The broadside came from the marketing industry’s online financial magazine Marketing Services Financial Intelligence (www.fintellect.com). Illustrating the distorting effect of the IASB rule, the publication said: “This morning Chime Communications announced to its shareholders that they could celebrate a profit of £17.9 million…or bemoan a loss of £1.3 million…or a variety of other numbers in between. And none of that confusion was the fault of Chime.”
“The fact is that any sane reader of Chime’s financial results would interpret them as showing that the group had made a very healthy profit – perhaps not quite as much as in the previous year, but pretty good nevertheless, especially as the benefits of the Olympics had to some extent been offset by the costs of negotiating and implementing the divestment of the Bell Pottinger public relations business”, the article continued.
“But then along came the International Accounting Standards Board with its ill-conceived rule-book. At a stroke £12 million of profit was rubbed out, not because it hadn’t been earned but because the accounting boffins at the IASB think that it should be used to make an immediate write-down in the cost of companies Chime has recently acquired. That is not how the IASB sees it, but that is the consequence of its rules.
“This particular example of accounting lunacy stems from the belief that if one company buys another on terms that include payments geared to future financial performance, and the beneficiaries are employees (almost inevitable in a ‘people’ business), the performance related part of the purchase price should be treated as remuneration. So this year an amount of £12 million that is being paid to acquire Chime subsidiaries has had to be treated as remuneration and written off against profits, instead of adding to the book value of those investments.”
Even the Chime board was driven to express restrained criticism of the accounting rules in its results announcement, saying: “Whilst the directors do not believe that the treatment reflects the substance of the arrangements, they have complied with it and this has resulted in a charge of £11.5 million in 2012 for deemed remuneration.”
Marketing Services Fiancnial Intelligence’s editor Bob Willott said that the situation raises a very important question: “Is it wrong to value the purchase price of a creative business by direct reference to its present and future earnings? Would the IASB prefer a buyer to write out a fat cheque and then keep his fingers crossed? What would the acquirer’s shareholders think?”
Willott acknowledged that deals may be made where the buyer wants to provide financial incentives to key staff and that it would be hard to argue that such bonuses are anything but remuneration. “But there is a difference between buying ownership and buying employees”, he said. “The acquired company has a market value whether it is being bought from employees or anyone else. That value must take into account the stability of the executive team, but their ongoing employment is a matter for negotiation with their employing company (albeit under its prospective new ownership). If it can be demonstrated that the terms of employment are seriously inadequate in relation to their ability to motivate and retain the services of the key people, and there is evidence that the earn-out aspect has been inflated to compensate for that, then an argument could be made that some of the earn-out component is in substance remuneration. But to impose a requirement for all earnout payments to be treated as remuneration is irrational and plainly stupid.”
Willott complains that this type of accounting controversy is causing companies like Chime to prepare two sets of accounts – one to comply with the law and the other to give a meaningful picture to shareholders. “The growing use of “highlighted”