CUNA Regulatory Comment Call
August 16, 2005
FASB Proposed Guidance on Mergers
- The Financial Accounting Standards Board (FASB), along with the International Accounting Standards Board, has released its Exposure Draft (proposal) which would significantly change accounting practice for mergers of credit unions and mutual institutions (including thrifts and mutual banks).
- The proposal would implement the FASB merger rule that eliminates the pooling-of- interests method of accounting for business combinations (simple combination of the balance sheets of the merging entities), the approach presently used in the majority of credit union mergers. Instead, the proposal requires the use of the purchase method of accounting (which FASB terms the acquisition method).
- In the typical credit union merger, the surviving credit union shows the assets and liabilities of the non- surviving credit union on its balance sheet at book value. Instead, under the acquisition method, the surviving credit union would have to measure and show on its books the fair (market) value of the non-surviving credit union.
- In addition, FASB decided that the amount and nature of the acquired equity as well as the basis for determining the fair value of the acquired mutual enterprise should be disclosed in the surviving entitys balance sheets. Significant costs would be involved in determining the fair value of the acquired entitys balance sheet, including determination of goodwill and intangible assets. Further, there would be ongoing costs associated with assessing any potential impairment of goodwill and intangible assets (annually at a minimum).
- Under FASBs Exposure Draft, in a merger the retained earnings of the non-surviving credit union would be shown on the surviving credit unions books as a separate line item called acquired equity (based on fair value) instead of retained earnings. Unfortunately, the Federal Credit Union Act defines net worth for purposes of prompt corrective action (PCA) as retained earnings only. Therefore, after a merger under GAAP (generally accepted accounting principles), not all of the equity of the surviving credit union would count for purposes of PCA. If a credit unions net worth ratio falls below the level mandated by the statute, the credit union would be subject to regulatory action. CUNA would like to ensure that the acquired net worth in the new FASB rule would be consistent with PCA net worth and reflect economic reality.
- CUNA and CUNAs Accounting Task Force have vigorously advocated with FASB over the concern that the proposal would not allow the merged credit union to count the retained earnings of the acquired credit union on its balance sheet, which could lower its net worth category classification under prompt corrective action (PCA). This is especially of concern in the context of the merger of two similar size credit unions. Despite these efforts, FASB is determined to require the acquisition approach for all credit union mergers.
- CUNA has worked proactively to support such a legislative correction to the problem that FASBs proposal would unintentionally cause for credit unions. Two bills are pending in Congress that, if enacted into law, would address the problem the Credit Union Regulatory Improvements Act (CURIA) and the Net Worth Amendment for Credit Unions Act. The Net Worth for Credit Unions Act, H.R. 1042, passed the House on a voice vote June 13, 2005. The FASB Chairman has testified that the net worth legislation would not (negatively) impact the standard-setting activities of FASB or GAAP.
- This Comment Call focuses on the remaining issue of whether the guidance on how to determine fair value is effective and useful and, if not, how it could be improved.
- CUNAs Accounting Task Force and CFO Council will be closely reviewing this proposal and taking the lead in developing CUNAs comments to FASB.
- Credit unions may continue to account for mergers using the pooling method until this guidance becomes final.
- FASBs goal is to issue the final guidance for this project in mid-2006. The target effective date for the final guidance is January 1, 2007. FASB plans to hold public roundtable meetings at its Connecticut offices on October 27, 2005.
- Comments are due to FASB by October 28, 2005. Please send your comments to CUNA by October 7, 2005. Please feel free to fax your responses to CUNA at 202-638-7052; e-mail them to Associate General Counsel Mary Dunn at firstname.lastname@example.org or to Senior Regulatory Counsel Catherine Orr at email@example.com; or mail them to Mary or Catherine in c/o CUNA's Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, 6th Floor - South Building, Washington, DC 20004. You may also contact us at 800-356-9655, ext. 6743, if you would like a copy of the Exposure Draft, or you may access it here.
- Back in 2001, FASB issued a final rule requiring organizations to account for mergers using the purchase method of accounting in which one organization is deemed to purchase the other. This replaces the traditional pooling method of accounting a simple combination of balance sheets of the two organizations, which CUNA believes is the more accurate description of what happens in the case of a credit union merger.
- Recognizing that mutual institutions were unique, FASB delayed the effective date for credit unions and mutuals until it developed special guidance for implementation of the acquisition method. This guidance is contained in the proposal just published. This proposed guidance (proposed Statement) would replace current FASB Statement (FAS) No. 141, Business Combinations.
- FASB has made some changes to its proposal in large part based on the results of the field visits with Americo FCU in Erie, Pa and several mutual enterprises conducted in 2004.
DESCRIPTION OF THE EXPOSURE DRAFT
Identifying the Acquirer
- The acquiring credit union must be identified for every business combination.
- This issue of which credit union is the acquirer is most likely to arise in the case where 2 like-size credit unions merge.
- In the majority of credit union mergers, the larger of the 2 credit unions will be
assumed to be the acquirer. However, if the acquirer is not apparent, the following should be
considered in making that determination:
- The entity that transfers the consideration (that is, payment) may provide evidence about which entity is the acquirer. For example, in a business combination effected solely through the transfer of cash or other assets or by incurring liabilities, the entity that transfers the cash or other assets or incurs the liabilities is likely to be the acquirer.
- If the fair value of one of the combining entities is significantly greater than that of the other combining entity or entities, the entity with the greatest fair value is likely to be the acquirer.
- If the business combination results in the management of one of the combining entities being able to dominate the selection of the management team of the resulting combined entity, the entity whose management is able to dominate is likely to be the acquirer.
- In a business combination involving more than two entities, determining the acquirer shall include a consideration of, among other things, which of the combining entities initiated the combination and whether the assets, revenues, or income of one of the combining entities significantly exceeds those of the others.
Determining the Acquisition Date
- The acquirer generally obtains control of the acquiree on the closing date, which is the date that the acquirer transfers the consideration, acquires the assets, and assumes the liabilities of the acquiree. In some cases, the acquisition date may precede the closing date. For example, the acquisition date may precede the closing date if a written agreement provides that the acquirer obtains control of the acquiree on a date before the closing date.
Measuring the Fair Value of the Acquiree
- The proposed Statement would require the acquirer to measure the fair value of the acquiree, as a whole, and the assets acquired and the liabilities assumed at their fair values as of the acquisition date.
- When determining the fair value of the non-surviving credit union, that measurement
should be based on observable prices for a business that is similar to the non-surviving
credit union. If such information is not available, the surviving credit union should
estimate fair value using multiple valuation techniques consistent with the market approach or
income approach. These approaches are very similar to the standard approaches used in
commercial real estate appraisals.
- The market approach involves (1) defining and assessing the available marketplace data and (adjusting, if necessary) to derive one or more valuation ratios and (2) applying the appropriate valuation ratios to the non-surviving credit union. In identifying comparable businesses, the surviving credit union should take into account such factors as: products and services; markets served; competitors and position within the industry; capital structure and historical and forecast financial performance; and the depth of management, the expertise of personnel, and the maturity of the business. Ideally, marketplace data would be based on other credit unions.
- The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present amount (discounted). The estimate of fair value is based on the value indicated by marketplace expectations about those future amounts. If an estimated cash flow model is used, the cash flows should be based on the expected cash flows of the non-surviving credit union, which are likely to include adjustment for member benefits (such as the cost of reduced fees charged for goods and services).
Measuring and Recognizing the Assets Acquired and the Liabilities Assumed
- The acquirer would need to account for acquisition-related costs incurred in connection with the business combination separately from the business combination (generally as expenses).
- The proposed Statement mandates the acquirer to measure and recognize the acquisition- date fair value of the assets acquired and liabilities assumed as part of the business combination, with limited exceptions. Those exceptions are: goodwill; long-lived assets; and operating lease at market terms.
- Goodwill would be measured and recognized as the excess of the fair value of the acquiree, as a whole, over the net amount of the recognized identifiable assets acquired and liabilities assumed.
- According to the proposed Statement, the acquirer is to recognize any adjustments made during the measurement period to the provisional values of the assets acquired and liabilities assumed as if the accounting for the business combination had been completed at the acquisition date. Therefore, comparative information for prior periods presented in financial statements would be adjusted.
- The surviving credit union would be required to disclose information that enables readers of its financial statements to evaluate the nature and financial effect of business combinations that occur: (1) during the reporting period and (2) after the balance sheet date but before the financial statements are issued.
- Among the disclosures the surviving credit union would have to make would be:
- The name and description of the acquired credit union.
- The acquisition date.
- The primary reasons for the business combination, including a description of the factors that contributed to the recognition of goodwill.
- The acquisition-date fair value of the acquiree and the basis for measuring that value.
- The amounts recognized as of the acquisition date for each major class of assets acquired and liabilities assumed in the form of a condensed balance sheet.
- The amount of costs incurred in connection with the business combination, the amount recognized as an expense and the line item(s) in the income statement in which those expenses are recognized.
QUESTIONS TO CONSIDER REGARDING THE EXPOSURE DRAFT
(It is not necessary to respond to every question. Please respond to those
issues about which you have a strong opinion.)
Measuring the Fair Value of the Acquiree
- Does the Proposed Statement provide sufficient guidance for measuring the fair value
of an acquiree? (For more detailed information, please see paragraphs A8A26; also see
paragraphs 19 and 20 as well as paragraphs B56B99.)
If not, what additional guidance is needed?
- Do you agree that the costs that the acquirer incurs in connection with a business
combination -- for example valuation costs, legal fees and accounting fees -- are not assets
and generally should be expensed? (See paragraph 27 and paragraphs B93B99.)
If not, why?
Measuring and Recognizing the Assets Acquired and the Liabilities Assumed
This Exposure Draft proposes that an acquirer measure and recognize as of the acquisition date the fair value of the assets acquired and liabilities assumed as part of the business combination, with limited exceptions. (See paragraphs 2841 and paragraphs B100B142.)
- Do you believe that these proposed changes to the accounting for business combinations are appropriate?
If not, which changes do you believe are inappropriate, why, and what alternatives do you propose?
This Exposure Draft proposes that an acquirer recognize adjustments made during the measurement period to the provisional values of the assets acquired and liabilities assumed as if the accounting for the business combination had been completed at the acquisition date. Thus, comparative information for prior periods presented in financial statements would be adjusted, including any change in depreciation, amortization, or other income effect recognized as a result of completing the initial accounting. (See paragraphs 6268 and paragraphs B161B167.)
- Do you agree that comparative information for prior periods presented in financial statements
should be adjusted for the effects of measurement period adjustments?
If not, what alternative do you propose and why?
This Exposure Draft proposes broad disclosure objectives that are intended to ensure that users of financial statements are provided with adequate information to enable them to evaluate the nature and financial effects of business combinations. Those objectives are supplemented by specific minimum disclosure requirements. In most instances, the objectives would be met by the minimum disclosure requirements that follow each of the broad objectives. However, in some circumstances, an acquirer might be required to disclose additional information necessary to meet the disclosure objectives. (See paragraphs 7181 and paragraphs B184B191.)
- Do you agree with the disclosure provisions (minimum disclosure requirements)?
If not, how would you propose amending the objectives or what disclosure requirements would you propose adding or deleting, and why?
- Other comments.
Eric Richard General Counsel (202) 508-6742 firstname.lastname@example.org |
Mary Mitchell Dunn SVP & Associate General Counsel (202) 508-6736 email@example.com
Jeffrey Bloch Assistant General Counsel (202) 508-6732 firstname.lastname@example.org
Lilly Thomas Assistant General Counsel (202) 508-6733 email@example.com
Catherine Orr Senior Regulatory Counsel (202) 508-6743 firstname.lastname@example.org