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— Rules of the Road —
 The Financial Accounting Standards Board is simplifying its plans to change fair-value accounting rules for contingent assets or liabilities acquired in a merger or acquisition. Such contingencies are common in M&A transactions and include potential liabilities or rewards from pending lawsuits or other matters. In reassessing planned guidance about how to account for potential future losses or contingencies in the context of a business combination, FASB decided last month to revert to the general language used in previous rules, but insists it isn't backtracking. The board said it will make one important revision to the standard, FAS 141R, so that contingencies could be recognized at fair value to insure that valuations can be "reasonably estimated." That broadens the previous M&A proposal, which required fair value if it could be "determined."
"This is our version of 'Groundhog Day,'" said FASB Chairman Robert Herz during the board's open meeting Feb. 25. "We're now on our fifth iteration, probably, of this, starting with the original development of 141R." The word "determined" proved to be a sticking point with the previous proposal after FASB observers argued that nothing can be accurately determined in today's markets. Under current rules, companies must disclose all loss contingencies unless their likelihood is remote. And companies would also be required to disclose any contingency, no matter how remote, that is expected to be resolved within a year and could severely affect the company's financial position, results or cash flow. That means all the details about potential lawsuit liabilities would be shifted from the footnotes and into the body of the corporate financial statement. Lawyers have argued that the requirement infringes on attorney-client confidentiality provisions and would lead to disclosure of information that would prejudice the outcome of the contingency or lawsuit and complicate the outcome of a transaction. "Applying fair value to contingencies is a layer of complexity that may be too great. The more simplified approach will help dealflow," says Michael Scanlon, a partner at Gibson, Dunn & Crutcher LLP in Washington. Scanlon adds that limiting variables will increase chances of completing a transaction. If an acquirer decides fair value of such an asset or liability cannot be reasonably estimated, the board said it would then revert to existing guidance in FAS 5, Accounting for Contingencies, and FIN 14, Reasonable Estimation of the Amount of a Loss. The old rules say that companies must take a financial charge for a contingent loss only if it appears probable that the loss has occurred and that its amount can be reasonably estimated. If those conditions are not met, companies must still disclose the loss contingency, but only if there is a reasonable possibility that a loss has occurred. The accounting standards board also decided to remove from the business combination standard, FAS 141R, the guidance around when and how to value such contingencies after they're initially brought into a company's books. "I don't think we're going to resolve all this until we resolve the bigger issues" around recognition, measurement and disclosure of contingencies more broadly beyond business combinations, Herz said. The board has been trying for years to come up with a plan for the fair-value measurement of various contingencies, more specifically those related to pending or threatened litigation, and has been criticized for the plan. Critics of the rule say plaintiffs might be encouraged to make wildly excessive claims to pressure companies into entering a quick settlement rather than having to book a contingency. In its comments to the board, Huron Consulting Group Inc. of Chicago also argued that the provision, as it stood, would produce complicated audits because corporate counsels would not always be able to provide the information independent auditors need to value the contingency. FASB added that it will amend FAS 141R to kill a requirement to disclose a range of estimates related to contingencies, and eliminate "contingent consideration" from the scope of the planned staff guidance. Contingent consideration covers earnouts or other arrangements that establish future payments to a seller based on performance of an acquired entity. Donna Block covers accounting for The Deal. |
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