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M&A Accounting: Brave New World

7/21/08

We usually don’t report on the dry subject of M&A accounting but you’ll want to know what the regulators have in store for you this winter.

Wrestling with Ghosts
Actually, it’s quasi-regulators, the Financial Accounting Standards Board (FASB). They’re the non-profit CPA body designated by the SEC to define “generally accepted accounting practice” or GAAP. If you don’t comply with FASB’s accounting standards you aren’t GAAP, and if you’re not GAAP you won’t get a clean audit.

What has inspired the rule-makers at FASB to pound their keyboards is the rising contribution of intangibles -- things like intellectual property and contracts -- to a company’s overall value. Said another way, in the information age bricks-and-mortar assets are becoming less relevant.

Being accountants, FASB’s members want to quantify these intangibles. So they’ve published SFAS 141(R) which will cover all deals closing with fiscal years beginning after December 15.

SFAS 141(R) delights the accounting profession along with lawyers and valuation consultants because it requires third-party experts to estimate the fair market value of each asset and liability purchased -- trademarks, copyrights, lawsuits, contingent earn-outs, indemnification contracts, R&D, the know-how of factory employees down the road, maybe even Steve Job’s product design brilliance.

And the Losers Are...
For the same reasons, SFAS 141(R) aggravates buyers, sellers and investment bankers. The new rules will clog transactions with more red tape, add new transaction costs, invite lawsuits, increase acquisition goodwill, and jack up the buyer’s earnings volatility due to constant “fair market” revisions of that goodwill.

Buyers and investment bankers also don’t like that fact that SFAS 141(R) requires all pre-deal acquisition fees and post-deal restructuring costs to be expensed rather than capitalized.

While we’re sympathetic to the dilemma of tracking value in an increasingly intangible world, we don’t think trying to count the number of angels on the head of a pin works. Some things are simply not amenable to detailed quantification. If they were, market research would guarantee each product’s success before launch. And banks would lend to start-ups based on five-year projections. Even putting aside the fact that some things are unknowable with precision, what’s the value of a process that introduces more balance sheet and earnings surprises?

Beating the Clock
SFAS 141(R) does have some benefit: it coordinates American accounting with international standards (IFRS), thereby easing trans-national deals. But the trade-off is another burden on business, joining Sarbanes-Oxley’s role in the decline of American IPO’s and the dearth of micro-cap coverage caused by Spitzer’s banishment of equity research by investment banks.

We suspect that, along with the prospect of higher taxes imposed by a new Administration, the imminent implementation of SFAS 141(R) is accelerating transaction volume now as buyers and sellers attempt to beat the December 15 clock.


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