Armanino Blog

Closer to International Accounting Principles

by Jeremy Sucharski
October 06, 2010

With the recent movement towards International Accounting Standards it's of little surprise replacement standards are beginning to siphon through the pipeline. The latest statement, FAS 141(R), is a joint effort between the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) and is a replacement for 1994’s FAS 141 affecting all for-profit organizations. FAS 141(R) continues the movement toward the greater use of fair values in financial reporting and increased transparency through expanded disclosures. This new standard will change the way business acquisitions are accounted for at the acquisition date and in subsequent periods.

Companies need to apply the new standard in order to comply with any requirements they may have to maintain their financial accounts on Generally Accepted Accounting Principles (GAAP). SEC registrants and private companies subject to audit must follow the GAAP standards that are applicable to them which may encompass the new FAS 141(R). It is important to understand the ramifications of the new standard on financial statements in order to anticipate the full effects of the acquisition in terms of key ratios, earnings, financial positions, debt covenants, etc.

The Differences Between FAS 141 and 141(R)

Since FAS 141(R) replaces FAS 141 it’s important to understand the differences (outlined in detail below) between the two.

  • Acquisition-related transaction and restructuring costs will be expensed rather than treated as part of the cost of the acquisition and included in the purchase price for the net assets acquired.
  • For step acquisitions where the acquirer has already made partial investments in the acquiree, previous equity interests held prior to obtaining control will be re-measured to their acquisition-date fair values, with any gain or loss recognized in earning.
  • Adjustments made to finalize the initial accounting for an acquisition will require that the acquirer revise any previously issued post-acquisition financial information in future financial statements to reflect any adjustments as if they had been recorded on the acquisition date.
  • Asset values will no longer be reduced when acquisitions result in a "bargain purchase;" instead, the bargain purchase will result in the recognition of a gain in earnings.
  • In Process Research and Development (IPRD) will be recognized at fair value and will no longer be immediately expensed. It will be measured at fair value and treated like an asset with an indefinite life subject to an annual impairment test until the projects are completed or abandoned.
  • The definitions of a business and a business combination have been expanded, which may result in an increased number of transactions that will qualify as business combinations.
  • For all business combinations (whether partial, full or step acquisitions), the acquirer will record 100% of all assets and liabilities of the acquiree including goodwill, generally at their fair values.
  • Some contingent assets and liabilities acquired will be recognized on a fair value basis at the date of acquisition. The practice today is to give no recognition to such items at the acquisition date.
  • Contingent consideration will be recognized on a fair value basis at the date of acquisition. Depending on the terms of the agreement for some of these arrangements, changes in fair value will be recognized in earnings until settled.
  • Reversals of acquired deferred tax asset valuation allowances and changes to the acquired income tax uncertainties will be recognized in earnings, except for qualified measurement period adjustments (up to one year after the date of acquisition).
  • Transition provisions for the adoptions of FAS 141(R) are prospective with the exception of accounting for changes in valuation allowance for acquired deferred tax assets and the resolution of uncertain tax positions accounted for under FIN 48. Aside from measurement period adjustments, the changes in these tax items will be recognized in income tax expense rather than as an additional cost of the acquisition.

Planning for the Change

While the effective date for FAS 141(R) is not until January 1, 2009, many companies with past acquisitions need to understand that FAS 141(R) may have an impact on goodwill and income tax expense to the extent there are valuation allowances for deferred tax assets and liabilities for uncertain tax positions that are unresolved for acquisitions that close both before and after the effective date regardless of whether there are plans for acquisitions in 2009 and the future. The accounting for those acquisitions will be different and will affect earning in the periods of and after the transaction’s close.

Understanding that transaction costs will be expensed in the period incurred instead of being part of the acquisition costs as they are now may result in earnings volatility that does not currently exist. This may alter a company’s strategy in terms of when certain due diligence work is performed, as such costs will be expensed as incurred, which may precede the period in which a transaction closes and is announced. This may necessitate explanations of variances in earnings making it harder to maintain confidentiality. If a company plans to make a step acquisition, they may be subject to larger asset and liabilities being recorded at the date of the acquisition. Additionally, application of FAS 141(R) may result in a larger asset basis and a higher level of goodwill, which may create problems for annual tests for impairment.

Spending Time Wisely

The principle of using acquisition date fair values may require more of your time and that of professional valuation experts for measurement and valuation. The more effort required developing the initial accounting will also affect the hours an auditor will spend on the audit. Additionally, further costs may be incurred if the acquiree has any defined benefit plans or if there is more extensive work needed to recognize the tax implications of the purchase price allocation.

To ensure your time is best spent and fees are kept to a minimum, Armanino can assist with professional valuation services for the tangible and intangible assets and liabilities being acquired. We can assist with applying the new standard and develop the accounting documentation that is needed to support the accounting.

October 06, 2010

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