Accounting rule makers have dropped a bombshell on the M&A marketplace by proposing a global shake-up in the way acquirers value their targets and manage the financial outcomes of their deals. The projected impact on deal pricing and execution growing out of the core of the proposal, which sets fair market value as the touchstone for calculating the target’s worth, is not clear, accounting pros say. But they suggest that specific components requiring buyers to immediately book the costs of several deal-related outlays would cut into earnings just after transactions are completed. Nevertheless, experts think that once the changes settle in, dealmaking will continue to be ruled by such traditional influences as competition for targets in the merger market, strategic objectives, and competitive advantage. Establishment of the “acquisition method” of accounting for mergers and acquisitions, pegged to fair market value of assets acquired and liabilities assumed, was proffered jointly on June 30 by the U.S. Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), its global counterpart. The proposal represented the first major joint project of the two bodies in the M&A arena and, if adopted, will have a worldwide effect after a lengthy period of comment and review. Present plans call for the new standards to take effect for deals completed after Dec. 15, 2006. Although fair market value standards open a host of unanswered questions and create problems in how to crunch the right numbers for some balance sheet entries, accounting experts say the most easily determinable effects stem from quick expensing of deal-related costs that have been capitalized, or spaced over several fiscal periods. It’s too early to gauge the full impact of the new setup, says Robert Willens, a Managing Director at Lehman Brothers, but the changes that can be sized up are “negative in the sense that they are going to penalize earnings of the acquiring company. Buyers and targets will have to expense deal costs rather than capitalize them as part of goodwill, which has always been the case.” Among the items to be immediately expensed are: * Fees and other expenses paid to advisers that help get the deal done; * In-process research and development; and * Post-acquisition restructuring costs, for which a buyer could once set up reserve cushions. Another potential trouble spot that could be especially vexing for middle-market deals is a requirement that contingent payment arrangements be assigned fair market values when the transaction closes and that the values be adjusted as long as they remain in effect after closing. These may include earn-outs that would generate additional compensation for sellers based on post-deal performance or proceeds from litigation that was resolved after the deal was completed. How to determine fair market value for these instruments is still up in the air. The new proposal marks the latest in a series of directives by the FASB, which overhauled M&A accounting, the most critical of which eliminated pooling-of-interest accounting treatment and required all deals to use the purchase accounting method. Overall, the trend has been a movement away from the traditional historical cost basis toward fair market value standards. Mark McDade, a Transaction Services Partner at PricewaterhouseCoopers, notes that quick expensing of deal costs is entirely consistent with a fair value approach. The cost to get to fair market value is “basically irrelevant,” he says. “The fact that you had to pay accountants and lawyers and investment bankers to get the deal done, they (rule makers) say, is operating costs and should not be reflected in the fair value of the business.” Taking a fast hit on deal expenses could trigger some tensions between cost-conscious clients and advisers but the experts believe these will be worked out over time. However, they point out that the relationship problem will be exacerbated by the added costs of more-probing due diligence costs in the wake of the wave of corporate scandals. But fixing fair market values in areas beyond current technical reach remains a longer-range dilemma, and the accounting police haven’t provided much guidance. Dealmakers should be able to handle physical assets and intangibles that can be depreciated. But there are soft spots, such as intangibles that aren’t easily bought and sold in liquid and visible markets. For starters, the rule makers presumably offered a simple fix by matching price and value. Thus, the price paid is equal to the fair market value of the whole of the target. “The presumption is that what you are paying is what the target’s fair market value is,” Willens says. But he adds that the two Boards “don’t give us a lot of help” on handling hard-to-value assets. “It’s easy to write accounting rules,” McDade says. “The problem is figuring out value with a reasonable degree of reliability when there is no observable market and no generally accepted view of fair value. That’s the struggle that we’ll go through.” The accounting changes will have no impact on the tax aspects of M&A, such allocating the purchase price to the acquired assets. (c) 2005 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com

To read the entire story, you must be logged in.
Please log in now or register with us.
Register

How useful was this post?

Tell us more about your rating decision