to reclassify those investments retroactively which have been worst hit in the financial turmoil (Q3) and will have a very minimal chance of their appreciation in the next year (even over their book value).

This reclassification will enable companies to restate their Q3 earnings and boost Q4 earnings. Accountants who have an eye on the stock markets and have a punting trait in them will be much in demand to cherry pick these investments to boost their companies growth. 

For instance, consider a bank has an equal portfolio mix of real estate investments and FMCG stocks, say $50M each and both were classified as held for sale.

• On July 1, 2008, the value of the real estate portfolio was $30M and FMCG stocks were $40M 
• Losses recorded on account of the fair valuations in the company are $30M ($50M-$30M for real estate) & ($50M-$40M) for FMCG
• Your company's investment analyst has forecasted a bearish view on real estate stocks, while being bullish on the FMCG stocks for the next year
• Given this view, accountants reclassify only real estate stocks from held for sale to held for maturity, thereby restating their values back to $50M and reversing the $20M loss in the books.
• Total revised losses on account of the reclassification are now $10M (on FMCG stocks). There is an earnings boost to the extent of $20M (real estate reclass)  for the current quarter of reclassification.
• If the FMCG stocks rebound in the next quarter, these losses will also reverse on the basis of their fair valuations.

A smart accountant will retain the losses on the FMCG stocks as "rainfall provisions" to be utilised in the next quarter. In case the stock prices rebound, the losses reverse, if the economic crisis deepens, he still has the option to reclassify this investment to held for maturity and thereby giving his company an earnings boost in a deeper economic crisis.

Ain't IFRS getting accountants to be more creative and albeit triggering a sense of punting in them.

How not to Recessionise your job - Catch 22 pointers

Its Q4, and its that time of the year when yankee FPA's are sitting alongside with all business heads to shore up 2009 numbers albeit on excel sheets. Without guessing, a lot of the work next year will center on pruning costs given the dire economic outlook. A lot of companies have built up large capacities (plants, service centres) in the last fiscal with the growth mantra might just find the reverse happening next year. So can companies cut their fixed costs, maybe not but variable costs like payroll is very much on the cards.

Cutting jobs is perhaps the toughest choice a company makes especially when the mantra in the near past was "employees are our most valuable assets"- ask Naresh Goyal

With over 150,000 jobs lost in the month of October alone in the US (source ADP survey), the HR's axe has fallen rather quickly. Well these are a SUBSTANCE OVER FORM pointers towards ensuring the axe does not fall on you.

• If your boss was one of those "i saw Karzzz this friday" when you were working your donkey ass off reporting ...grrrnt.. and you just cant stand him..ugggh. get into discussing tandoori nights and urmila and Himesh's next movie for the short term... the better your relationship with him, the less likely you are to be cut.
• Do not post your resumes on job portals, your HR might just have access to these portals and will just about know who to cut basis the resumes on these portals. HR's like to keep the loyal kin intact. Its a catch 22 aint it, while you want to keep an eye on the job market. Well this is what you can do, look for portals which respect your privacy,displays your profile without your name or your present employment status to recruiters.... try http://www.shine.com/ for instance .. even monster is decent provided you have switched off the visibilty tag.
• Boss, cant you grant me some ESOPS?? will pay right down in cash at 20% premium on future cash flow valuations........gulp...... i beleive in this company's future (your boss might think you are big time crazy, but a lil loss on stocks (as though Dalal street hasnt made you a lot poorer) might just be the best ROI you have ever made in your life.
• Be the light box, don't be in a constant state of bad mood highlighting how vulnerable everyones' position in the Company is, try and be like Kareena's first half role from Jab We Met; bubbly
• Be visible on the floor, talk to everyone, a sweet hellozz to other functions, but most importanty, socialise with your HR breed....ahem... when was the last time you met this breed....increment letter....hmmm or when ,arre yar HR mein ek good looking ladki aayi hai
• Learn to use your calendar better, go for all those voluntary and involuntary meetings and be punctual on time... dont sit right in the front or the back .. stay in the middle. 
• Prove your value to the firm, Companies will not like to eliminate people if their customers find out that your contribution is indispensable; CUSTOMER IS KING.
• Give realistic insights & solutions- when your boss is drawing up a restructuring plan;
• Be open to change, even if it means you have to hotelise your cubicle with others - a little less trading on the stock portals - worth the effort;
• Start using NRI words to your colleagues like HEY CHIEF, HEY BIG MAN, WHATS UP DUDE -will make you sound BIG.... and VISIBLE.... and ......recessioned proof;
• Summary , just become the CORPORATE VISIBLE CITIZEN.
• Better read all blogs you can find on this subject... will keep you morally fighting for an another day

Its time to suck up now before you become the FP&A's number on that excel sheet....

Excel over form

Prevent duplicate entries in excel sheet

Many of us would have used data validation more to use the list (drop down) tool, the data validation with a minor tweak can prevent you from entering duplicate entries in a specific range of cells. Its pretty easy, heres how

1. First select the range of cells you want to apply the Data Validation rule to. Also, note the Active Cell (the unshaded cell in the selected range);
2. In Excel 2003: From the Data menu select Data Validation. In Excel 2007: On the Data tab, click the Data Validation dropdown in the Data Tools group and select Data Validation from the options;
3. On the Settings tab select Custom from the Allow dropdown;
4. In the Formula field enter =COUNTIF(selected_range,active_cell)=1 Make sure you use Absolute References (i.e. dollar signs $A$1:$A$200) ** for the selected_range and a Relative Reference (i.e. no dollar signs A1) for the active_cell;
5. Click the Error Alert tab and enter a Title for the error (i.e. Duplicate Entry!) & Click OK.

Identifying Your Conditionally Formatted Cells (XL2003/XL2007)

If you're a fan of Conditional Formatting you likely have struggled with this little problem. Once you have applied Conditional Formatting to a range (or ranges) of cells you may have needed to go back later and make changes to the formatting or the condition used. You need to make the change to all the cells you previously formatted, but how can you tell which cells have Conditional Formatting?Not a problem!

There is an easy way to identify cells that have Conditional Formatting applied.

1. Press the F5 key (or click Edit, Go To) and click the Special button at the bottom of the Go To dialog. Click on the Conditional Formats option and another option (All, Same) becomes available.
2. To identify which cells have Conditional Formatting the same as the currently Active Cell, click Same and OK. All cells on the worksheet that have the same Conditional Formatting will be selected.
3. You can now easily make changes or select additional cells to apply the formatting to.Instead of selecting the Same option, All will help you identify all cells in your worksheet containing Conditional Formatting.

PWC settles for a $97.5M settlement - (adds liquidity)

In times of bailouts, the FED  needs a helping hand. PWC just did.. for its client AIG. 

PricewaterhouseCoopers agreed to pay $97.5 million to the state of Ohio to settle a class-action lawsuit on behalf of investors in troubled insurer AIG (American International Group). In May 2005, AIG's accounting problems led to a $3.9-billion restatement, and removal of former CEO Maurice Greenberg.

The settlement is among the 10 highest to be paid by an accounting firm to settle a securities fraud class action lawsuit, according to Nancy Rogers, Ohio's attorney general.

The "partial" settlement, on Friday, came after the Ohio Public Employees Retirement System,  and the Ohio Police and Pension Fund filed a lawsuit seeking damages for investors who bought AIG securities from 1999 to 2005. In the complaint, PwC was accused of violating securities laws relating to a market division scheme allegedly involving AIG that was disclosed in 2004 and improper accounting for reinsurance and other transactions.

AIG currently is facing another lawsuit filed in May by the Jacksonville Police and Fire Pension Fund. The Florida fund accused the insurer of manipulating the market by making false statements about its financial health before disclosing a first quarter loss of $7.8 billion. PwC is not implicated in that lawsuit and in February it gave a warning sign of AIG's problems when it found that there was a "material weakness in its internal control" relating to the accounting of its credit default swaps portfolio.

Last month the U.S. government agreed to an $85 billion bail out AIG in exchange for warrants to purchase 80 percent of the company, which is selling off several units of its business to repay the loan.

American Banks ask SEC to give them a fair deal

Well to be honest, i guess Fair value accounting was reserved more for columnists and bloggers like us, rather than to be used practically.

In the latest dent, the American Banking Association (ABA) has asked the SEC to step in and override the controversial FAS 157. In a sharp critique, the ABA has gone after FASB' staff position 157-3 arguing that the revised guidance by the FASB still requires banks to mark-to-market assets at fire sale prices. "Given the importance of this issue, the impact it has on the crisis in the financial markets, and the seeming inability of the FASB to address in a meaningful way the problems of using fair-value in dysfunctional markets, we believe it is necessary for the SEC to use its statutory authority to step in and override the guidance issued by FASB," Edward L. Yingling, president and chief executive officer of the ABA wrote in a letter to SEC Chairman Christopher Cox.

I am not sure what the FASB's revised guidance (FSP 157-3) was set to achieve, after taking more flak than any other accounting pronouncement, the revised guidance should have addressed the needs of the current market situations, rather it has complicated to level beyond compare. This is why

• The revised guidance did away with the requirement of mark-to-marking distressed assets at exit prices - Kudos to this (the BIG 4 were against this)
• Distressed assets were to be valued on a composite valuation model to reflect the true value of the assets. This is a much required guidance, as in illiquid markets, the best way to mark-to-market is on the basis of the holding capacity of the investor rather than the market condition - kudos to this
• In calculating the fair value, the valuation model must factor in the liquidity risk of the asset........did i hear it right THE LIQUIDITY RISK........... ain't this a circular error.

On one hand, the pronouncement does away with the requirement of fair-valuing the assets at fire prices in an illiquid market, but at the same time requires valuation models to include the impact of liquidity risk in valuing this assets. Whats the difference.....does the need to value distressed assets arises in liquid market or illiquid markets.....

Well a silver lining, the DOW Jones is up 11% at the time of writing this blog, here's hoping we get out of this illiquid mess and FAS 157. SEC its upta you

Wall Street gets ready to PLAY-BOY

A 700 point crash...ouch. market to go below 10K ......ooof......no increments this year...oooi maa/biwi/GF, a quarter close admist dusshera and diwali.........arre mat yaad dilao yaar, then what about financial analysts on PLAYBOY ...oomph bring it on

Well when the chips are down, sex is the best thing to cheer you up. Playboy the adult entertainment magazine, might just get your spirits UP.

The adult entertainment magazine, famous for its photo spreads of nude women is launching a search for models to pose for its upcoming feature, "Women of Wall Street" for its Feb 2009 edition.

Playboy has in the past published editions with themes such as Women of Enron and Women of Worldcom, now comes up with this idea "Women of Wall Street" to cheer up moods in a dull and sombre market. "When the news gets bad, then maybe that's a chance to make people smile by coming up with something that puts a different twist on it," said Gary Cole, Playboy's photo editor.

To be eligible for the shoot, the model (female) must be 18 years of age and must have worked in a financial institution. Well wonder what accountants will have to comment on the true fair value of the fairer sex .... i mean the financial statements as per FAS 157.

So coming Feb 09,  for starters; quit looking at ICICIdirect.com (by popular vote) you aint gonna get richer, stop reading financial news portals....... just oogle by visiting playboy.com to get real hot Wall Street action. I bet even your boss may put in his shirt.

FORGET THE BULLS AND THE BEARS, ITS THE REIGN OF THE BUNNY.

P.S - Disclaimer -  this article is meant only for readers over 18........ I do not hold any playboy.com stocks (hmm not a bad company to invest in - what do you say) and neither do i have any affiliations with LAY-MAN (lehman)

GE serves warrants for Buffet

General Electric received a helping hand in the wake of US's "credit crisis" from the BANK BUFFET. A lot of valuers and investors around the world have been speculating to know the true valuations of GE, with its opaque mix of finance and manufacturing. Well the BANK OF BUFFET just figured it out.

GE issued warrants of preferred stock worth $3 BN @ $22.25 per share, $2 below its last traded price and almost half its stock price at the beginning of the year.

GE who, wants to hold on to its AAA rating, also offered to issue another $12BN in form of common stock to other investors.

Many analysts felt Buffet's move is a show of returning the favour to the US, by giving a helping hand and bringing back confidence in resurrecting the US economy. Buffet who last week invested $5BN in Goldman Sachs, has now contributed personally close to 1% of money equivalent of the massive $700BN bailout package.

The soothsayer from Ohama did play it tough in striking the deal, with the interest rate on the stock pegged at 10%, a shade lower than GE's cost of equity, which is pegged to be in the range of 12% to 14%, and much higher than GE's average cost of debt @5.5%.

Many investment bankers felt that, this move would further disturb the sentiments of the economy, as they expected the big giant "GE" to give a helping hand to the US economy.

While GE boasts some $846 billion in assets, close to $600 billion of that is on the finance side--either in the form of loans or leased assets like airplanes. There's also $100 billion in intangibles and goodwill, leaving less than $200 billion in hard assets like buildings, equipment and inventory. It has about $90 billion in commercial paper, which is short-term, low-cost borrowing made for as little as one month. Commercial paper costs have risen for G.E., as it has for others, though it has been tapping that market throughout the crisis

Warren believes he may have bought GE's stock at rock bottom & believes the US economy have hit the bottom. If he is right then the US conglomerate will recover, will sell and lease more planes, automotive and finance them.

If he is wrong, then GE will be forced to borrow more or sell its stock much cheaper. Hoping Brand Buffet's gamble pays off this time.