From the IFRS Institute - Nov 15, 2018
When a US company is acquired by a foreign investor, acquisition accounting and GAAP policy alignment are often top of mind for financial reporting implications. There are however many more complexities to work through, in particular if the US company or its new parent are listed in the United States or elsewhere: SEC filing and other regulatory requirements, potential dual reporting and choice of GAAP for books and records, IT systems, change in year-end dates and internal controls. In summary, it is more than just a GAAP conversion.
The widespread use of IFRS around the world, combined with the sustained interest from foreign investors in the United States, means US companies are frequently acquired by an IFRS preparer. Often these US companies apply US GAAP and are SEC registrants and/or the acquirer is a public company in the United States or another jurisdiction.
Aligning accounting policies between the US company (the acquiree) and its new parent becomes top of mind when thinking about the financial reporting implications of such transactions. With the end of the IASB and FASB convergence efforts, existing differences between IFRS and US GAAP are likely to be long-standing, including for ‘convergence projects’ such as leases, financial instruments and insurance contracts.
In our article,Converting from US GAAP to IFRS, we explore ten factors for a successful conversion from US GAAP to IFRS. Specifically, Factor 4 (comprehensive and detailed gap assessment) and Factor 7 (assessment of regulatory requirements) are worth repeating here. It’s also important to highlight that unlike US GAAP, IFRS requires uniform accounting policies across the group. Therefore, for example, it would not be appropriate for the US company to maintain a first-in first-out approach to inventory cost measurement if its new parent uses a weighted-average cost method for similar products, although both approaches are acceptable under IFRS.
However, the adoption of IFRS in the context of an acquisition is often combined with other issues. In this article, we address five other hot topics that should be included in the comprehensive assessment.
Acquisition and push-down accounting
For purposes of the consolidated financial statements of the parent, the transaction is subject to IFRS 3[1]if it is a business combination.[2]This means that the acquired assets and assumed liabilities are generally measured at fair value, and goodwill (or a bargain purchase gain) is recognized. This exercise is not significantly different from that under US GAAP.[3]
Both parties need to agree on how and where the purchase price adjustments (PPAs) are booked in the records. PPAs are the intangible assets identified on acquisition along with the fair value step-up of other assets and liabilities and any goodwill. Typically, PPAs are booked in the US company’s general ledger or its consolidation reporting package. This is consistent with IFRS requirements to treat those PPAs as assets and liabilities of the acquiree, maintained in its functional currency (likely US dollars in this case). However, in practice goodwill is sometimes maintained at the parent level. And top-side adjustments made by the parent are not always pushed down to the US company’s ledger. Such practical decisions matter because they determine, for example, who will be responsible for subsequent impairment testing.
Further, the US company may still have to prepare stand-alone financial statements, either under IFRS or US GAAP. US GAAP allows (or requires in certain circ*mstances) ‘push-down’ accounting where the PPAs are recognized in the stand-alone financial statements of the acquiree. One benefit of push-down accounting is that dual reporting is made easier going forward.
Push-down accounting is not permitted under IFRS, and therefore the US company may have to maintain two sets of IFRS numbers: one for the parent consolidation and one for its stand-alone financial statements. However, if the US company adopts IFRS in its stand-alone financial statements for the first time after push-down accounting has been applied under US GAAP, it may keep the pushed-down values as the deemed cost for certain assets, such as property, plant and equipment or identifiable intangibles.
These complexities highlight the importance of the US company having a good understanding of all its PPAs even if monitored at the parent level, and of both sides understanding how some of those reporting choices will affect the US company going forward.
SEC and other external financial reporting matters
On acquisition, the capital and debt structure of the US company typically changes. Depending on how the deal is designed, funding may be obtained through the parent and the US company may wish to de-register or withdraw public debt to suspend the requirement of periodic filings with the SEC. However, this is not always immediately possible and takes steps to accomplish.
Other private US companies with third-party debt continuing post acquisition should consider whether lenders still require US GAAP stand-alone financial statements or would accept IFRS.
The deal may be of such significance to the acquirer that investors need to understand the financial impact resulting from the acquisition of the investee. For example, if the acquirer is a Foreign Private Issuer, in conjunction with a 1933 Act filing, SEC S-X Rule 3-05 requires the filing of audited financial statements under US GAAP, IFRS as issued by the IASB, or home-country GAAP reconciled to US GAAP for the target if certain quantitative thresholds are met. In addition, investors might need to understand what the financial statements of the combined group would look like requiring pro forma financial information either under SEC S-X Art. 11 or its equivalent in a foreign jurisdiction. Many foreign jurisdictions have equivalent rules that could give rise to the need for audited historical IFRS information and/or pro forma IFRS information. The disclosure requirements in IFRS 3 for the acquirer in the year of acquisition can help address these potential requirements.
All of these situations have a downstream impact on pre- and post-acquisition financial reporting requirements, which need to be anticipated in the early stages of the deal conception. Involving outside advisers with a rounded knowledge of cross-border financial reporting and regulatory requirements is often a key success factor.
Dual reporting
As discussed above, certain US companies need or wish to maintain post-acquisition US GAAP stand-alone financial statements in addition to their IFRS reporting package. Maintaining two sets of books and records creates additional needs around systems, data, processes, controls and resources.
Selecting the primary versus secondary GAAP is key and requires thorough forward-thinking, because it will drive many downstream organizational decisions. In most cases, when the US company remains an SEC filer, US GAAP will be the primary GAAP.
The frequency of the reporting in each GAAP may be a useful data point in the selection. For example, IFRS may make more sense as the primary GAAP if IFRS reporting to the parent is prepared monthly versus US GAAP stand-alone financial statements annually.
It’s also worth noting that US federal tax is GAAP-agnostic, meaning a US company can chose its GAAP for book purposes independent of tax and does not have to maintain US GAAP books just for tax purposes. However, if US GAAP books are prepared, they will take priority for tax purposes.
If data, systems, processes and controls are built around US GAAP financial reporting, it’s important that a separate controlled process is put in place to produce IFRS financial information, and vice versa. This is especially true when adjustments, reclassifications, etc. to the other GAAP are handled through top-side or out-of-systems entries.
IT systems and processes
IT systems and processes may be heavily impacted by the magnitude and complexity of IFRS and US GAAP differences. For example, lease accounting under the new lease standards[4]and the allowance for credit losses[5]are substantially different. Often a separate solution, or a significant update or remake of an existing one, is needed to be able to report under IFRS. Additionally, the US company may need to revisit its chart of accounts structure to allow proper mapping to the parent’s reporting system.
This assumes that the US company’s and its parent’s financial year-end dates align, which may not always be the case. IFRS companies in Japan, for example, generally select a year-end of March 31 while banks in Canada require a year-end of October 31. The US company may have the option of keeping different financial year-end dates or changing its legacy year-end date to match the parent’s, which could have a significant impact on IT systems and processes.
Some might think changing financial year-end is as simple as adjusting a date in the system or running a standard report over a different period. However, many systems are set up to process and report transactions on a calendar-period basis. Simply running a report on March 31 may give you 3 months instead of 12 months of depreciation, for example.
Resources and internal controls
Imagine all of the above factors on a spectrum from left to right.
- On the far left: a plain vanilla cash deal with purchase price close to book value, no dual reporting requirements and no IFRS adjustments.
- On the far right: an acquisition with a new capital structure, push-down accounting, dual reporting requirements and significant IFRS-US GAAP differences.
It goes without saying that if a US company leans more toward the right end of the spectrum, the transaction will have a significant impact on resources and internal controls. The company in transition often does not have the resources to handle all the changes in a timely and detailed manner. Internal control considerations are pushed to the back while external resources are hired to maneuver through the transition.
The following are two key risks that may arise:
- potential lack of knowledge transfer to the IFRS process owners; and
- significant efforts for internal control remediation or even process and/or system redesign.
Trying to understand where the company is (or potentially will be) is important to grasp the magnitude of the implications when being acquired by an IFRS company.
Visit KPMG Accounting Advisory Services –Accounting Change Services: assistance in conversion from one accounting basis to another.
