Transactions Blog

Recently the President of the Brussels Criminal Court judged that the investigation of KB Lux was not performed on valid terms. This decision again raises questions about how to tackle economic crime and how to deal with fraudsters. In a day-to-day business environment we are more inclined to take measures internally, which in light of the KB Lux decision appears to be a more effective method. In addition, companies are often confronted with questions when dealing with a new cooperation, joint venture, merger or acquisition. These situations call for a fraud due diligence in order to avoid the inheritance of fraud risks. Due diligence investigations often prove crucial in identifying fraud risks and detecting incidences of fraud outside the books and records.

E.g. a purchaser who discovers post-deal that one of the sellers has defrauded or bribed vendors of the purchased company may be confronted with the fiscal, financial and legal consequences of such behaviour. A thorough pre-deal fraud due diligence might reveal such liabilities in many cases.

Accounting for acquisitions has changed. The International Accounting Standards Board released a revised standard on business combinations in January 2008 (IFRS 3 Revised), accompanied by a revised standard on consolidated financial statements (IAS 27 Revised).

 The new standards are expected to add to earnings volatility, making earnings harder to predict.

 PwC has produced a guide IFRS 3R: Impact on earnings, the crucial Q&A for decision-makers  which aims to help dealmakers and preparers of financial statements communicate the consequences of a business combination on the current and future earnings.

 I would like to highlight in this posting 2 aspects in particular:

-          transaction costs no longer form part of the acquisition price; they should be expensed as they are incurred and the related services are received

-          contingent consideration (like earn-outs payable based on post-acquisition earnings or on the success of a significant uncertain project) is required to be recognised at fair value, even it is not deemed to be probable of payment at the date of acquisition. All subsequent changes in debt contingent consideration are then recognised in the income statement, rather than against goodwill as today. This means that an increase in the liability for strong performance results in an expense in the income statement. Acquirers will have to explain this component of the performance: the acquired business has performed well but earnings are lower because of additional payments due to the seller.

 As you can see with these two examples, acquisitive companies can expect increased earnings volatility, both in the year of the acquisition and in the years following.

 As a result, the standards will also:

-          influence acquisition negotiations and deal structures in an effort to mitigate unwanted earnings impact

-          potentially impact the scope and extent of due diligence and data-gathering exercises prior to acquisition

-          expand the call for valuation expertise