Professional services firm, Deloitte, has urged companies to immediately come to grips with the new accounting standards on mergers, acquisitions and similar transactions due to the complexity and volatility they’re expected to create in reported profits.

Issued yesterday by the International Accounting Standards Board, the revised accounting standards have a strong focus on fair value (i.e., an estimate of the market value of an asset – or liability – for which a fair market price is often not readily available).

In particular, IFRS 3 Business Combinations and IAS 27 Consolidated and Separate Financial Statements, will significantly alter the way in which business combinations and changes in ownership interests are accounted for.

Companies making acquisitions will witness immediate, and perhaps, unexpected profit impacts.

Stephen Ferris, a Corporate Finance partner who leads Deloitte’s IFRS valuation services in Australia, said that while fair value is supportable from a technical and conceptual perspective, it can often be difficult to implement in practical terms.

"The International Valuation Standards Committee (IVSC) is already trying to formalise valuation standards under the existing accounting requirements.

"Deloitte’s experience reveals significant uncertainty around the identification and valuation processes for intangible assets, as the IVSC process illustrates," Mr Ferris said.

"The new requirements will expand the fair value requirements to encompass subjective areas such as earn outs, more types of intangible assets, pre-existing holdings and minority interests."

Debbie Hankey, a National Accounting Technical partner with Deloitte, said that immediate expensing of transaction costs, such as legal costs, advisers’ fees and stamp duties, is a contentious area.

"Investors are going to ask why companies are reporting an immediate lower earnings outcome from making a sound business acquisition," Ms Hankey said.

"There are also other immediate profit impacts arising from employee share option schemes and so-called ‘pre-existing relationships’ between the acquirer and acquiree, such as existing supply contracts, legal disputes and franchise agreements.

"The unhelpful aspect of these profit impacts is that they may cloud the underlying performance of the group. 

"We expect that the current trend towards analysts and others focussing on ‘cash earnings’ or ‘underlying profit’ is going to accelerate with these changes. 

"It also tells you that the volatility and potential uncertainty created by the new requirements will need careful stakeholder management to avoid unfavourable market reactions.

"Some of these revised requirements are actually clarifying existing requirements.  This means they should be taken into account even before 2009 when the new standards become mandatory."

Mr Ferris said the new standards are now a reality.

"Companies need to ensure that they come to grips with them as soon as possible.  They should be planning for their introduction now but also looking for opportunities that might arise from the transition," Mr Ferris said.

Related links:

• Accounting alert 2008/01 – Further changes in business combination accounting 
• IAS Plus Newsletter (PDF, 121KB)