Is There a GAAP in M&A?
How IFRS impacts mergers and acquisitions differently.December 1, 2011
by Brian Reed, CPA, CVA
As efforts to converge U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) continue, we need to recognize how differences between those two standards can affect merger and acquisition (M&A) activities.
GAAP offers considerable rules and guidance, while IFRS is more of a principles-based standard. GAAP and IFRS also present specific differences in the ways they address revenue recognition, business combinations and other M&A concerns. Those differences must be acknowledged when conducting due diligence.
In many situations, revenue is recognized sooner with IFRS than it is with GAAP. Under GAAP, revenue in certain instances is amortized over a defined-service period, while IFRS potentially allows for greater up-front revenue recognition when performance has occurred.
GAAP requires deferring revenue recognition on part of a multi-element contract, if failure to deliver remaining elements triggers a refund. With IFRS, revenue is generally recognized on a delivered element, even if a refund occurs later.
For long-term construction contracts, GAAP allows the “percentage of completion” approach if certain criteria are met. The completed contract method is also required under some circumstances. If the percentage of completion cannot be estimated reliably, IFRS requires use of cost-recovery method or a revenue-cost approach. IFRS does not let us use the completed contract method.
Inventory write-downs establish a new cost basis under GAAP, which cannot be reversed. However, IFRS allows write-downs to be reversed up to the original impairment amount if the reason for the impairment no longer exists.
Such differences may add complexity when we analyze the earnings of an M&A target.
GAAP and IFRS Differences for Business Combinations
The Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) 805 and the International Accounting Standards Board’s (IASB) IFRS 3 regarding business combinations was one of the first major FASB-IASB convergence projects. Significant differences still remain between GAAP and IFRS.
Both ASC 805 and IFRS 3R use the acquisition method to account for all business combinations. The underlying transaction is measured at fair value. However, other differences may occur. For example, IFRS 3R does not give specific guidance on how to determine fair value. That could lead to significant differences between the fair values determined at the acquisition date.
GAAP measures a non-controlling interest at fair value. That fair value includes the non-controlling interest’s share of goodwill. IFRS measures a non-controlling interest at either fair value including goodwill or the proportionate fair value share of the acquiree’s identifiable net assets, excluding goodwill.
GAAP and IFRS differ in how they measure assets and liabilities arising from contingencies as well. For initial recognition, GAAP distinguishes between contractual and non-contractual contingencies. IFRS initially recognizes a contingent liability at the acquisition date, if a present obligation arises from past events and its fair value can be reliably measured. However, IFRS does not offer us specific guidance for defining “present obligation.”
GAAP and IFRS Offer Similarities, Differences for Impairment of Long-Lived Assets and Goodwill
GAAP and IFRS provide similar definitions of indicators used to assess the impairment of long-lived assets. Both require that we review goodwill at least annually and more frequently in the presence of impairment indicators. Both also require that an impaired asset be written down, with an impairment loss recognized.
GAAP and IFRS differ, though, in testing for impairment of long-lived assets, calculating the impairment loss for a long-lived asset, allocating goodwill and calculating the goodwill-impairment loss. Accounting Standard Codification 360-10-35 (ASC 360-10-35) provides guidance for recognizing the impairment of long-lived assets under GAAP, while International Accounting Standard 36 (IAS 36) provides related guidance for addressing impairment within IFRS. Whenever impairment issues arise, we need to consult those differing standards. For example, one of the significant differences between US GAAP and IFRS is that under IFRS the impairment of long-lived assets not being held for sale can be reversed in total, which would potentially create significant fluctuations in net income and asset values on the balance sheet. That can create significant fluctuations in net income and asset values on the balance sheet. IFRS does not let us reverse goodwill impairment.
Other Accounting Differences in GAAP and IFRS
GAAP and IFRS offer differences in their treatments of leases, joint ventures and intangible assets.
For leases, GAAP requires testing whether or not the fair value of land merits separate classification in a lease of land and building. IFRS requires that separate classification, unless the amount that would be recognized for the land, is deemed immaterial. GAAP and IFRS also differ in their recognition of gains or losses in the sales of operating or capital leasebacks.
CPAs generally use the equity method in GAAP to account for joint ventures, whereas IAS 31 allows the use of either the proportionate consolidation method or the equity method for accounting for joint ventures within IFRS.
GAAP calculations for determining the impairment loss on intangible assets with an indefinite life are based on how much the carrying value of an asset exceeds its fair value. IFRS bases that measurement on how much an asset’s carrying value exceeds its recoverable amount.
The Outlook for IFRS in the United States
The U.S. Securities and Exchange Commission (SEC) supports GAAP-IFRS convergence efforts and use of IFRS as a worldwide accounting standard. The SEC has repeatedly stated, though, that it will provide at least four years’ notice before requiring IFRS reporting by public corporations in the United States.While the SEC has not issued a precise timetable regarding IFRS adoption, FASB and IASB convergence efforts continue. Global economies continue to become more integrated. Such events illustrate the importance of being aware of how IFRS affect M&A.
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Brian A. Reed, CPA, CVA, is the director of Transaction Advisory Services at Weaver LLP, with offices throughout Texas. He can be reached at 972-448-6936.