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New rules come because of the need for change to address the changing needs of business. This paper seeks expound on this idea by explaining the differences between the old accounting standard under rule 141 and the new rule 141 as revised on for mergers and consolidations. The first rule for the purpose of this paper is alternatively found as SFAS 141 while the new rule as SFAS 141R.
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Analysis and Discussion
The new rule no longer allows the recording of acquisition under the pooling of interest method in accounting for business combination. Under the pooling of interest method or uniting of interest, the stockholder of the combining enterprises combine into one entity of the whole of all the net assets and operations to achieve a continuing mutual sharing of the risks and benefits of the combined enterprise but neither party may be identified as the acquirer. The new rule, now under SFAS 141R, prescribes only accounting for all business combinations using a single method called acquisition, where one party called the acquirer is always identified as acquiring the other entity called the acquiree. Despite the seeming similarity of the use of acquisition method the revised standard includes procedures that could change immediate and future income statement and balance sheet in connection with business combinations.
One significant change under the new rule is that the acquirer may not anymore designate and effective date of business combination to the beginning of the period thus it now impossible refrain from presenting preacquisition earnings of the acquiree.
Another change under SFAS 141(R) is the requirement to use provisional amounts for the acquisition should there be incompleteness of accounting at the end of the reporting period. Still another change under SFAS 141(R) is the requirement that business combinations that were exempt from SFAS 141.
The old rule 141 had also the purchase price to include direct acquisition transaction costs which may include payments made by the acquirer to third parties for legal and accounting fees, and other fees for valuation services. Under the new rule 141 said transaction costs must be accounted for separately from the business combination since they are considered as assets acquired and liabilities assumed, hence they would made as expense under the amendment.
Another change under SFAS 141(R) is its treatment of contingent assets and liabilities which has generated controversies. Contingencies could be identifiable assets acquired or liabilities assumed by the acquirer but the ultimate benefit or settlement is dependent or contingent on the outcome of some future event. These are separate from goodwill and will be recorded at fair value. The acquirer is required to comply with “more likely than not” criterion under the Statement of Financial Concepts 6, Elements of Financial Statements, if it has to recognize these kind of contingencies as part of the acquisition.
The controversy appear to come from the inherent difficulty in measuring the fair value of contingent assets and liabilities since the fair value of the said contingent assets and liabilities will have to depend on the quality and availability of information as of acquisition date. Since the estimate will be based on assumptions which will require inputs from third parties, it is possible that estimates could be overstated or abused unless there is criteria or mechanism that will check the same. Since the revised rule will have to use higher of the fair of the acquisition date or their amount, management of the acquirer might probably take advantage of this in overstating their assets and understating their contingent liabilities. The new rule however has provided that after the acquisition the earlier recorded higher fair market value could go down eventually because the contingent assets will be measured at the lower of their fair value at the acquisition date or their estimated realizable value.
The idea of contingent liabilities to former owners if future events occur or certain conditions are met appears to be very controversial indeed. It would be the interest of the acquirer to minimize this kind of liability. It is logical to argue that it would be on the burden of the former owners to assert that the transaction or event would “more like than not” to happen so that they would have to make a claim from the acquirer. But it could be argued that the recognition of contingent liabilities would be directly or closely related with the acquisition of contingent assets. Since recognition of contingent assets will be linked to contingent assets, it is highly probable that acquirers would most likely understate said contingent assets so that contingent liabilities would be minimized. But since former stockholders would hold on to their interests, the effect would seemed to restrain the capacity of the acquirer to maximize the return for the new company created as a result of combination or acquisition. In this sense, the company could not go against its true nature. Since there is no use to overstating contingent assets or understating contingent liabilities, it would be more consistent to reason to be just objective about it and be true to whatever may be validly recognized as contingent assets or liabilities.
It may noted however that not all changes in the fair value of contingent considerations will be favourable to the former owners to which liability may have been promised to be made. The changes to qualify as such require the presence of additional information about facts and changes at the acquisition date compared with measurement period changes. If the changes in fair value of contingent considerations fail to qualify under the requirement, the new rule provides that benefit will accrue alone to the new owners of the corporation without fulfilling the promise to old owners. This will therefore strike a sense of balance of what could be fairly attributed to the effort and performance of the new owners
Another difference of the two rules is in the accounting for research and development costs. Under the old rule 141, there is the recognition into the expense as to the fair value of acquired in-process and research and development but under the new rule acquired in-process and research and development although measured similarly using fair value, the same will capitalized instead with an indefinite life, which musts tested regularly for impairment but not amortized. But amortization is still possible when the life of the acquired intangible asset becomes determinable at project completion.
The paper found the several changes in new Rule 141 (R) as compared with the old Rule 141. Not all were changed since the fundamental way of accounting for acquisition under single method (acquisition) still subsists. Having an acquirer and an acquiree is a reality that must be known under the new rule where the acquirer may not anymore designate and effective date of business combination to the beginning of the period thus it is now not possible to not to present preacquisition earnings of the acquiree.
Among the several changes, the most controversial comes as to rule on the use of contingent assets and liabilities where the fair value of the said contingent assets and liabilities depends on the quality and availability of information as of acquisition date that may entail assumption. As analysed earlier, it is possible that the estimate based on assumptions and that require inputs from third parties, the possibility if overstating or understating could be abused unless there is criteria or mechanism that will check the same. The use higher of the fair value at acquisition date may have companies’ management to take advantage of this in overstating their assets and understating their contingent liabilities based on the normal expectation that they will do according to personal interest. Incidentally, the new rule also provides that a way of correcting possible overstatement since the lower fair value at the acquisition date or their estimated realizable value will come after.
Under the normal course of events there is reason to deduce that it would be the interest of the acquirer to minimize this kind of contingent liability. Since recognition of contingent liabilities will be linked to contingent assets, it is probable that acquirers would most likely understate said contingent assets so that contingent liabilities would be minimized. But the new company as acquirer could not go against itself by restraining itself to grow big and fast just because a contingent liability is in the offing to old owners should profits become big. The rule makes it fairer to acquirers who will have to exert more efforts to improve the new company as the rule provides that not all changes in the fair value of contingent considerations will be favourable to the former owners to which liability may have been promised to be made. The changes need to qualify as additional information about facts and changes at the acquisition date compared with measurement period changes or the same income will form part of income from continuing operation and the benefit will accrue alone to the new owners of the corporation without fulfilling the promise to old owners. The new rules which are made to change the old rules may justify themselves in addressing the need for changes in addressing the changing needs of business through the use of contingent assets and liabilities and other introduced changes because situations and conditions had changed when the old rules are made.
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