FASB to Close Options For Post-Deal Restructuring Costs The rule proposal would require booking expenses as paid, kayoing excess reserves and one-quarter earnings hits

Accounting rule writers are putting another crack in the “cookie jar.” In its latest attack on areas of potential abuse, the FASB has proposed sharply closing off options for managing out-of-pocket costs of business restructurings following acquisitions. Under a rule proposed in August, expenses involved in postacquisition realignments would have to be booked as they are incurred. That would ban creation of reserves against future expenses and piling up all expenses at one time so acquirers can bite the bullet in a single quarter. In effect, acquiring companies would have to parcel out the restructuring costs – including such items as severance pay for displaced workers, plant closings, and taxes – over several quarters and create a continuous, longer-term hit on the bottom line. Accounting techniques for booking restructuring costs long have been targeted by critics as fertile ground for producing manipulated or inflated earnings. They were among an assemblage of tactics targeted for attack during the 1990s by the SEC under the chairmanship of Arthur Levitt. Collectively, they were called the “cookie jar” because of the way they could sweeten a company’s earnings if deftly applied. For example, Levitt and other critics have charged that companies often inflate reserves beyond what they really need to finance restructuring and then channel the surplus into earnings. Although the proposed rule, which is to take effect in December 2005, would have a pervasive impact on m&a because postacquisition restructurings are common and their costs can be significant, it was not expected to impact the pace or volume of mergers generally. Mark McDade, a Transaction Services Partner at PricewaterhouseCoopers, says that acquirers buy for operating and strategic reasons and that these forces are far more influential than accounting issues. “Common sense will prevail,” he states. Nevertheless, a requirement for recording expenses as they occur could have a major impact on the pricing, valuation, and negotiation of deals. Robert Willens, a Managing Director and corporate tax expert at Lehman Brothers, notes that the rule also would eliminate a favorite trick of some acquirers that allowed them to brighten results after a deal. Willens says the proposal would bar acquirers from directing their target companies to eat restructuring costs before the deal closes. That much-criticized technique often was employed without disclosure by frequent acquirer Tyco International Ltd. Indeed, many of the proposed changes unveiled by the FASB as part of its business combinations project have taken aim at Tyco practices. If the new rule was not expected to slow deal flow, these likely effects on the transaction process were foreseen: * Acquirers would have to manage their restructuring programs more effectively to get a tighter handle on costs. Among other things, that would require buyers to have their post-deal restructuring plans firmed up in advance of closing. Although upfront planning is considered good integration practice, strategic consultants often complain that acquirers largely pay it lip service. * Negotiations are expected to take longer as acquirers and sellers try to square pricing and evaluation with the new realities of booking restructuring costs. * Investor relations professionals may find it challenging to explain to major investors why their client companies are suffering earnings pressures for lengthy periods beyond the deal closing. Willens notes that it has been standard operating practice for acquirers to set up large reserves against future expenses. ” You always wanted to throw as much as you could into the restructuring reserve,” he says. “Later on, if you found you didn’t need the reserve because you didn’t restructure as much as you anticipated, you would throw the reserve back into earnings.” McDade says the rule also would prevent acquirers from packing expenses into one quarter by eliminating “the bunching of nonrecurring charges.” Acquiring companies frequently like to bundle all extraordinary expenses so they can get all the “bad news” out of the way in one fell swoop. In a previous swing at the cookie jar, the FASB in 2002 promulgated a rule requiring pay-as-you-go booking of expenses for straightforward business restructurings that did not involve acquisitions. The latest proposed rule would equalize treatment on acquisition-related restructuring. Neither rule affects the way companies account for sales of divisions and subsidiaries, at either gains or losses, which are governed by different sections of the accounting rulebook. McDade also points out that it is significant that the expenses have to be recorded under the fair value principle because that continues the shift in the traditional historical costs accounting approach to valuing assets and liabilities to the “fair value model.” “Now, the accounting model asks what it is worth,” he states. The fair value approach previously was applied to rules governing expensing of executive stock options and valuation of postacquisition earn-outs paid to managers of selling companies. “You could wind up with a balance sheet that is entirely marked to market,” he says. McDade expects that both accountants and their business clients will face considerable adjustments in the way they calculate assets and liabilities under an across-the-board fair value methodology. Corporate executives, he asserts, do not yet have wide experience in fair value assessments. n Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com