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How revised M&A accounting standards are impacting deals

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Accounting for mergers and acquisitions has always been complex. Since new standards changed the way businesses account for and report deals, it’s become even harder. Are you changing the way you work …

Accounting for mergers and acquisitions has always been complex. Since new standards changed the way businesses account for and report deals, it’s become even harder. Are you changing the way you work to cope with the challenges? See how a new approach to planning, valuing contingent payments and more comprehensive due diligence can help you reduce the risk of unwanted surprises.

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  • 1. Perspectives on how revised M&A accounting standards are impacting deals November 2011 A publication from the Transaction Services practice At a glance Changes to accounting standards enacted several years ago have impacted the way companies approach deals. Companies have adjusted their processes and planning to address increased uncertainty caused by the accounting rules. Contingent consideration remains a viable approach for many companies to tie payouts to performance, despite fair value reporting challenges.
  • 2. Accounting for mergers and acquisitions has always been complex—and in the two plus years since a new standard changed the way companies account for and report deals, that endeavor has become even more involved. The resulting challenges were evident when more than 1,500 accounting, finance and deal professionals participated in a PwC webcast titled “How deals have changed: Lessons learned from applying the revised M&A accounting standards.” The webcast was led by Jonathan Isler and Matthew Sabatini, partners in PwC’s Transaction Services group, and discussed the impacts of ASC 805 (formerly FASB 141R). The standard introduced new accounting concepts and valuation complexities that have changed the way many companies approach mergers and acquisitions. (1) Recent/planned transactions* Transactions completed or planned within six months 16% No recent or planned transactions 24% 60% 2 PwC Perspectives on how revised M&A accounting standards are impacting deals Unsure or not applicable
  • 3. Perspectives on how revised M&A accounting standards are impacting deals Through responses to polling questions and interactions during the webcast held earlier in 2011, participants shared their views on how the changed accounting standard has impacted their deals process. Input collected and summarized here reveals insights and observations about deal trends following the change in accounting standards for reporting business combinations. Recent deal activity reporting that deal transactions had been completed within the past six months or were planned within the next six months (see Chart 1 on preceding page). Deal activity has the potential to intensify as companies look for ways to grow. In particular, the pace of deal activity among domestic companies may increase as companies seek to expand internationally through mergers and acquisitions. Today’s deal environment is not without its challenges, however. Several questions posed by participants focused on distressed transactions as well as the frequency of deals being abandoned. The economic environment has posed challenges off and on for deal activity. However, the trend was up at the time of our webcast, with 60% of respondents (2) Greatest concern from the impact of acquisition accounting* Unpredictability in setting the ultimate purchase price 21% 28% Impact on deal close timing 36% 15% Greater earnings volatility Unsure or not applicable New standard leads to more robust diligence The application of ASC 805 has had a significant impact on the due diligence process. Because the standard introduced new complexities related to valuation and poses the potential for greater earnings volatility after an acquisition, more companies are undergoing a lengthier and more comprehensive due diligence process. The tax and accounting functions are now often involved much earlier in the deal process to help identify potential post-deal accounting impacts and to mitigate the risk of having to recast financial statements at a later date. In a roundtable PwC hosted in early 2011 with M&A professionals from leading technology companies, we noted how corporate finance teams are becoming the “eyes and ears of the CFO,” helping to test assumptions throughout the deal process. See PwC’s publication titled The Eyes of the CFO: the finance M&A function for more insights. Valuation specialists are working more closely with the diligence team to understand the deal drivers and the operations of the target—that play directly into the valuation issues. The standard allows companies to book preliminary acquisition results based on estimated values, but also requires them to adjust those numbers later, if the estimates aren’t reasonably accurate. 3
  • 4. More broadly, the earnings impact reflected in deal models and business cases are being revisited in light of actual post-close results, with greater scrutiny on deviations that could have been addressed earlier in the deal process. Nearly one in five respondents polled in our webcast indicated that pre-acquisition deal model valuation and earnings assumptions were inconsistent with post-acquisition accounting results. Replicating a “post-deal,” compliancefocused valuation during the due diligence phase can help companies better estimate a deal’s accretive or dilutive effect on earnings. The potential benefits include greater confidence in building a business case for the deal and better communication to the company’s board of directors and other key stakeholders. The process allows companies to identify intangible assets and liabilities requiring recognition in acquisition accounting, assess tax implications of transactions, and provide a clearer understanding of issues that may affect the sale and purchase agreement, such as adjustments to working capital targets. Planning and process phases more involved Since the adoption of the new standard, we’ve also seen more companies working to build early integration planning into the diligence process. Companies appear to recognize a greater need for the integration process to quickly capture deal value and track progress, particularly with the cost of restructuring efforts impacting operating profit. We’ve also seen companies taking steps to provide more timely and detailed stakeholder messaging to help manage expectations that result from greater transparency around restructuring activity. Before the changes, businesses focused on communicating the benefits of the restructuring activities; now, there’s a lot more sensitivity to not just talking about the benefits, but the expected costs as well. Deal structures shift Deal structures have shifted somewhat since the new standard was implemented, with many companies moving from fast- (3) When the impact of acquisition accounting is considered* Before the transaction closes, at a high level 21% 37% 8% Before the transaction closes, in detail After the transaction closes 33% 4 Unsure or not applicable PwC Perspectives on how revised M&A accounting standards are impacting deals paced, auction-based transactions to more carefully negotiated deals. In addition, we’ve observed that transactions have become more sensitive to the timing of the deal close. More deal participants are attempting to close transactions earlier in the quarter to allow sufficient time to compile the opening balance sheet and related fair value estimates. Companies are focused on getting the deal executed as efficiently as possible to make the reporting clean and accurate. Many want to get the acquisition accounting done quickly and accurately and move on to minimize the risk of having to recast numbers later. Standard increases unpredictability Many of the challenges resulting from ASC 805 are related to the uncertainty of valuation and the related income statement volatility, a sentiment confirmed by our webcast participants, who indicated that volatility was of greatest concern (see Chart 2 on page 3). The impact of increased earnings volatility has prompted many companies to assess issues related to acquisition accounting earlier in the deal process. Among our webcast participants, 70% said that they evaluate acquisition accounting impacts before a transaction closes—33% in detail and 37% at a high level (see Chart 3). The pitfalls of estimating the impact of acquisition accounting by relying on high-level benchmarking studies were evidenced by challenges identified by our webcast participants. Greater visibility is being placed on deviations from the business case and accretion/ dilution estimates.
  • 5. The pitfalls of estimating the impact of acquisition accounting by relying on high-level benchmarking studies were evidenced by challenges identified by our webcast participants. Contingent consideration challenges accounting (or potentially treat them as compensation expense). Depending on the terms of the contingent consideration, acquirers may be required to subsequently record these instruments at their fair value each reporting period, contributing to earnings volatility. Many expected ASC 805 to significantly impact the use of contingent consideration—also known as “earnouts.” These provisions may serve to bridge a “valuation gap” in negotiations between the buyer and seller, or may provide postdeal incentives to selling shareholders by tying their payout to future company performance targets. Despite the challenges posed by the fair value reporting requirement, 31% of webcast participants said that the new accounting standard has not affected their use of contingent consideration (see Chart 4). Disregarding those who had replied “unsure or not applicable,” Companies using contingent consideration must now report their fair value as part of the acquisition the majority of respondents had not changed their use of contingent consideration—in fact, 11% had increased their use. Still, our participants raised numerous questions about contingent consideration, underscoring the challenges that companies face in valuing variable elements in acquisitions. Many of the questions focused on equity versus liability treatment of contingent consideration and other issues regarding how these provisions are valued or when they are required to be treated as compensation expense. Conclusion (4) Use of contingent consideration* Yes, we have increased the use of contingent consideration 11% 11% 47% 31% Yes, we have decreased the use of contingent consideration No, our use of contingent consideration has been unchanged Unsure or not applicable Companies can reduce the risk of a surprise impact of the revised M&A accounting standards through increased planning. For example, earnings uncertainty can potentially be reduced by employing a more robust approach to valuation during the diligence process. We also have heard from deal participants that contingent consideration, while more challenging to value under the revised standards, remains a viable approach to executing deals. Taking an integrated approach that jointly considers the valuation, technical accounting and tax impacts of a deal can help structure your approach to address these issues. *Source: Responses to polling questions asked of participants of the webcast “How deals have changed: Lessons learned from applying the revised M&A accounting standards.” 5
  • 6. www.pwc.com/ustransactionservices To have a deeper conversation about how this subject may affect your business, please contact: For a deeper discussion on deal considerations, please contact one of our regional leaders or your local PwC partner: Matthew Sabatini Partner, Transaction Services (646) 471-7450 matthew.e.sabatini@us.pwc.com Martyn Curragh Partner, US Practice Leader, Transaction Services (646) 471-2622 martyn.curragh@us.pwc.com Gary Tillett Partner, New York Metro Region Leader, Transaction Services (646) 471-2600 gary.tillett@us.pwc.com Scott Snyder Partner, East Region Leader, Transaction Services (267) 330-2250 scott.snyder@us.pwc.com Mel Niemeyer Partner, Central Region Leader, Transaction Services (312) 298-4500 mel.niemeyer@us.pwc.com Mark Ross Partner, West Region Leader, Transaction Services (415) 498-5265 mark.ross@us.pwc.com About our deals publications: PwC provides tactical and strategic thinking on a wide range of issues that affect the deal community. Visit us at www.pwc.com/ustransactionservices to download our most current publications. © 2012 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved.) PwC refers to the United States member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. AT-13-0122