Near the end of last year, the Financial Accounting Standards Board (FASB) altered its view on how companies should account for business combinations, revising Statement No. 141 to be broader in scope and generally more in line with international accounting principles.
Among the changes, the revision forces acquirers to be more thorough in their reporting, spelling out exactly what assets are acquired, what liabilities assumed and any non-controlling interest in the company being bought. Things like acquisition costs, which have typically been balled into the purchase price, now have to be expensed separately.
Another key component in the revision dictates that acquirers need to recognize and measure the goodwill acquired in a business combination or a gain from a “bargain” purchase. If a “fair value” assessment reveals a bargain price in which the company was acquired for less than its net asset value, then that gain can immediately be reflected in a company’s earnings.
A third point in the revision determines the kind of information acquirers have to disclose so third parties can evaluate the nature and financial impact of a business combination. This kind of addition will likely take the form of footnotes in financial statements and provide insight into how the acquirer arrived at a given number.
The revised FASB statement scheduled to take effect Dec. 15, 2008 is also more inclusive than the original and applies to all transactions and events in which one entity obtains control over another. Step acquisitions for example, when a company is acquired over time through successive minority-stake purchases, will require the buyer to reassess the fair value of the acquired stakes whenever a new purchase is made.
The impetus behind these changes was to align U.S. accounting practices with standards used internationally. According to a story in sister publication Investment Dealers’ Digest back in September, roughly 100 countries already use the accounting guidelines of International Financial Reporting Standards (IFRS), established by the International Accounting Standards Board (IASB). Moreover, there has been a push for convergence in accounting standards from large multinational organizations, and last July, the Securities and Exchange Commission proposed allowing foreign companies to use the IFRS accounting guidelines when reporting in the U.S. The SEC also published a concept release for public comment to consider allowing U.S. corporations to adopt IFRS.
While the revised FASB statement serves to better align U.S. and international accounting practices, differences do still exist. For one, as it relates to the non-controlling interest acquisitions, Statement 141 requires buyers to value investments at their acquisition-date fair value, while IFRS allows buyers the option of measuring a non-controlling interest on the basis of its proportionate interest in the identifiable net assets being acquired.
Despite some incongruities, experts see the revision as a move in the right direction. According to Stamos Nicholas, the national leader of business valuation for Deloitte Financial Advisory Services, on top of better aligning global accounting standards, the revision to Statement 141 should also “provide a better reflection of overall transaction economics.”
“I don’t think this will change how companies pursue transactions, necessarily, but it will certainly impact how buyers structure deals,” he notes. “There’s going to be more work that has to be done around recording and reporting business combinations. Not only will companies have to put more effort into monitoring transactions, but they will have to be more mindful to the processes and procedures that go into updating a transaction in their financial statements.”
Even as Nicholas believes the revision represents an improvement over how businesses currently account for deals, he still anticipates it will take some time before companies fully understand what is expected. Measuring fair value, for example, is not as cut-and-dry as simply accounting for a business at cost, and when FASB issued SFAS 157 back in September 2006 clarifying the definition of fair value and how it should be applied to GAAP there was still some resistance in the private equity community because fair-value assessments seemed less concrete. With that said, as more companies and investors employ fair value, the more consistent it will become.
“There’s always refinement that can be done,” Nicholas says. “The measurements aim to be more reliable and thorough, but there are a lot of moving parts, and businesses have to be very careful about capturing accurately the holistic view of a given transaction. … Fair value is here to stay, but there still needs to be some clarification and more guidance from regulators as to how to implement it in a consistent way.”
Nicholas notes that the Fair Value Resource Group was formed for this very reason, and was even brought in to help advise FASB on these specific issues. He also adds that the enforcement agencies, such as the Securities and Exchange Commission, will be “vigilant” in enforcing the new rules once they take effect.