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The Starting Line: Cleaning up books before new rules

More big write-offs are in the offing, leaving companies to decide whether they should start cleaning financial house now.

Margaret Kane Former Staff writer, CNET News
Margaret is a former news editor for CNET News, based in the Boston bureau.
Margaret Kane
4 min read
BOSTON--The numbers are pretty staggering: Corning writes off $5.1 billion in inventory and acquisitions. JDS Uniphase writes off $38.7 billion in goodwill. Verisign writes off $9.9 billion in acquisitions and related goodwill.

And more are likely to come, said James Simms, managing director of Adams, Harkness & Hill and co-head of the brokerage firm's mergers and acquisitions division, who was speaking at the firm's conference here.

Why? Well, some of it is surely related to the plunging valuations of tech stocks, which have caused many companies to re-evaluate the premium prices they paid during acquisition sprees.

But many of those write-offs may be an attempt by companies to get their financial houses in order before a new set of accounting rules goes into effect related to how they account for those premiums, analysts said.

The Financial Accounting Standards Board recently implemented two new rules that did away with a popular merger accounting method known as pooling of interests--in which two companies combine their balance sheets after a merger--and revised how companies account for goodwill.

Goodwill essentially reflects the premium paid for a company over and above the real value of all of its assets. Traditionally that excess was amortized over a long period of time, allowing companies to write off a little bit of the acquisition charge every quarter.

But the new rules will significantly alter what is considered goodwill, and they will require companies to do an annual "impairment test" to determine if the goodwill has lost its value. Instead of writing off the goodwill every quarter, it will sit until it's determined to be impaired, at which point a company will write off the entire amount.

The new rules are extremely complex, so much so that Simms joked they should have been titled "The Auditor and Accountant Full Employment Act."

"At the conclusion of this meeting, you should go out and call your accountant," Simms said. "This means revisiting deals that are old and cold."

Act now or wait for rules?
In fact the process is so hairy that Simms speculated many companies are going through their books now, in an effort to deal with the issue before they're forced to work under the new rules. The rule eliminating pooling of interests mergers went into effect June 30, but most companies will have until Jan. 1, 2002 before they can no longer amortize goodwill.

"I have to assume that what JDS Uniphase realized was something akin to realizing you have to clean the house before your parents get home," Simms said. Companies are going to be saying, "We'll make our own decisions rather than have someone else tell us what to do."

But there may be some advantages to waiting for the new rules to take effect, said Pat McConnell, a senior managing director in equity research and head of accounting and taxation at Bear Stearns.

Companies that record impairment charges when they switch to the new accounting rules will be able to cite them as a by-product of the new accounting change, which is regarded by most people as a one-time event.

The accounting upheaval could have an impact beyond the financial statements. Simms speculated that many companies may put off doing big deals until they've managed to straighten up their finances.

Mergers and acquisitions "probably won't be robust again until after the impairment analyses have taken place," he said.

The return of merger mania?
But even once everyone's worked through the accounting headaches, it may be some time before the tech world returns to the heyday of the '90s, Simms said.

"There was a connection between pooling, (inflated stock) valuations and venture funding that fed on itself; it was a vicious cycle," he said. "With the disappearance of pooling we've pulled the capstone out of that arch."

That's not to say that all deal making will cease. Indeed, there has been a flurry of acquisitions in the past week or so.

Electrical components maker Vishay Intertechnology on Wednesday said it agreed to buy General Semiconductor for $538.9 million in stock. Nokia agreed to buy Amber Networks, a networking infrastructure company, in a $421 million stock swap. And Sanmina said it was buying fellow contract electronics manufacturer SCI Systems in a deal worth $4.45 billion in stock.

Bear Stearns' McConnell noted that as long as the acquisitions don't require significant write-offs, they shouldn't be affected all that much by the new accounting rules.

"Presumably you shouldn't have an impairment on a new acquisition so I wouldn't see new rules as a particular roadblock," she said.

But Simms is predicting that overall merger and acquisition volumes this year will be less than half of what they were a year ago.

"The rationale for much of the (merger and acquisition) activity was the assumption that to succeed one needed to grow fast," Simms said. "And for a long time there was no downside to a bad deal."

Deals that do get done in the near future will have more rational justifications and understandable valuations, he said. Deals may also become more complex, with more cash and stock combinations and the creation of special securities. Hostile deals and leveraged buyouts could also make a comeback.

While the new accounting rules will create headaches for the accounting departments, they will also "drive better thinking and better valuations," he said.