Accounting rules “increasingly hard to take seriously”

April 25, 2012 - PRLog -- It is becoming increasingly hard to take seriously the accounting rules made by the International Accounting Standards Board, according to an analysis published in "Marketing Services Financial Intelligence".  The publication cites three examples of rules that it says seem to come from an unreal world.

The examples are:
•   The ban on including direct costs of acquisitions – like professional fees – as part of the cost of the acquisition itself.  Instead the costs must be written off against profits in the year they arise.  
•   The requirement, where two wholly-owned businesses are merged into one, that any goodwill attributable to the company that has surrendered its business must be written off completely even where the revenue-earning capability remains intact.
•   The manner in which companies are required to account for acquisitions that involve deferred payments, the amounts of which may be determined by a performance-related formula.

The article is particularly critical of how a revised version of International Financial Reporting Standard 3 requires the cost of an acquisition that includes the estimate of further amounts payable in the future to be treated as a fixed amount, despite the fact that by definition a performance related valuation will be incapable of precise calculation until a later date.  If the original estimate proves to be wrong – “an absolute certainty”, the article says - the variation is treated as part of the acquiring company’s profit or loss for the year in which the adjustment arises.

"Marketing Services Financial Intelligence" claims that, under the IASB’s rules, there is an incentive to be excessively generous in the initial valuation of the deferred purchase price so that the company can subsequently report a profit as the estimated purchase price declines.

“The IASB’s thinking seems to be based on a flawed assumption – namely that any variation in the amount eventually payable is not an adjustment to an earlier estimate of the value of the company being acquired (measured by reference to its profit-earning capability), but instead is in part a financing cost or credit influenced by hypothetical outside forces in the same way as exchange rate movements affect what is paid to settle a fixed obligation expressed in a foreign currency”, commented editor Bob Willott.

“Until the IASB produced its latest rule on the matter, most normal people would have expected to account for a downward or upward price adjustment by reducing or increasing the cost attributed to the asset acquired and by making a corresponding alteration to the amount appearing as a creditor.

“One of the reasons why the acquisition of ‘people’ businesses, such as marketing agencies, is paid for by instalments geared to ongoing financial performance is that it is very difficult to form a firm view about value when it is geared to the profit-earning capability of a business that is dependant on intangible assets like people, clients, reputation and location.  So the buyer contracts to value and pay for the acquisition by reference to the actual profits earned over several years following purchase.”

The article argues that acquisition deals that involve “put” and/or “call” options have also fallen foul of the IASB’s rules that require companies to account for the initial partial purchase as if the target company has been bought in its entirety.   In doing so, the buyer must estimate the present value of the likely cost of acquiring the outstanding shares if and when the option is exercised.

Each year the potential cost of buying the outstanding shares is reassessed.  If it changes from the initial estimate, the difference is included as part of the prospective acquirer's profit or loss for the year in which the revised assessment occurs.   “Again the reporting company may find its annual profits oscillating wildly for no useful purpose”, Willott says.

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