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Goodwill harder to find in convergence

Goodwill harder to find in convergence

THE COSTS of mergers and acquisitions will become more transparent as converging international accounting rules shift costs that have been counted as goodwill onto profit and loss accounts,…

THE COSTS of mergers and acquisitions will become more transparent as converging international accounting rules shift costs that have been counted as goodwill onto profit and loss accounts, according to an audit expert.

KPMG audit partner, Kris Peach, said the International Accounting Standards Board’s (IASB) release last month of new standards for “business combinations” and non-controlling interests marks a big step towards convergence of the International Financial Reporting Standards and the US Generally Accepted Accounting Principles (GAAP).

“The really big change is the fact that your transaction costs are going to have to be expensed and so that’s where it will cause some grief,” she said.

Peach said significant costs involved in any major deal, including advisers, such as lawyers and auditors, would now have to be included on balance sheets rather than being included in goodwill, for instance.

“You will pay a lot of advisers to give you advice on how to structure a deal. These are called transaction costs and in the past you would have wrapped them up and included them in the cost of investment and you will have to expense it whereas you [previously] included it in goodwill,” Peach explained. “It means you are going to have a hit on your profit and loss accounts immediately as a result of doing this transaction.”

Peach said some companies “would not be impressed by this” because they would find it hard to explain “why they’ve made a loss on day one” even though they actually hadn’t.

Although the changes won’t take effect until 1 July 2009, she said it was still very important that companies understood the changes so they are in a position to explain their effect to shareholders.

The US Financial Accounting Standards Board released its version of the same standards in December. However, Peach said there remain differences.

One of the important changes is the treatment of non-controlling interests, or minority interests. Under the new IASB standards, they have chosen to give a choice between having to measure the “full fair value” of the proportion of net assets in a target, or staying with the present system of companies just calculating the value of the proportion they have purchased.

The US standards don’t give a choice, they just require a full fair value calculation, including goodwill.

She said the IASB has compromised because many of its members said the change was unworkable.

“Why that caused such a ruckus was that everybody said: ‘but if I have only purchased 80 per cent [of a company], I know how much 80 per cent is worth because that’s what I paid. I don’t know how much it would be worth to buy 100 per cent, because there might be a premium for control’,” she said.

Other changes include to contingencies, which can allow companies to alter their purchase price over a set period according to the performance of the target. Peach said the adjustments that are then made are usually included in goodwill.

Instead, the expected contingent amount will remain on the accounts, and any further changes will be included on the profit and loss. There will also be further guidance on required rights and vendor indemnities and mergers and acquisitions by contract alone and those involving mutuals will be covered by the standards.

This article first appeared in Risk Management Magazine, Lawyers Weekly’s sister publication.

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