Almost everyone likes a story (see my earlier column, ‘How to tell your corporate story’); it’s often the best way to illustrate a point. In the first of an occasional series, I’ll look at life through the eyes of a fictional CEO who, in this first instalment, is struggling to reconcile acquisition accounting and the real world. He shares his concerns with his Crack Accounting Team (CAT).
CEO: We need to make sure we report the acquisition of Target Firm [TF] in the best possible way. I am a little worried that this was an expensive deal and that some shareholders may focus on the cost and not the value.
CAT: We can help here. The cost in the cashflow statement is just what we paid, less any cash on the target’s balance sheet. We can simply avoid mentioning the debt we have assumed. It’s easy to bury in the balance sheet reconciliation.
CEO: That sounds great, but TF had very little cash at the time.
The cash balance will go up and no one will notice
CAT: No problem; we just get TF to borrow a lot of money before the deal closes. The cash balance will go up and no one will notice. TF’s management will be happy to help; they are keen to get their severance packages.
CEO: Great! Now, let’s talk about the balance sheet. What are these new intangible assets?
CAT: IFRS requires us to ascribe values to things like TF’s customer lists and brands, even though we can’t capitalise these for our company.
CEO: So, you just made it all up?
CAT: No, it was a very sophisticated exercise, but with significant manual intervention.
CEO: So you did make it up.
CAT: And we also had to work out how long these assets would last so we can amortise them down to zero.
CEO: Did you make that up, too?
Silence.
CEO: ‘Amortise down to zero’: does that mean that our profits will be reduced by a non-cash annual charge for an asset we wouldn’t be able to capitalise organically? And that TF’s operating profits will be reduced simply because it has a new owner?
We will introduce a new metric called ‘adjusted profit’ and back out all the acquisition stuff
CAT: Yes, that’s correct.
CEO: And when the last customer has been written down to zero, our profits will suddenly jump? In a way that makes no economic sense?
CAT: Excellent, you’re getting the hang of this.
CEO: But what will our shareholders think of all this?
CAT: That’s simple; we will introduce a new metric called ‘adjusted profit’ and back out all the acquisition accounting stuff.
CEO: Won’t they complain?
CAT: No, investors are used to backing out all this nonsense. Everyone does it.
CEO: OK, let’s talk about the goodwill. This is what’s left of the acquisition premium after we ran out of customers and brands to capitalise, right?
CAT: Yes, but we have to run a test every year to see if the value has been impaired.
CEO: How do you test the value of a balancing item?
Impairments are just a belated recognition that the acquisition was a disaster
CAT: It’s a sophisticated test with lots of undisclosed assumptions and significant manual intervention.
CEO: Let me guess….
Silence.
CEO: But what if we fail the test? Won’t the share price collapse?
CAT: Well, first we can change the boundary of the cash-generating unit that has the goodwill. A larger CGU is more likely to pass. And we don’t have to disclose the size of the CGU, or if we change it.
CEO: But what if we have to impair anyway?
CAT: Relax, don’t worry about it. Impairments are just a belated recognition that the acquisition was a disaster. Investors usually spot that the acquisition has failed long before the impairment. And the share price often rises as a relief bounce … And the new CEO will blame it all on you, anyway.
