Rule Makes Execs Think Twice About Dealmaking

A Deloite survey says FASB's new merger rule will put the kibosh on transactions that until recently would have gone forward.

Just six months after the Financial Accounting Standards Board issued its revised rule on business combinations, corporate executives are saying the technical pronouncement will change the way they do business.

In a recent survey, 40 percent of 1,850 executives said FAS 141(R), Business Combinations, would cause them to “rethink” deal strategy and affect planned deal activity, according to Deloitte Financial Advisory Services, which conducted the online poll.

Only 4 percent of the respondents said their companies have already finished assessing the valuation impact of the new rule.

“The finance and accounting, business development, tax and legal departments of companies are working to understand the implications of Statement 141(R), as the process for how a deal is consummated and reported will require significant preliminary and ongoing analyses,” noted Stamos Nicholas, Deloitte’s national business valuation leader.

FAS 141(R) is the first global standard to be issued since FASB and its overseas counterpart, the International Accounting Standards Board, began their joint rulemaking convergence project in 2002. One aim of the project is to harmonize international standards with U.S. generally accepted accounting principles to better meet the demands of global investors. It’s also intended to cut complexity and costs from the financial reporting process, particularly for multinationals that are forced to record results using several different local standards.

However, the launch of the maiden rule has created controversy, mainly because FAS 141(R) is a major departure from the historical cost accounting that many companies use. To the chagrin of many companies, the new rule mandates the use of FAS 157, Fair Value Measurement, which introduces a standardized way to measure financial assets and liabilities at fair value using a three-level hierarchy based on risk-related criteria.

As always, acquiring companies value the target company’s assets and liabilities, identifiable intangible assets, and some previously unrecognized contingencies at fair value at the time of the sale. But under the new measurement system, unobservable assets and liabilities, such as contingent liabilities that are measured using estimates, must be valued on what the company believes a hypothetical third party would pay for them, rather than rely on in-house models. “The most difficult part of implementing FAS 141(R) is coming to grips with fair-value principles that were never required before,” Jay Hanson of McGladrey & Pullen told CFO.com in an earlier interview.

For example, Hanson opined on potential problems related to the way companies record merger-and-acquisition transactions in which the acquiring company buys less than 100 percent of a target company.

In those cases, the contingent consideration — which include future payouts such as lawsuit settlements or earnouts — must be estimated if they are determinable. Then the acquirer records the estimated payout as part of the sale price on the day the deal closes. In addition, when the payout is eventually made, the company records the difference between the estimated fair value and the actual payout as an expense or gain. Currently, contingent considerations are not recorded on the balance sheet until the payout is made.

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