Eight Reasons to Focus Early on Statements 141R and 160

 

 

In late 2007, the FASB issued two new standards: one revises the accounting for business combinations (Statement No. 141R); the other changes the accounting and reporting for minority interests (Statement No. 160).  Both are effective for periods beginning after December 15, 2008.  The lead time before these standards take effect may seem generous, but acquisitive companies will likely need the time to plan ahead.

 

With limited exceptions related to income taxes, Statement 141R is effective prospectively for transactions consummated after its effective date.  Thus, for a calendar year-end company, a business combination consummated on January 1, 2009 could have a very different effect on earnings than one consummated on December 29, 2008.  The following are eight good reasons to focus early on Statements 141R and 160 when contemplating mergers and acquisitions subject to the changing accounting requirements.

 

1. The few days from agreement or announcement date to consummation date can make a big difference.

 

The timing of deals will be more critical because Statement 141R defines the acquisition date as the date the acquirer obtains control, changing the definition under the current standard by eliminating the ability to measure the assets acquired and liabilities assumed at the date the parties agree to terms.

 

Statement 141R’s stricter definition of the acquisition date can make a world of difference in certain deals.  For example, deals that involve exchanges of equity interests during times of volatile stock prices, or that involve significant amounts of contingent consideration and are consummated in the days immediately prior to the effective date of Statement 141R.

 

2. Statement 141R’s “acquisition method” may sound familiar, but it casts a wider net.  

 

The revised standard retains some fundamental concepts of Statement 141, including the “acquisition method” of accounting (known as the “purchase method” in the current standard) for all business combinations.  However, the revised Statement broadens the definitions of both businesses and business combinations, resulting in the acquisition method applying to more events and transactions.  Under the new standard, even transactions lacking a transfer of consideration will require use of the acquisition method, and the requirement that transactions involve businesses which are self-sustaining and revenue generating is removed.

 

3. Statement 141R expands the required use of fair values.

 

As a general principle, Statement 141R requires the acquirer to recognize all assets acquired and liabilities assumed, as well as any non-controlling interest in the acquiree, at fair value as of the acquisition date.  There are exceptions to measurement at fair value, but fewer than under previous standards.  This expanded use of fair values can have a significant effect on business combinations that are achieved in stages (step transactions).

 

4. Earnings in the year of acquisition and subsequent years will differ.  

 

The new requirements may have a significant effect on earnings in the year of acquisition and in subsequent years.  These effects may be difficult to forecast as unexpected acquisition-year expenses may arise, and future expenses may be tied to asset valuations that are difficult to predict, especially in today’s economy.  The changes to the accounting for acquisition-related and restructuring costs are mirror images of the changes to the accounting for in-process research and development and result in expensing costs as incurred rather than allocating these amounts to the acquired assets and liabilities.  The effect on earnings for individual acquisitions will depend on the relative magnitude of these amounts. 

 

5. The earnings effects of step sales and step purchases will be different. 

 

Currently step sales result in gain or loss, but only to the extent of the interest sold and no gain is reported on step purchases.  Under the new standard, gains or losses will not be recognized for step sales unless there is a loss of control but will be recognized for step purchases.  Step sales with a loss of control will require gains and losses be recorded on both the interest sold and that retained.  This is entirely different from the current treatment, and somewhat counter-intuitive.

 

6. More items may need to be remeasured or require post-acquisition monitoring.

 

As a corollary to the expanded use of fair values, some items measured at fair value at the acquisition date may require more attention in the subsequent periods, making earnings more volatile and difficult to predict.  These items include contingent consideration, in-process research and development, and pre-acquisition contingencies.

 

7. Statement 141R’s income tax provisions can trigger disclosures in 2008.

 

As noted previously, Statement 141R generally is effective prospectively for business combinations consummated after the effective date.  However, one provision related to income tax accounting also applies to business combinations consummated prior to the Statement’s effective date.  This provision applies to changes in the accounting for adjustments to valuation allowances (or unrecognized tax benefits) attributable to a business combination.

 

8. Statement 160’s reporting requirements may affect key financial ratios. 

 

Currently, minority interest is not part of shareholders’ equity.  Under Statement 160, minority interest will become part of shareholders’ equity which may affect key financial ratios, such as debt-equity ratios.

 

Steps to Take Now

 

The following are specific steps that management can take or at least start thinking about now: 

 

Consider the effects on any deals currently in the pipeline that might not be consummated until after the effective dates of the new standards.

 

Weigh the accounting consequences when considering the timing of future acquisitions.

 

Brainstorm ways to adapt negotiations to incorporate factors that might mitigate the impact on current earnings or the volatility of future earnings.

 

Ensure adequate expertise and controls are in place for the expanded fair value measurements and subsequent monitoring.

 

Prepare for any adverse impacts on financial ratios that may lie ahead if the company proceeds with business combinations under Statements 141R and 160.  

 

In conclusion, management and audit committees of companies likely to be affected by these standards will want to understand how they will affect controls, audits and fees and should discuss these effects with their external auditors including what additional testing or procedures might be warranted.