Since Taiwan started allowing the establishment of financial holding companies in 2001, mergers and acquisitions have frequently made headlines, and the amounts of money involved have been considerable. For the reader's consideration, this article will take advantage of the official interpretations issued by the Accounting Research and Development Foundation of the ROC (ARDF) to analyze M&A methods and their impact on financial statements.
When an M&A transaction takes place, the first consideration is whether it constitutes a reorganization among affiliated companies or a merger of unaffiliated companies, as treatment in the financial statements is different in the two cases. Under Article 4 of the Financial Holding Company Act, for financial holding companies, "affiliated companies" refers to where the holding company holds more than 25% of a financial institution's voting shares or total capital, or where the company selects or indirectly appoints more than have of the financial institution's directors. For other industries, the applicable regulation is paragraph 17 of Statement of Financial Accounting Standards No. 5, which requires only that one company have control or "significant influence" over the other.
Affiliated Company Reorganization
If the transaction involved constitutes a reorganization of affiliated companies, then the dissolved company's stockholders must take the original book value of its long-term investment as the cost of acquiring equity newly issued by the surviving company. When stock is swapped, one must assess whether the value of such long-term investment has suffered impairment, and if so, recognize it as a loss.
When the surviving company acquires the dissolved company's assets, the original book value of the dissolved company's net assets is used as the basis to account for the net assets acquired, and must be compared with the recognizable fair value of the assets when the investments were originally made; if there is no other evidence showing that the price paid at the time was unreasonable, the difference is then goodwill. Under rules in SFAS 1, paragraph 77, and SFAS 25, paragraphs 21 and 22, this goodwill may be amortized for up to 20 years from the date of acquisition. Goodwill that has not been finished being amortized by the effective date of the merger must continue to be amortized over the originally chosen amortization period. The abovementioned goodwill must be tested regularly for impairment under SFAS 35 rules.
Unaffiliated Company M&A
If the transaction does not constitute an M&A transaction between affiliated companies, then following paragraph 3 of "Enterprise Mergers and Acquisitions Act Accounting Treatment", and ARDF pronouncements (AFDF Letters (85) Ji-Mi 220 and 221), the applicable accounting treatments are the purchase method or the pooling of interest method.
1. Purchase method
Book entry is by cost of acquisition and fair value of acquired net assets. The difference occurring between the two is recognized as goodwill or negative goodwill. Also, if the acquisition was paid for in cash, then the cost of acquisition is the purchase price paid; if it is paid with issued securities, then the cost of acquisition is the fair value of the issued securities. The above goodwill must be amortized in accordance with regulations, and must undergo regular testing for asset impairment. If impairment occurs, it must be recognized as a loss which may not be reversed.
2. Pooling of interest method
The vantage point of the pooling of interest method is from the start of the merger, so the surviving company enters the book value of the dissolved company in its accounts. When merging under the pooling of interest method, the dissolved company may adopt different accounting principles to account for assets or liabilities generally similar to those of the surviving company. If the different accounting principles are better suited to the dissolved company, then it is appropriate to adjust account entries so that they are in keeping with generally similar accounting principles after the merger.
International Accounting Standard Rules
Originally, under the rules of International Accounting Standard (IAS) 22, methods for the accounting treatment of mergers and acquisitions included the purchase method and the pooling of interest method. This meant that the comparability of financial statements could be compromised when different accounting treatments were applied to similar transactions, and resulted in incentives to arrange transactions solely to take advantage of the differences. For these reasons, International Financial Reporting Standards (IFRS) No. 3 came to replace IAS 22, and it requires that the purchase method be applied in the accounting treatment of enterprise mergers and acquisitions.
Accounting treatment methods generally use objective measurement and the recorded facts of transactions. Consequently, M&A valuation and planning should refer back to the essence of the business transactions involved. As described above, the accounting treatment of enterprise mergers and acquisitions in Taiwan includes both purchase and pooling of interest methods. When adopting the purchase method, corporations must take special care in valuing the goodwill of the acquired enterprise, and test regularly for possible impairment. When adopting the pooling of interest method, it is still necessary to comply with the related regulations and, in the interest of international harmonization, valuation should be done with caution in order to avoid compromising the transparency and comparability of financial statement information.