FASB Seeks to Banish Key M&A Costs In Calculating Acquisition Goodwill

There may be more bad blood over goodwill. Acquiring companies and the accounting profession’s key rule-making body appear headed for another series of skirmishes growing out of last year’s actions to eliminate of pooling-of-interest accounting and promulgate new regulations for managing goodwill in acquisitions. Although the conflicts might look arcane to non-accountants, millions of dollars in m&a costs or benefits are at stake per deal – and even purchase prices could be impacted. The Financial Accounting Standards Board (FASB) reopened the controversy with a series of proposals over the last few months designed to block some acquisition-related outlays from being included in goodwill. The two most pervasive center on professional fees incurred during an acquisition and some costs of restructuring and integration after a deal closes. Another proposal would order less favorable accounting treatment for contingent payments, or earn-outs. Accounting experts think that other exclusionary ideas could be on the way, even though the current proposals are a long way from enactment. Goodwill gains buyers’ favor The latest tussles reflect the dramatic shift in the way acquirers handle goodwill – generally defined as the difference between the fair value of a target’s assets and the purchase price. Acquiring companies that formerly tried to avoid goodwill now find it more favorable to maximize the goodwill they carry into their balance sheets after a deal. Under the rules changes that took effect in June 2001, the FASB decreed that purchase accounting, which resulted in accumulation of acquisition goodwill, was to be used in all m&a transactions. But in a trade-off designed to cushion the shift, the board scrapped a requirement for the annual write-downs of goodwill that were charged to earnings. Instead, companies now test their goodwill entries every year and write it off entirely when it becomes impaired, or loses significant value. Freed of the yearly hit to earnings, acquirers now find it more advantageous to pack as much as possible of a purchase price into goodwill rather than assign large parts to depreciable intangible assets. Robert Willens, managing director and corporate tax expert at Lehman Brothers, says that the board never liked giving up amortization of goodwill and now is “trying to erode it in a quiet, behind-the-scenes way.” “They can’t eliminate it entirely, but by reducing the amount of goodwill, they accomplish their goals to a certain extent.” Ray Beier, a partner in the transaction services group at PricewaterhouseCoopers, says he isn’t pleased about the way the FASB is going, especially with regard to the treatment of direct acquisition costs, but cautions that the process of making the rules has a long way to go, including lengthy periods for comments on the draft. Under the most controversial reclassification proposal unveiled to date, fees paid to bankers, lawyers, accountants, and other professional advisers would be excluded from the purchase price and, therefore, not included in goodwill. Instead, they would be classified as “period costs,” which would be charged to the acquirer’s expenses. An astonishing approach to costs “How can they possibly conclude that they are not direct costs of the deal?” Willens remarks. “They would not be incurred if it weren’t for the deal,” he adds. Describing himself as “puzzled” by the approach, Beier notes that excluding direct costs from goodwill “seems to be directly contrary to the basic accounting model that you are supposed to capitalize costs to acquire an asset and that the costs to acquire an asset include direct transaction costs.” Although there may be some dispute as to exactly what is a direct cost, “apparently they have thrown the baby out with the bathwater” in trying to resolve the question. “I just don’t think it’s good accounting,” Beier says. Also in the works is a proposal to order acquirers to expense such post-acquisition costs as disposing of a target’s unwanted operations, laying off workers, or relocating employees. Historically, Willens says, these restructuring and integration costs have been treated as assumed liabilities that are part of the acquisition cost and they “almost always become part of goodwill.” An acquirer, Willens says, usually will take these costs into account when developing a bid for a target, and “it seems proper to regard these costs as an element of the purchase cost.” When contingent payments are part of a deal structure, the acquirer historically recorded their fair value when the payment became “fixed and determinable,” Willens notes, and then assigned the amount to goodwill. Under the rules change proposal, the acquirer would have to record the value when the deal is completed and then book gains or losses as the values change until the payments are actually made. Contingent payments appear in relatively few deals but tend to be used more frequently to get deals done when there are big gaps between what acquirers want to pay and what sellers are willing to accept. Such a wide disparity is a current reality in the m&a marketplace. Dealmakers do not like to use earn-outs much because they tend to become bones of contention after the deal is done. The proposed FASB change would aggravate the issue even more, Willens says, and make deals even harder to complete.