by Glenn Cheney

Norwalk, Conn. - The Financial Accounting Standards Board has pushed back its plan to issue three proposed statements on business combinations. Originally hoping to release the exposure drafts this summer, the board now plans to take a few more months to resolve some difficult issues.

The three proposals would clarify and expand on the provisions and scope of Statements 141 and 142, which address business combinations and goodwill, respectively. The new projects deal with purchase-method procedures, not-for-profit organizations and combinations of mutual enterprises.

The board plans to issue all three at the same time, but not until the fourth quarter of 2003.

Financial Executives International, which has long called for FASB to act more quickly, is expressing relief that the time frame for the project on purchase-method procedures has been extended. The organization sees FASB working toward more than mere clarifications.

“The proposed changes are extensive and significant, and there is cause for concern in a couple of areas,” said Dean Krogman, FEI vice president of technical activities. “We need to see a little more due process.”

One of the likely changes may be the expensing, rather than amortizing, of legal and advisory fees associated with the combination of businesses. The board is also seen as moving toward requiring that all contingencies - obligations for higher offers if the seller can prove a promised value - be recognized at fair value on the acquisition date. Contingent liabilities may increase volatility. Contingent assets may impact profit and loss statements.

Ray Beier, senior partner at Big Four firm PriceWaterhouseCoopers and director of the firm’s transactions business, agreed that the changes are substantive and that the issue needs more public discussion.

“Extending the time frame of the project allows the financial community to further understand and provide input into the FASB process,” Beier said. “As the marketplace moves toward more mergers, and as FASB gets closer to committing itself, the marketplace will wake up and begin to assess FASB’s decisions.”

Incomprehensible complexity

Ron Bossio, FASB senior project manager, said that the board is tackling the issue because the purchase method has become too complex to apply correctly and consistently.

Incomprehensible complications arise in situations of serial acquisitions, where one entity buys a business unit that is subsequently bought by yet another entity. As the process develops several layers of costs and earnings, the understandability and usefulness of the financial information declines.

“Some would say that only an accountant can understand the procedures that we have in place today,” Bossio said. “I’m not sure that anybody in the community of users of financial information really knows what they’re getting.”

Krogman counters that companies have been using the purchase method for many years, and financial analysts have been able to interpret the subsequent financial reports.

The project on purchase-method procedures is being pursued in conjunction with the International Accounting Standards Board. The two boards have been trying to tackle the same issues at the same time to gradually derive identical standards. So far, they have kept up with each other - a respectable accomplishment, given that the IASB meets monthly in London, while FASB meets weekly in Norwalk, Conn.

The purchase method replaces the pooling-of-interests method that was once used in certain mergers, especially of equals. The IASB’s project is expected to establish accounting similar to that of Statement 141, augmented by clarifications hammered out with FASB.

FASB’s project aims to bring Statement 141 into closer compliance with various aspects of the board’s conceptual framework, among them the “completeness” notion of accounting for all assets and liabilities, the measuring of acquisitions at fair value and the essential nature of understandability.

Before issuing the exposure draft, the board plans to meet with a group of users of financial information - probably this month - to see if the proposal improves transparency.

Not-for-profit combinations

The project on combinations of not-for-profit organizations aims to establish a standard on the recognition and accounting of goodwill acquired when such organizations combine.

Not-for-profit organizations were excluded from the scope of Statement 141 during its development, so the issue of the purchase method versus the pooling-of-interest method has not been addressed. The board is expected to again eliminate the use of the pooling method.

The use of the purchase method, however, becomes questionable in situations where one nonprofit organization essentially gives itself to another, without the financial transaction of a traditional purchase. A community organization taking up responsibility for a church’s defunct soup kitchen, for example, would find it difficult, if not ludicrous, to account for the acquisition under a notion of fair value.

“Normally, we presume that the fair value of what you got was what you paid for it, but with not-for-profits, it’s hard to start with that as a presumptive attitude because the two organizations don’t have a profit or self-interest economic motive driving their business,” Bossio said. “You can’t assume it’s an arm’s-length transaction.”

The board is currently considering some kind of net-value approach. The question is whether a net-value approach would apply to all not-for-profits, or just those with certain characteristics. A merger or acquisition of hospitals, for example, could more readily be accounted for under the principles of Statement 141 because they function much as for-profit organizations do.

Mutual combinations

The board is working with the Canadian Accounting Standards Board to develop identical or very similar guidance on the accounting and reporting of combinations between mutual enterprises.

Mutual enterprises might be seen as entities sharing characteristics of both for-profit and not-for-profit organizations, such as cooperatives, credit unions and mutual insurance companies - organizations that have no profit or stockholders but which operate for the benefit of members who have an economic interest in operations. Mutual enterprises were not within the scope of Statement 141.

Again, fair value is an issue. Mutual enterprises often combine without actual financial transactions, making it difficult to measure the value of the combination. In March, FASB directed its staff to research issues surrounding the estimation of fair value of acquired mutual enterprises, including the appropriateness of achieving a fair-value measurement objective and the reliability of those estimates. Staff will report on markets that can be used to determine fair value.

“The decision, so far, is to treat mutual enterprises as any other for-profit company,” Bossio said. “Some of these organizations would prefer to have the net-asset approach, which would not record goodwill, and some would prefer to use the pooling method, but the board has pretty much moved beyond that possibility.”

Bossio foresees difficulties in coordinating changes in mutual enterprise accounting with the consequent necessary changes in legal regulations.

As for the extended discussion, Bossio said that this is normal for projects that have difficult issues to resolve. “Sometimes the choices are between things that have no nice, easy alternatives,” Bossio said. “Something that looks good has some warts on it, and a second alternative has other warts on it.”

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