Merger mania, all of it doubtless in the interest of creating global organisations that are capable of delivering shareholder value, is sweeping the world. In the UK the multibillion pound deals between Grand Met and Guinness, BP and Amoco and now BAT and Rothmans are more than matched Stateside by the multi-billion dollar Citicorp/ Travelers, Exxon/Mobil and Daimler/Chrysler deals. With such high profile and high value business combinations taking place on a regular basis, you could be forgiven if you do not believe that it is mere coincidence that an international group of accounting standard-setting bodies are publishing a proposal to ban merger accounting. And if you believe the standard-setting gossip, the idea of banning the so called “pooling of interest” method of accounting has “Made in the USA” stamped all over it. At the moment there are two ways of presenting the figures when two established businesses get together. The default method, certainly as far as the UK is concerned, is acquisition accounting. As every FD knows, acquisition accounting requires that the assets and liabilities of the acquired company only be restated at their fair, ie, current, values, and that goodwill be recognised on the consolidated balance sheet. At the same time, the profits of the acquired company are only taken into account from the date of the purchase. This is not good for earnings. It results in lower profit for the year of acquisition and higher charges to the profit and loss in subsequent years as the goodwill is amortised. It also has the effect of depreciating assets. In contrast, merger accounting is a dream for ambitious executives wanting to assure the world that their deal was a brilliant coup. All the profit from the start of the financial year in which the combination takes place is simply added together, giving the income statement a solid start. Perhaps more importantly, no adjustment is made to the value of the assets and liabilities. They are added together as though the two entities had always been one. That way there’s no higher asset value to depreciate and no nasty goodwill to worry about. Unsurprisingly, over the years, standard-setters have sought to place restrictions on the use of merger accounting. Under the UK’s relatively recent FRS6, merger accounting is still allowed, but there are criteria for it, most notably a check that one party does not dominate the combined entity. As a result, in the UK, mergers are high profile but rare. The database of Company Reporting magazine, reveals that, of 409 sets of UK accounts published in the last twelve months, only seven (1.9%) use merger accounting. Of those, just two, Diageo and White Young Green, used it for business combinations. Centrica used merger accounting for its demerger from British Gas. Halifax, Viridian, PIC International and J Sainsbury used it for restructuring. In the US there is nothing rare about pooling of interest. The US equivalent of FRS6 has 12 pooling tests but companies are able to meet them with ease. As one US standard-setter puts it: “Clearly what are takeovers are being accounted for as mergers. The Security and Exchange Commission (SEC) is sick to the back teeth with the whole business.” If the US suffers a bout of creative accounting the rest of the Anglo-Saxon world feels the effect, especially near neighbours. Canada has an accounting standard similar to FRS6 that follows the general rule that if you can identify an acquirer, then the deal is an acquisition. But the more lax US standard was putting so much unfair competitive pressure on Canadian industry, which couldn’t pull off the seemingly great mergers of its US rivals, that it is rumoured the banking regulators suggested to the Canadian accounting standard-setters that the accounting standard there should be brought into line with that south of the 49th parallel. In the UK there has been little hard evidence that FRS 6 is under siege. However, the G4+1 (ironically, the standard-setters in the five nations Australia, Canada, New Zealand, the UK, and the US, plus the International Accounting Standards Committee) decided to act in unison. Their discussion paper, for which the ASB wants responses by the middle of February 1999, makes the rather blunt suggestion of simply outlawing merger accounting altogether. It should be stressed, though, that banning merger accounting is not official ASB policy yet. The ASB hasn’t actually discussed the idea. Its concern was simply to publish the paper, to ensure that the UK was aware of international feeling and to ensure that a fully informed British voice is heard in the debate. One intriguing idea that the discussion paper raises – and then dismisses – is a replacement for the present rules on merger accounting. Entitled the “fresh start” method, this would require the restatement of the assets and liabilities of both parties to a business combination and the recognition of goodwill in respect of both. This is considered technically superior to merger accounting but has been condemned as impracticable, principally because it would not overcome the difficulty of knowing where to draw the line determining which method would be applied. Yet even with these drawing-the-line difficulties, fresh start accounting seems an idea worthy of further study. Indeed, in the rush to shore up an admittedly major, but short-term, problem, the whole issue of accounting for business combinations needs some thought. FDs across the globe may not like the thought of losing the alternative to acquisition accounting, but it is hard to see how any voices raised against the proposal will seem anything other than the cries of the self-interested and of creative accountants. Privately, UK standard-setters acknowledge that genuine mergers, which happen rarely in the UK, will suffer as a result of what was originally a US-only problem. It seems the few will have to pay the price of ensuring that this vital area of accounting is not abused. Peter Williams is a freelance journalist.
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