The FASB’s “simplification” proposals are coming fast, and some of them are making me furious. Proposed ASU No. 2015-260, which would roll back important anti-abuse provisions in ASC Topic 805—Business Combinations, is a very nice place to start.
A Perfectly Good GAAP
GAAP has long permitted companies to revise “provisional” measures of assets acquired and liabilities assumed (AA&LA) in a business acquisition. It’s more than a little bit hard for me to sympathize with a company that doesn’t have a really good idea of the actual value of the assets it acquired and the liabilities it has assumed, but that’s beside the point. The reality is that accounting rules have long accommodated management’s desire to have a “measurement period” in M&A accounting during which it may collect and process additional information about conditions that existed at the balance sheet date pertaining to particular assets and liabilities.
It is important for you to be aware as well that up until the issuance of FAS 141(R) in 2007, the measurement period rules had loopholes that made for interesting and imaginative financial statement manipulations. Paragraphs 52 -55 (ASC 805-10-25-13 thru 19 of FAS 141(R)) set forth a simple, reasonable and effective anti-abuse provision: if the acquirer adjusts during the measurement period its provisional amounts for the AA&LA, it must do so by restating the comparative financial statements in subsequent financial reports as needed.
And whaddyaknow, those paragraphs in FAS 141(R) worked as they were intended. Adjustments during the measurement period dwindled. Perhaps it did little to incentivize acquirors to adequately performing their due diligence at the time they closed on a deal; but now, at least they were acting as if they had.
Since It’s Not Broken, We Gotta “Simplify” It (If You Know What I Mean)
Now come some of the FASB’s “stakeholders” — that’s the doublespeak the Board uses to refer to groups when they can’t legitimately say that “users” or “investors” are included — to complain that GAAP is working too well. Quick like a fox, the FASB issues a fast-track “simplification” proposal that roll back the restatement requirement.
To set the stage for examining the Board’s questionable basis for the proposal, let’s use a simple example* to understand the effects it would have. My example is an adaption of the current and proposed illustrative example set forth in ASC 805-10-55-27 thru 28. The base case is rather vanilla, but just a few tweaks will get at the heart of the matter.
Acquirer acquires Target on April 1, 20×7. Acquirer seeks an independent appraisal for an intangible asset, which had a remaining useful life of 5 years (i.e., 20 quarters). The appraisal was not complete by the time Acquirer issued its financial statements for the quarter ended June 30, 20×7. In its Q2 financial statements, Acquirer recognized a provisional fair value for the intangible asset of $30,000 less 3 months’ amortization, and goodwill of $10,000.
During Q3, Acquirer received the independent appraisal, which estimated the asset’s acquisition-date fair value as $40,000.
Under current GAAP, the Q2 balance sheet is restated to report the intangible asset at $40,000 less 3 months’ amortization, and goodwill at zero; and the Q2 income statement reports the amortization expense of $2,000. But under the proposal, Q2 would not be restated. Therefore, total expenses in Q3 would be $2,500 — as compared to $1,500 in Q2.
Even before considering the tweaks that I hope you will find interesting and Board’s basis for conclusion, I am compelled to state the obvious: the proposal does not “simplify” the accounting during the measurement period. Both current GAAP and the proposal require the exact same data inputs and outputs, and process them the exact same way. If there is any “simplification,” it has to do with not providing investors with comparable information.
And, of course, a manager will have room to work with that lack of comparability. This is easily seen by changing the appraised value in the example from $40,000 to $20,000. That would be no big deal under current GAAP, but under the proposal, Q3 amortization expense is now only $500 as compared to $1,500 reported (and not restated) in Q2. Some months ago, investors and the board of directors were expecting a $1,500 hit to earnings every quarter for five years, and now comes the pleasant surprise that it will only be $500. Everybody wins! (And management gets a bigger bonus.)
To be most perverse, let’s set the appraised value at $50,000. Now, $10,000 positive goodwill is turned around to $10,000 negative goodwill, and management gets to report a whopping gain of $10,000 in Q3. That’s one way to make an earnings target! Whoopee!
A “Simplified” Basis for Conclusions
The heart of the Board’s basis for conclusions is paragraph BC5. To finish this post off, I’ll quote it with my comments interspersed
“The Board considered whether the benefits to users of recognizing adjustments to provisional amounts, as if the accounting for the business combination had been completed at the acquisition date, would justify the costs of revising previously issued financial statements.”
Hey, we’re not amending an SEC filing here. All we’re talkin’ about is revising comparative periods in current financial statements. Give them the numbers and sophomores could re-run the account balances lickety split. How much can this cost? Surely, back in 2007 (a mere 8 years ago) the Board duly considered these costs plus the benefits of requirement restatement.
“Stakeholders noted that the quality of provisional estimates has improved since the issuance … [of FAS 141(R)].”
Oh, so we’re saying that conditions have changed since 2007. Then please explain to your “stakeholders” why the quality of measurements would have improved for any other reason except for the existence of the paragraph that the FASB now wants to “simplify.”
“In many instances, the revisions to provisional amounts do not have a significant effect on financial statements and, as such, retrospective application does not significantly improve comparative period information. Stakeholders also noted that in instances in which the effect of the changes is not significant, entities do not adjust the comparative financial information. However, those entities must incur costs to provide evidence to their auditors that the effects of changes to the provisional amounts are not material to their financial statements.
As we all know, authoritative GAAP need not be applied to immaterial items. But, to tiptoe around that obvious reality, we now have to add “significant effect” to the FASB’s unofficial lexicon of accounting doublespeak. I doubt that the Board can explain how “significant” is a financial accounting (or auditing) concept that differs in any consequential way from “materiality”; or explain how their concept of “significance” is not in any Statement of Financial Accounting Concepts; or explain how something that is material might not necessarily be significant.
Moreover, for the Board to merely state that something does not have a “significant effect” doesn’t make it so. To paraphrase Abraham in the tale of Sodom and Gomorrah, how many “significant” adjustments to provisional amounts by issuers without a restatement requirement (to aid comparability and prevent abuse) would it take for the Board not to rain down burning sulfur on GAAP? (Whew, that’s a long way to go for a biblical reference!)
“One Board member noted a potential unintended consequence of removing retrospective application may be that entities would not be as diligent about finalizing the initial accounting for a business combination as entities have been under existing guidance, therefore potentially increasing the significance of the adjustments to provisional amounts.”
Just “one” board member happened to notice that the proposal would re-open the floodgates of loosey-goosey provisional measurements? Above all, however, under no circumstances must even one board member mention the financial statement shenanigans that might (more like will) take place if the proposal is finalized.
I would like to know how many board members considered the original intent of the provisions they now all want to obliterate? What about human nature has changed for the better since 2007?
“However, the Board concluded that the benefits from requiring retrospective application do not justify the resulting costs and complexity.”
There are no costs to be saved and there is no complexity to be eliminated. The basis for conclusions is a pretense to hide the fact that Proposed ASU 2015-160 does nothing more 0r less than to give one “stakeholder” group (management) one more option for fleecing another (investors).
*The simple spreadsheet that I wrote to calculate my numbers is here.