GAAP and IFRS

‘Business Combo’ Proposal Creating Rifts

The use of fair value rather than pooling, and changes in accounting for loan-loss reserves, are two major concerns.
Ed ZwirnJuly 18, 2005

One of the most ambitious proposals in the “convergence” agenda of the Financial Accounting Standards Board and the International Accounting Standards Board would replace the existing requirements of FASB Statement No. 141, Business Combinations, and IFRS 3.

The proposals retain the fundamental requirement of IFRS 3 and Statement 141 that all business combinations be accounted for using a single method in which one party is always identified as acquiring the other. Principal changes: The acquired company must be measured at fair value; goodwill attributable to any noncontrolling interests (not just the portion attributable to the acquirer) must be recognized; and fewer exceptions will be allowed to the principle of measuring, at fair value, assets acquired and liabilities assumed.

FASB and IASB released separate exposure drafts on June 30. The comment period ends October 28, but if initial reactions are any indication, the standard-setters have plenty of work ahead before everyone will be on the same page.

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Mary Griffin, senior policy advisor at the National Cooperative Business Association — which sent a comment letter to FASB on June 27, even before the release was published — says her group is critical of the proposal’s use of fair value to measure an acquisition, at least when one cooperative-type business acquires another. Griffin says that NCBA members, which include credit unions and rural electric cooperatives, want to continue using the pooling method to value such acquisitions.

“Our owners put in a certain amount, and their return is based on how much they use the services,” says Griffin. “To the users of financial information — and a lot of them would be the members of the coop — this doesn’t have much significance [and is] almost the opposite of what FASB wants to do in the investor-owned world.”

Changes in accounting for loan-loss reserves are the biggest concern of the American Bankers Association, according to director of tax and accounting Donna Fisher. Under current practice, she explains, a bank that has $100,000 in outstanding loans and posts $5,000 as a loan-loss reserve would show $200,000 in outstanding loans and $10,000 in reserves if it acquired a bank with “exactly the same loans and exactly the same credit quality.” But under the proposed standard — which would require assets to be measured at fair value — the hypothetical balance sheet for the post-acquisition company would show $195,000 in outstanding loans and only $5,000 of reserves. As a kicker, under fair-value accounting the value of these loans would fall if interest rates rose.

“If I do a lot of acquisitions,” says Fisher, “it’s going to look like I don’t have sufficient loan-loss reserves.” she said. Fisher adds that if the proposal were adopted, it may occasion a need for “retraining regulators” accustomed to judging the solvency of banks by the adequacy of their reserves.

Expressing broader objections, a 25-page comment letter submitted by Frank Brod, chairman of Financial Executive International’s corporate reporting committee, and Teri List, who chairs the Institute of Management Accountants financial reporting committee, had an almost exasperated tenor.

“The principles advanced in these drafts are consistent with a pattern we have observed,” wrote Brod and List. “Over the past 10 years the board has issued a significant number of standards that are among the most complex we have ever encountered.”

Among the proposal’s “significant difficulties” cited in the letter: “scopes that are broad and hard to comprehend, complex accounting principles that require extensive interpretive guidance, [and] measurement principles that presume a level of valuation capabilities that do not uniformly exist across the preparer community.” In conclusion, Brod and List argued that should comments as a whole “indicate only tepid support, the board should narrow the scope of the proposed changes.”

In other business, last week FASB met only in a so-called educational session. However the board did publish an exposure draft of a proposed interpretation, Accounting for Uncertain Tax Positions, which applies to Statement No. 109, Accounting for Income Taxes.

The proposal requires that in order for a company to recognize a tax break in its financial statements, it must meet a “probable recognition threshold” — that is, the company must have a high degree of confidence that the tax break “will be sustained upon audit by a taxing authority.” The draft contains guidance on measurement of the tax benefit, initial and subsequent recognition, derecognition, and other matters. It has a 60-day comment period.

No FASB board meetings are planned for this week. Topics for the next scheduled meeting, on July 27, have yet to be announced.

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