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particularly debt to equity and return on investment. Moreover, future profits would be inflated because they would not be matched against the cost of the investment.SFAS No. 142In 1996, the FASB put the issue of accounting for business combinations and the related topic of goodwill on its agenda in response to growing concerns voiced by constituents about the need forimproved standards to account for business combinations. In September 1999, the FASB published an exposure draft titled “Business Combinations and Intangible Assets.” The exposure draft proposed that the pooling of interests method be eliminated in favor of the purchase method
for business combinations (see Chapter 16) and that goodwill should be amortized over no more than 20 years, in contrast to the previously required amortization period of up to 40 years.The two proposals drew considerable interest and some vocal opposition, which resulted in a series of meetings between the FASB and its constituents as well as testimony before committeesof the U.S. House of Representatives and Senate. The opposition was based on the contention that recording large amounts of goodwill and subsequently amortizing goodwill over a 20-year period would result in a large drain on reported earnings. Subsequently, the Board issued a revised exposure draft, “Business Combinations and Intangible Assets—Accounting for Goodwill,” in early 2001; this draft proposed that goodwill not be amortized, but rather that it be tested for impairment.In June 2001, the FASB issued SFAS No. 141, “Business Combinations”36(see FASB ASC 805), and SFAS No. 142, “Goodwill and Other Intangible Assets”37(see FASB ASC 350). These statements changed the accounting for business combinations and goodwill. SFAS No. 141now requires that the purchase method of accounting be used for all business combinations.38SFAS No. 142changes the accounting treatment for goodwill from an amortization period not to exceed 40 years to an approach that requires, at a minimum, annual testing for impairment. The goodwill impairment test is to be performed at the reporting unit level, which is defined as an operating segment or one level below an operating segment (also known as a component).39Under the provisions of SFAS No. 142, the test for goodwill impairment is a two-step process:1.Compare the fair value of the reporting unit to its carrying value. In the event fair value exceeds carrying value, no further testing is required. However, if the carrying value of the reporting unit exceeds its fair value, step 2 is required.2.Calculate the implied fair value of goodwill by measuring the fair value of the net assets other than goodwill and subtracting this amount from the fair value of the reporting unit.In determining fair value, the FASB noted that the fair value of a reporting unit is the amount at which the whole unit could be bought or sold in a current transaction. As a result, quoted market prices in active markets were described as the best evidence of fair value. The FASB further indicated that if quoted market prices are not available, fair value should be based on the best