Statement 141R Brings Dramatic Change to M&A Accounting Standards
By Timothy R. Shelley, Cherry, Bekaert & Holland, L.L.P. (CB&H)
Email: tshelley@cbh.com

Late last year, the Financial Accounting Standards Board (FASB) issued Statement No. 141R (along with Statement No. 160), establishing new standards for accounting for business combinations. Effective for transactions with closing dates that occur on or after December 15, 2008 (2009 for companies with a calendar year end), Statement 141R dramatically changes accounting considerations that will play a greater significance in how businesses evaluate, negotiate and structure potential deals moving forward.

Statement 141R contains a number of changes to existing accounting standards, establishing the use of “full fair value” accounting as the standard and setting the stage for possible post-acquisition earnings volatility in the years ahead. The new standards also expand the definitions of businesses and business combinations, requiring more entities to be classified as businesses and more transactions to qualify as business combinations regardless of whether or not control or interest has been transferred.

Under these new standards, acquiring companies will need to use the “full fair value model of accounting as opposed to the current cost allocation model when measuring assets acquired and liabilities assumed. As a result, 100 percent of the target company’s assets and liabilities, including goodwill, will need to be recognized by the acquiring company at their full fair value (with very few exceptions specified in the standard), even when that fair value exceeds the acquisition price and/or less than 100 percent of those assets are being acquired.

This expanded use of fair value brings with it a number of substantial changes regarding how certain acquisition costs will be treated for reporting purposes. For example, transaction costs and restructuring charges can no longer be included as components of the purchase price since they cannot be considered part of the acquired entity’s fair value. Rather, they will now be accounted for under other GAAP – generally being expensed as incurred, treated as debt issue costs, or equity issuance costs, as applicable.

In many cases, restructuring costs will no longer qualify for inclusion as a liability assumed in acquisition accounting, but will now be accounted for under other GAAP and likely be reflected as charges to income in post-acquisition periods. In addition, in-process research and development (IPR&D) assets will now be recognized as an asset at their fair value rather than being expensed in the period the acquisition takes place.

Acquiring companies will need to record all assets and liabilities at their respective fair values on the acquisition’s closing date. Earn-out arrangements and other contractual contingencies are included under this requirement, requiring subsequent changes in fair value for certain liability-classified contingencies to be recognized in earnings reports thereafter until settled.

The full ramifications of this change will most likely present a significant challenge to the acquiring company given the difficultly in predicting any additional related expenses that may arise. Therefore, finalizing acquisition accounting concerns within the first reporting period following the deal’s close date will, in all probability, begin to assume a greater emphasis and earn-outs will probably become less frequent or scrutinized more closely to ensure they are structured to obtain equity classification.

Statement 141R’s focus on fair value will also have a substantial effect on step acquisitions in that the interests of the previous owners will be recognized at fair value, appropriately recording gains or losses in earnings. However, if the previous owners retain some control, then the shareholder equity should receive a credit or charge equal to the difference between the interest acquired and the carrying amount.

If the previous owners will not retain control, then the interest sold and the interest retained will be recognized as a gain or loss at fair value.

Overall, Statement 141R enacts a number of profound changes to the accounting standards that govern business combinations. Although early adoption is prohibited, businesses should act now to become familiar with the requirements of these new standards and to evaluate any potential impact the new requirements may have on deals under consideration that may not be finalized by the end of the year.

One day can now make all the difference for companies currently considering acquisition opportunities in 2008, and business acquisitions that don’t close this year could look substantially different in 2009.

Given the pre- and post-acquisition time and resources necessary to properly establish Statement 141R’s required use of “full fair value” and its other reporting requirements, it is recommended that management begin to prepare by working with their company’s external auditors and accounting advisors to gauge the impact these new standards will have given their company’s particular circumstances. By taking the time now to properly understand Statement 141R, management can ensure compliance, eliminate unforeseen reporting effects, and generally minimize transaction complications in the years ahead.

Tim is an Audit Partner with CB&H and a member of the Firm’s Private Business Group.