GAAP and IFRS

FASB Proposes Merger Restructuring Costs Makeover

New rule would curb use of one-time acquisition reserves to boost earnings.
Craig SchneiderAugust 16, 2004

The Financial Accounting Standards Board has proposed a new rule requiring companies to treat merger-restructuring costs as an expense as they occur, curbing the tendency for managers to book reserve liabilities upfront and save for a bad earnings day, according to a Dow Jones Newswire article.

The one-time merger reserve funds have typically been set up at the time of a merger for things like firing staff or closing factories of the acquired company, the wire service reported. FASB intends for the new rule, presented as part of a broader package of M&A accounting revisions, to take effect on or after Dec. 15, 2005. It expects to issue an exposure draft for public review and comment in the fourth quarter.

Regulators and accounting experts say plugging the merger loophole is an important step in helping investors better assess companies’ underlying earnings growth and operations. “Restructuring reserves set up in connection with acquisitions have long been used to hide the subsequent poor performance of companies from their investors,” Lynn Turner, former SEC chief accountant, told Dow Jones. “The FASB stopping this abuse is long overdue.”

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While FASB issued a similar standard in 2002 that required companies to recognize restructuring costs when they are actually spent, not when they are planned, it never specified how companies should account for the restructuring charges caused by a merger. The newswire notes alleged abuses of this loophole in the late 1990s by Cendant Corp., whose former senior management was accused by the Securities and Exchange Commission of intentionally overstating the company’s merger reserves in order to reverse the amounts in later periods to pad earnings.

Robert Willens, a tax and accounting expert at Lehman Brothers, believes the new rule change would have repercussions for nearly every acquisition, which often entail layoffs or other restructuring initiatives. “I would be hard pressed to think of any deal that didn’t involve some sort of restructuring of the acquired business,” he said in the article.

To be sure, there are exceptions to the proposed rule. One example, Dow Jones notes, would be when a company being bought promised severance pay to its workers for their services rendered before the takeover. Such costs could be recognized as liabilities to be carried over to the acquirer’s books.