Significant Revisions to M&A Accounting Standards

The rules in the accounting world change so often and are sometimes so complex it’s hard to keep up. New rules are increasingly receiving face-lifts or hidden under the numbering system of an old rule. In early December 2007, the Financial Accounting Standards Board (FASB) issued a major revision to the rules that govern accounting for mergers and acquisitions. The FASB also issued a companion standard that outlines the accounting and disclosure for non-controlling interests in consolidated financial statements.

The revised standard, SFAS 141R, Business Combinations, and new standard, SFAS 160, Non-controlling Interests in Consolidated Financial Statements, continue the FASB’s march toward fair value reporting and convergence with international accounting standards. The original merger and acquisition standard, SFAS 141, was issued only six years earlier. However, with M & A activity increasing on a global basis, the FASB entered this joint project with the International Accounting Standards Board to develop a single standard for domestic and cross border reporting; clarify which assets and liabilities should be recognized in initial business combination accounting; and require that assets acquired, liabilities assumed and equity interests consistently employ fair value measurements.

The changes in the business combination rules are so pervasive. It makes you wonder why the FASB didn’t just issue a completely new standard. You will see from the following summary that the changes are substantial. New standards are effective for annual periods beginning after December 15, 2008 and cannot be adopted before that date. So if you are contemplating a transaction near this date, it’s imperative to time the transaction appropriately for preferred application of old or new rules.

Scope
New Standard – Definitions of a business and a business combination will be expanded.
Implication – More transactions and events will qualify as business combinations and be accounted at fair value.

Fair Value
New Standard – All business combinations require that total assets and liabilities of an acquired business be recorded at their fair values.
Existing Standard – The acquisition is recorded using a cost accumulation approach focused primarily on total costs. Goodwill is recognized only to the extent of the controlling interest.
Implication – Determining fair values of assets and liabilities must be based on SFAS 157 — Fair Value Measurements. This determination will yield valuation challenges and require the advice of valuation specialists.

Contingent Consideration
New Standard – Earn-outs and contingent considerations will be recorded at fair value on the acquisition date.
Existing Standard – Earn-outs were generally not accounted for until contingency was settled or resolved at purchase date.
Implication – Measuring contingent consideration at fair value may require the use of complex valuation techniques that are highly subjective and based on a variety of assumptions. Contingent considerations that qualify as liabilities will result in fair value adjustments in subsequent periods, and will directly impact earnings, instead of additional purchase price.

Contingencies
New Standard – Acquired contingencies will generally be recorded at fair value at the acquisition date. In subsequent periods, contingent liabilities will be measured at the higher of their acquisition date fair value or the amount determined under SFAS 5. Contingent assets will be measured at the lower of their acquisition date fair value or
the estimated amounts to be realized.
Existing Standard – Acquired contingencies are recorded if probable and can be reasonably estimated.
Implication – Measuring contingencies at fair value may require use of complex valuation techniques that are highly subjective.

Acquisition Costs
New Standard – Acquisition costs will generally be expensed as incurred.
Existing Standard – Acquisition costs are generally capitalized as a component of the acquisition price.
Implication – Expensing cquisition costs will lead to lower earnings in the period before the transaction but reduce risk of goodwill impairment in subsequent periods.

Restructuring Costs
New Standard – Restructuring costs will generally be expensed after acquisition date.
Existing Standard – Restructuring costs are capitalized in the opening balance sheet for certain restructuring reserves (e.g., exit costs, relocation, plant shut-down and employee termination).
Implication – The expense of restructuring costs will result in increased charges to earnings over several periods as the target company is integrated.

In-process Research and Development (IPR&D)
New Standard – In-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date.
Existing Standard – In-process research and development costs are measured at fair value and expensed unless the assets have an alternative future use.
Implication – IPR&D charges will impact future earnings when that asset is amortized or impaired in subsequent periods (rather than expensed at the acquisition date). Assessing intangible assets for impairment will challenge project evolution.

Acquisition Date
New Standard – Business combination acquisition date is the date the acquirer obtains control of the acquiree.
Existing Standard – Business combination acquisition date is the date a deal is agreed or announced.
Implication – By obtaining control of an acquiree, an acquirer is responsible and accountable for all of the their assets, liabilities and activities, regardless of ownership percentage.

Income Taxes
New Standard – Changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period will impact income tax expense.
Existing Standard – The above assets and acquirements are recorded as an adjustment to the cost of the acquisition.
Implication – Changes in valuation allowances and other tax reserves made after the measurement period may result in increased income statement volatility. It’s an important consideration to the expected effective tax rate in the accretion/dilution analysis.

Non-controlling Interests (NCI) Presentation
New Standard – NCI will be recognized in the equity section, and losses in excess of NCI’s equity interest will continue to be allocated to NCI.
Existing Standard – NCI is termed minority interest and generally presented as a mezzanine item between liabilities and equity in the balance sheet.
Implication – The new presentation could increase consolidated equity balances and impact balance sheet financial ratios.

The accounting for merger and acquisition transactions is complex and requires thoughtful understanding and planning. We encourage you to address these issues in the early phase of transaction negotiation and are available to guide you through this process.

For more information, contact: F. Jeffrey Kovacs, CPA, Accounting and Audit Shareholder, Director of Quality Control, at 412.281.2545 or jkovacs@alpern.com.

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