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Accounting changes impact M&A

Posted: May 06, 2008, 1:15 PM by Jonathan Ratner
Market Call, Takeovers

It may be hard for some of us to remember, but it wasn’t long ago that global markets were in a state of M&A euphoria. But the rather sudden shift in macroeconomic conditions may mean companies that have made recent acquisitions will have to take impairment charges for goodwill and other related intangibles sooner rather than later, UBS Securities said in a recent report.

Accounting changes for M&A transactions worldwide mean acquirers now have to recognize intangible assets – things like trademarks, lease agreements and databases – as well as goodwill on their balance sheets. This can give rise to material write-downs of the value of these acquired intangibles and when recognized on income statements, can sometimes dwarf a company’s earnings from operations, analyst Dennis Jullens told clients.

He is glad to see that accounting is catching up with the economic reality, with spending on intangible assets increasingly being treated as an asset instead of a cost. UBS feels the old accounting model that only recognizes expenditure on tangibles as an asset “distorts performance measures and balance sheet metrics.” This is because full expensing of intangibles may motivate companies to cancel or defer this spending in order to boost reported earnings in a particular period, possibly at the expense of long-term value creation.

Most Canadian companies will have to covert to these international financial reporting standards (IFRS) from generally accepted accounting principles (GAAP) in January 2011.

“In general, we view impairment charges as confirmation from companies and their auditors of information that is already reflected in share prices,” Mr. Jullens said. “However, the pace of economic change could make impairment charges more important during the current downturn, as they can convey new information about a company’s prospects.”

For 228 larger European companies, goodwill and other intangibles accounted for 4.4% of the balance sheet total at the end of 2007. This equates to roughly €1.45-trillion, up from around €1.3-trillion in 2006 when the proportion of the total was the same.

Topping the list of European names with the highest percentage of goodwill on their balance sheet was Telecom Italia at 51%, with goodwill of €44.4-billion and total assets of €87.4-billion. However, Vodafone Group had the most goodwill at €62.1-billion, demonstrating the strong representation from telecom names in the top 20.

Despite these rather large figures and the potential for related charges, Mr. Jullens emphasized that they are not necessarily market-moving events and depend on whether or not they tell the market anything new about the company’s prospects.

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