The Financial Accounting Standards Board and the International Accounting Standards Board have issued an exposure draft of a proposed new standard on business combinations. If approved, the standard should help facilitate global consistency in accounting for transnational mergers and acquisitions.

"This is the first time FASB and the IASB have developed a joint proposal for a single standard," said FASB project manager Stephanie Tamulis. "A single standard on business combinations will benefit preparers, investors and creditors, because it will improve the comparability of financial information around the world, and simplify the accounting for companies that issue financial statements in accordance with international financial reporting standards and U.S. generally accepted accounting principles, or reconcile from one set of standards to the other."

Ironically, though the proposed accounting standard is intended to simplify business combinations, it is expected to hit considerable resistance from the corporate sector.

Alfred King, vice chair of the Annapolis, Md.-based valuation company Marshall & Stevens, found little good in the proposal, and criticized its complexity. He noted that the original standard on business combinations, APB Opinion 16, had about 10 pages. Statement 141, which the proposal would supersede, had 113. The new proposal has 236.

"What happened to principles-based standards?" King asked. "This is not principles-based. It's definitely rules-based."

The proposed standard would retain the fundamental requirements of Statement 141 to account for business combinations using the purchase method of accounting. The proposed standard, however, would apply to many more companies, including mutual entities, acquisitions achieved by contracts alone, and variable-interest entities that are businesses. It replaces the term "purchase method" with "acquisition method."

The principal changes proposed include a requirement to measure the acquired entity at its fair value at the acquisition date, and to recognize the goodwill attributable to any noncontrolling interest, rather than just the portion attributable to the acquirer.

King said that the fair value measurement and goodwill recognition rule is about the only part of the proposal that he likes. "This, in my judgment, is an improvement rather than a deprovement," he said, coining a word that he felt might apply to much of the rest of the proposal.

King and some others have been especially critical of the proposal's new rule on contingent liabilities, which would, King said, inevitably produce misleading information on pending lawsuits. Such liabilities would have to be reported at fair value. Though the defending company could eventually pay a large amount if found culpable, or nothing if exonerated, the fair value of the suit would be a theoretical number somewhere between nothing and the amount of the actual settlement, inevitably an inaccurate number.

Worsening that inaccuracy, King said, is the subsequent recognition of that theoretical fair value as income after a lawsuit is settled in the company's favor, producing a false impression of cash flow.

Other changes

The standard would also change the accounting for the costs associated with an acquisition, recognizing them as expenses when incurred, rather than capitalized as part of the business combination.

The proposal also changes the definition of "business combination" to mean "a transaction or other event in which an acquirer obtains control of one or more businesses."

In a move away from rules-based standards, the proposal suggests doing away with many of the exceptions to the principle of measuring assets acquired and liabilities assumed in a business combination at fair value.

Earlier this year, the Institute of Management Accountants and Financial Executives International sent FASB a letter strongly criticizing several expected aspects of the proposal, as well as the general complexity of FASB pronouncements.

IMA president and chief executive officer Paul Sharman expressed pointed disappointment in the proposal.

"FASB ignored our letter," he said. "The sense I received was that they are motivated by some agenda to justify their existence. The common-sense posture of the IMA financial reporting committee apparently did not help them in that regard. Financial accounting rules are already grossly complicated in the United States, and the proposed standard on business combinations makes it worse. Some folks here say that U.S. regulations are sophisticated. That is a mistake, the posture of the mouse on a treadmill."

The IASB and FASB also issued identical drafts proposing that noncontrolling interests (or NCI, previously referred to as minority interests) be classified as equity within the consolidated financial statements, and that acquisitions of noncontrolling interests be accounted for as equity transactions. The boards believe that this proposed statement will resolve a diversity in practice that exists because of an absence of clear accounting guidance.

"Noncontrolling interests have been classified as liabilities, equity or, most commonly, as mezzanine items between liabilities and equity," FASB's Tamulis said. "Various presentation practices have emerged because there is no clear accounting guidance in this area. Requiring that NCI be classified as equity is significant, because it would eliminate the alternative practices, and because of the accounting that results from that decision."

Tamulis explained that the decision on NCI came about in developing the accounting for step acquisitions, which is largely dictated by the nature and classification of NCI.

"If you believe that NCI is equity, that leads you in one direction for accounting for step acquisitions," she said. "If you believe NCI is a liability, it leads you in a completely different direction. Therefore, the boards had to reach final conclusions about the nature and classification of NCI before they could reach decisions about how to account for step acquisitions."

FASB and the IASB plan to hold public roundtable discussions on both proposals on Oct. 27, 2005, in Norwalk, Conn., and on Nov. 9, 2005, in London. The comment period closes on Oct. 28, 2005. Letters sent to either board will be shared with the other.

Register or login for access to this item and much more

All Accounting Today content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access