On May 22, 2013, the Financial Accounting Foundation (FAF) issued a post-implementation review (PIR) report on the accounting rule that the Financial Accounting Standards Board (FASB) prescribes for business combination accounting—specifically, FASB Statement No. 141 (Revised 2007), Business Combinations, now codified into FASB Codification Topic 805. In general, the report found that Statement 141(R) improved rules for the purchase method of accounting for business combinations but that problems remain, particularly in relation to fair value measurements. The PIR report also acknowledges unexpected compliance costs for companies that have applied the requirements in Statement 141(R).
The FAF is the parent or oversight organization of the FASB, and this is the third of several expected PIR reports that are planned to be issued. The first two PIR reports addressed the accounting rules for uncertain tax positions and segment reporting. These accounting rules were initially issued as FASB Interpretation No. 46, Accounting for Uncertainty in Income Taxes, and FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information, but are now codified into FASB Codification Topics 740 and 280, respectively.
PIR Purpose and Process
As discussed more fully in my prior blog article, “Post-Implementation Reviews of U.S. Accounting Standards,” the PIR process was designed to assist the trustees of the FAF with their ongoing efforts to evaluate the effectiveness of accounting standards as well as the standard-setting process itself. The trustees of the FAF believe that separating the standard-setting process from the review process makes the review process independent of standard setting, hopefully, in both fact and appearance.
The PIR process is performed by a dedicated PIR team. The team leader reports directly to the FAF president and to the oversight committee established by the trustees. The team leader directly supervises the day-to-day activities of other review staff, which includes experienced members of the FASB staff who have been “released” to the FAF to devote full-time efforts to the PIR function. The FAF believes that having former standard-setting staff engaged in the PIR process is highly desirable and minimizes the learning curve. The FAF believes that it has established policies and procedures to maintain the confidentiality of PIR procedures, information, and stakeholder input when appropriate.
Business Combinations PIR Report
Unlike the PIR reports addressing income taxes and segment reporting, the latest PIR report on business combinations is a bit more critical of the FASB’s accounting rule. This PIR report found that Statement 141(R) resolved some of the issues associated with the purchase method of accounting for business combinations; that its principles and requirements generally are understandable and can be applied as intended; and that investors generally find the resulting information to be useful.
However, the review team determined that some investors question the reliability of reported information related to assets and liabilities that are difficult to measure at fair value, that result in a bargain purchase, or that may be asset purchases. The review team also found that the standard in certain areas introduced more costs and complexity to business combination accounting than the FASB had anticipated.
International Financial Reporting Standards (IFRS) are set by the International Accounting Standards Board (IASB), and the IASB also is now conducting a PIR of IFRS 3 (revised 2007), Business Combinations, which was issued concurrently with Statement 141(R).
The PIR report on Statement 141(R) notes that the review team received input from investors and other financial statement users; preparers of various sizes from a range of industries, with different levels of experience with the standard; auditors; academics; and financial regulators. The PIR report notes that the review team believes that its conclusions were based on “judgment, considering all the input received, and striving to be objective and balanced.” As set forth in the PIR report, the review team concluded that:
Statement 141(R) resolved some of the practice issues associated with the purchase method of accounting for business combinations that the FASB adopted with the issuance of FASB Statement No. 141, Business Combinations, in June 2001. Statement 141(R) replaced this standard in its entirety. Some practice issues remain unresolved, including identifying when a new basis of accounting is appropriate and accounting for combinations between joint ventures and organizations under common control. Additionally, Statement 141(R) is convergent with IFRS 3 in many areas; however, some differences remain between the requirements of Statement 141(R) and IFRS 3.
Statement 141(R)’s principles and requirements are understandable and generally can be applied as the FASB intended. The requirements in Statement 141(R) that stakeholders had the most difficulty applying relate to measuring assets acquired and liabilities assumed using the fair value requirements in FASB Statement No. 157, Fair Value Measurements (codified into FASB Codification Topic 820); measuring the fair value of contingent consideration; and determining whether a transaction is a business combination or an asset purchase. Preparers for medium to small organizations reported the most difficulty in applying the standard.
Investors generally find the information resulting from application of Statement 141(R) useful in understanding and analyzing most business combination transactions, including the measurement of the transaction at fair value. However, some review participants question the reliability or decision usefulness of the reported information for business combinations that (a) include assets and liabilities that are difficult to measure at fair value, (b) result in a bargain purchase, or (c) in substance may be asset purchases.
The costs and complexity of applying Statement 141(R) are higher than the FASB anticipated. Much of the complexity relates to the application of Statement 157’s measurement requirements to certain items. The costs relate to the extensive external valuation expertise being sought by both preparers and auditors of financial statements. Smaller organizations may face additional costs for timely access to external resources.
Statement 141(R) achieved improvements in the relevance and completeness of business combination information. Improvements in the area of comparability, reliability, and representational faithfulness of that information were not fully achieved in large part because of the questions about the reliability of fair value measurement requirements.
The PIR report also included the following recommendations from the PIR team as to improvements to the standard-setting process:
Enhance and formalize the process for identifying, prioritizing, tracking, and resolving significant financial reporting issues.
Regularly report on and update the status of those issues and their relative priorities.
Clearly identify and document the need a project will address and how the determination of need was made.
When resuming a deferred project, document the FASB’s reassessment of the need for the project.
Consistently conduct key research (such as field work and review of academic studies) as early as possible in the agenda-setting and deliberation phases. In addition, fully identify, in a standard’s basis for conclusions, any research and (or) economic principles relied upon when concluding on a significant issue.
FASB Response to Business Combinations PIR Report
In exercising one of her last responsibilities in her final term as FASB chairman, Leslie F. Seidman made the following statement about the PIR on business combinations:
The FASB believes that any plan to undertake a separate project to review or amend Statement 141(R) should be coordinated with the IASB once the PIR of IFRS 3 is complete and should consider the results of this PIR Report, the PIR Report on IFRS 3, and the PIR Report on Statement 157.
Clearly, a major complaint with Statement 141(R) was issues associated with fair value measurements. This is not surprising considering that fair value is such a significant and complex topic for accountants. The fair value standard (Statement 157) was issued in September 2006, whereas Statement 141(R) was issued in December 2007. That time lag was clearly insufficient to allow the new fair value requirements to be applied to another complex topic such as business combinations.
Look for the PIR reports on Statement 157 and IFRS 3 in the coming months. As to possible changes, both the FASB and the IASB have periodically been accused of moving the pace of a glacier. Sometimes that is okay, and maybe that is the approach they should have used when rolling out Statement 141(R) and IFRS 3.
While the “report card” the FAF delivered to the FASB on Statement 141(R) did not assign a letter grade, rest assured, if one was given it would not have been an “A.” Then again, the improvements it made for users and readers of financial statements was clearly discernible—clearly it would have earned better than a “D.” And, you have to give the FAF credit for having and using a procedure to evaluate the effectiveness of standard-setting in the United States.
About the Author
Ron Pippin is an experienced CPA based in Wheaton, IL. His 40 plus year career includes being an audit partner in Arthur Andersen, a member of Andersen’s Professional Standards Group (“national office”) in Chicago, the Director of Financial Reporting for a Fortune 50 company and most recently, the editorial director of CCH’s Accounting Research Manager. Currently, Ron does independent writing and analysis together with accounting consultation on a variety of topics.