Devil in the details of accounting changes

PHILADELPHIA (Reuters) - If the devil is in the details, new merger accounting rules that go into effect next week may be quite a beast.

The new rules, effective December 15, may make it more difficult to place a value on acquisitions and may add volatility to the earnings of the buyer, according to accountants and merger attorneys.

As companies adjust to the broader rules and new nuances of the accounting changes, they could move more slowly in deal negotiations to ensure they do not get bitten by the new requirements.

"From a pure theoretical standpoint, accounting shouldn't affect whether you do a deal or not," said Greg Forsythe, director and Business Valuation technical specialist at Deloitte Financial Advisory Services.

"But some changes will cause companies to be very careful in structuring a deal to make sure they don't have unfortunate accounting happening to them," Forsythe said.

The new accounting rules, which bring U.S. accounting practices more closely in line with international financial reporting standards, could affect the planning and execution of merger agreements, and the disclosure of costs and fees related to deals.

"It's a big deal in the context of factors that come into play, but at the end of the day the big issue in the merger environment right now is the ability to finance deals and the underlying cash flow of companies," said Neil Dhar, partner with PriceWaterhouseCoopers Transaction Services in Chicago.

FAIR VALUE

The biggest change requires that any assets and liabilities being acquired must be accounted for at fair market value on the date of acquisition. The current system calls for values to be based on companies' assumptions or estimates.

"Valuation is complex and you need a lot of different inputs and you need lots of factors to figure valuation," Dhar said.

With the Standard & Poor's index down 38 percent so far this year, placing a price tag on acquisitions has already been challenging for the dealmakers brave enough to enter negotiations in the volatile markets.

"This probably increases the examination process and the length of time for negotiations. It will take a lot of work to get fair values," said Edward Ketz, an associate accounting professor at Pennsylvania State University.

For stock transactions, there will be additional changes. The value of the buyer's stock issued in a deal will be measured on the closing date, not on the date of a deal's announcement. That will mean that any fluctuation in the buyer's stock price will change the value of the deal.

RED FLAG?

Another change affects fees paid to bankers, attorneys or accountants. These costs now must be expensed each quarter in which they occur -- even if the costs precede the announcement of a deal. Expensing these fees will weigh on earnings in the quarters they occur, accountants said.

Recording fees signal to shareholders and rivals that a company is involved in deal negotiations, accounting experts said.

"It could potentially signal to the market that you are looking at a transaction. You're going to have to explain why you have advisory fees or transaction costs," Dhar said.

Also, buying companies with heavy research and development budgets may become more challenging. The new rules require the cost of in-process R&D acquired in a merger to be spread over the life of the project. The previous rules let companies book the expected fees up front and write them off as part of the cost of the merger.

"That makes the due diligence process much harder and more risky," said Edward Ketz, an associate accounting professor at Pennsylvania State University.

Due to the global credit crunch, companies have steered clear of acquisitions, despite some previous predictions by accounting experts that a spate of deals would hit before the new rules went into effect.

"It may have an effect but it won't be as significant as the financial crisis we're experiencing," Ketz said. "Three years ago I'd say this would be a primary effect but now it's fallen to a low second place."

(Reporting by Jessica Hall, editing by Matthew Lewis)