New standards effective at the beginning of 2009 will impact the accounting for mergers and acquisitions.
The last time the standards were changed, in 2001, the changes were dramatic. The new standards, effective for all acquisitions consummated in the first fiscal year beginning on or after Dec. 15, 2008 (for calendar year-end companies, beginning in 2009), will have an impact on deal negotiations and on deal structure, besides the accounting implications.
FAIR VALUE ACCOUNTING
The focus of the new standards is on the use of fair value accounting. In other words, all assets acquired and liabilities assumed in an acquisition are to be measured at their fair values on the date of acquisition (called the acquisition method). By contrast, the former standards, although they applied fair value accounting, focused more on an accumulation of costs related to the acquisition (called the purchase method).
M&A transaction costs typically include payments to investment bankers, attorneys, accountants, appraisers and other advisors. Previously, these costs were capitalized as part of the overall purchase price for an acquisition. Under the new standards, these costs will be expensed as incurred, because they are considered incremental costs to the transaction and not a component of the fair value of the business acquired. Therefore, earnings in the period prior to the acquisition will be negatively impacted.
Under the new standards, costs to restructure the operations of an acquired company can be recognized as part of the acquisition accounting only if certain conditions are met - that is, the acquirer's restructuring plan must be in place at the date of the acquisition. The cost of these restructurings will be charged to earnings in the post-acquisition period. Previously, these costs were recorded as a liability at the time of the acquisition, resulting in higher goodwill.
Previously, earn-outs were considered part of the acquisition cost. Under the new standards, earn-outs and other contingent consideration are to be recorded at fair value at the date of the acquisition, regardless of the likelihood of payment. Subsequent changes in the fair value of most contingent consideration will be recorded in earnings. However, if the contingent condition is classified as equity, it would not be adjusted for changes in fair value in subsequent periods.
In-process research and development will continue to be measured at fair value on the acquisition date. However, these assets will no longer be written off as a one-time expense immediately after the acquisition. Instead, IPR&D will be capitalized and recorded as an indefinite-lived intangible asset, subject to impairment until completion. Abandoned projects will be written off as an expense.
The acquisition date is the closing date of the transaction. If equity securities are issued as all or a part of the purchase price, these will be measured on the closing date, rather than the announcement date. Therefore, changes in the value of the acquirer's stock after the announcement date and before closing will have an impact on the amount of the purchase price for accounting purposes.
As was the case before, companies will have a one-year period of time to recognize adjustments to the provisional values that are recorded. However, the new standards require that prior-period statements be revised to record any material adjustments of the estimated provisional amounts recorded at the acquisition date. This will likely increase the due diligence efforts to provide more accurate estimates, thus reducing the likelihood of having to revise prior-period statements.
In summary, fair value accounting is pervasive throughout the new standard. The resulting changes, although they may not at first blush appear to be dramatic, are indeed significant.
Morris Hollander is a partner with Florida-based Rachlin LLP (www.rachlin.com).
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