Reconciliation of the Accounting by Foreign Private Issuers for Business Combinations

Federal RegisterDec 20, 1994

Ask Donna

What actually matters in this document.

Text

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 249

[Release Nos. 33-7119; 34-35095; FR 45; International Series Release

No. 759; File No. S7-13-94]

RIN 3235-AG16

Reconciliation of the Accounting by Foreign Private Issuers for

Business Combinations

AGENCY: Securities and Exchange Commission.

ACTION: Final rules.

-----------------------------------------------------------------------

SUMMARY: The Commission is announcing the adoption of amendments to

Form 20-F to streamline the financial statement reconciliation

requirements for foreign private issuers that have entered into

business combinations. The amendments eliminate the requirement to

reconcile to U.S. generally accepted accounting principles certain

differences attributable to the method of accounting for a business

combination or the amortization period of goodwill and negative

goodwill, provided the financial statements comply with International

Accounting Standard No. 22, ``Business Combinations,'' as amended,

regarding those items.

EFFECTIVE DATE: December 20, 1994.

FOR FURTHER INFORMATION CONTACT:

Wayne E. Carnall, Deputy Chief Accountant, Division of Corporation

Finance at (202) 942-2960 U.S. Securities and Exchange Commission, Mail

Stop 3-13, 450 Fifth Street NW., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Commission is adopting amendments to

Form 20-F\1\ under the Securities Exchange Act of 1934 (the ``Exchange

Act'').\2\

---------------------------------------------------------------------------

\1\17 CFR 249.220f.

\2\15 U.S.C. 78a et seq.

---------------------------------------------------------------------------

I. Introduction

The Commission is adopting amendments to streamline the financial

statement reconciliation requirements for foreign private issuers that

have entered into business combinations. The amendments eliminate the

requirement to reconcile to U.S. generally accepted accounting

principles (``GAAP'') certain differences attributable to the method of

accounting for a business combination or the amortization period of

goodwill and negative goodwill, provided the financial statements

comply with International Accounting Standard No. 22, ``Business

Combinations,'' as amended (``IAS 22''), regarding those items.

The amendments adopted today were proposed by the Commission on

April 19, 1994.\3\ Comments received on the proposing release were

divided almost evenly in their views.\4\ Commenters questioning the

proposal expressed concern about the lack of comparability to U.S. GAAP

that would result from adoption of the proposal, and observed that the

reconciled balance sheet and net income information furnished under the

proposed rule would be a hybrid of U.S. GAAP and International

Accounting Standards (``IAS''). Those supporting the proposal cited the

cost and complexity of reconciling the pervasive differences

attributable to an issuer's method of accounting for business

combinations and, in the case of a supporting letter from financial

analysts, the lack of comparability which exists presently under the

U.S. accounting rules applicable to business combinations.

---------------------------------------------------------------------------

\3\See Securities Act Release No. 7056 (April 19, 1994) (59 FR

21821) (the ``Proposing Release'').

\4\Nine comment letters on the proposal were received. Those

letters and a summary of the comments are available for public

inspection and copying in File No. S7-13-94 at the Commission's

Public Reference Room in Washington, DC.

---------------------------------------------------------------------------

The Commission believes that acceptance of the guidance in IAS 22

with respect to the particular matters addressed by the amendment,

without reconciliation to U.S. GAAP, will not result in the loss of

material information that is necessary for a U.S. investor to make an

informed investment decision. Accordingly, the amendments are being

adopted substantially as proposed, although certain modifications and

clarifications are included in response to recommendations and other

comments received.

II. Method of Accounting for Business Combinations

As adopted, the amendments eliminate the requirement that foreign

private issuers quantify the effects of differences arising solely from

the different criteria applied to the selection of the basic method of

accounting for a business combination if the criteria used in the

primary financial statements for determining the method are

consistently applied and are consistent with IAS 22. The two basic

methods of accounting can be summarized as either ``pooling of

interests'' or ``purchase'' as determined under U.S. GAAP primarily

pursuant to Accounting Principles Board Opinion No. 16, ``Accounting

for Business Combinations'' (``APB 16''), or ``uniting of interests''

and ``acquisition'' under IAS 22.

APB 16 and IAS 22 have a similar conceptual framework underlying

the particular conditions they establish for determining which of the

two basic accounting methods should be applied to a business

combination. Both standards acknowledge limited circumstances under

which remeasurement of an acquired company's assets and liabilities

pursuant to the purchase or acquisition method is not appropriate, but

the particular criteria qualifying a transaction for pooling of

interests (under APB 16) and uniting of interests (under IAS 22) are

different, with IAS 22 being generally more restrictive.

The Commission believes that the criteria articulated in IAS 22 are

sufficiently clear so that companies and their auditors can be expected

to apply the guidance in a consistent manner to similar transactions.

Although different from the criteria in U.S. GAAP, the criteria in IAS

No. 22 provide a rational and effective basis for distinguishing the

substantively unique transactions for which the special accounting

treatment is appropriate. The criteria in IAS No. 22 appear

sufficiently rigorous to restrict the use of uniting of interests

accounting to a relatively small class of similar transactions. The

Commission believes that financial statements of foreign private

issuers that distinguish business combinations on the basis specified

by IAS No. 22 will provide information that is sufficiently informative

and useful to investors without a reconciliation of that departure to

U.S. GAAP.

In evaluating the concerns expressed about the effects on

comparability of the proposed use of IAS 22, the level of comparability

under current U.S. accounting principles needs to be examined. Although

the two accounting methods of ``purchase'' and ``pooling'' prescribed

by U.S. GAAP produce very significant financial reporting differences,

many transactions that are accounted for in the U.S. as poolings of

interests are difficult to distinguish economically or structurally

from transactions accounted for as purchases. Because the criteria

qualifying a transaction for pooling under U.S. GAAP are restrictive, a

registrant is rarely if ever compelled to account for a transaction as

a pooling if it does not want to do so. The registrant may elect to

avoid pooling accounting through essentially nonsubstantive

modifications of merger terms or other insignificant actions. Under IAS

22, it is even more difficult to qualify a business combination as a

uniting of interests, or pooling. Many transactions that would quality

for pooling under U.S. GAAP would be accounted for as purchases under

IAS 22. As under the U.S. rule, issuers could elect to avoid pooling

accounting by the essentially subjective designation of an acquirer. On

balance, it would appear that using the provisions of IAS 22 to

determine whether a combination is accounted for as a purchase or

pooling will not materially affect the comparability of financial

statements.

A substantial degree of comparability will be retained under the

rules adopted today because they provide that the effects of

differences in amounts determined upon application of either the

purchase or pooling methods of accounting would continue to be

quantified. For example, if the acquisition method is applicable to a

business combination under IAS 22, differences between the amounts

assigned in the issuer's primary financial statements to tangible and

intangible assets and liabilities and those amounts as would be

determined using the purchase method applied in accordance with U.S.

GAAP must be identified and quantified in the reconciliation. If a

determination has been made pursuant to the criteria in IAS 22 that the

uniting of interest method is appropriate, then differences between the

accounting used in the primary financial statements and the accounting

that would be required for a pooling of interests under U.S. GAAP must

be included in the reconciliation to U.S. GAAP. In response to

comments, language in the amendment has been modified to more clearly

describe the continuing requirement to reconcile the amounts that would

be reported under U.S. GAAP for the particular method of accounting

that was determined to be applicable using the criteria contained in

IAS 22.

As suggested by many commenters, the new provisions will not be

available with respect to business combinations that are promoter

transactions, leveraged buyouts, mergers of entities under common

control, or reverse acquisitions. The final rule indicates that those

types of transactions would continue to be required to be reconciled in

full to U.S. GAAP. The rule also states that other business

combinations that are not addressed by IAS 22 are not eligible for

relief from reconciliation.

III. Accounting for Goodwill and Negative Goodwill

The amendments also eliminate the requirement that foreign private

issuers quantify the effects of differences arising from the period of

amortization of both goodwill and negative goodwill, as proposed. Under

IAS 22, goodwill and negative goodwill is amortized over a period not

exceeding five years unless a longer period, not exceeding twenty

years, can be justified. Accounting Principles Board Opinion No. 17,

``Accounting for Intangibles'' (AFB 17''), requires the amortization of

goodwill or negative goodwill over its useful life, except that the

period cannot exceed forty years.

Some commenters raised concerns about the proposed rule because the

resulting amount would not be comparable to U.S. GAAP. However, if the

primary financial statements reflect an amortization period that

complies with IAS 22, a reconciliation of differences in goodwill

amortization periods does not necessarily improve the comparability of

financial statements in a material fashion. U.S. companies presently

exercise substantial judgment in selecting an amortization period for

goodwill, and significant differences among similarly situated

companies can be seen among companies reporting to the Commission. The

accounting differences between IAS 22 and APB 17 are not so opaque as

to result in the loss of material information to investors. If the

useful life of goodwill or amortization period of negative goodwill

exceeds five years, justification of the longer period is required by

paragraph 72 of IAS 22 to be furnished in a note to the primary

financial statements. Registrants will continue to be required under

both Item 17 and 18 of Form 20-F to describe the accounting

differences, even where relief from quantification of differences is

granted by this rule.

The relief from reconciliation permitted under the adopted rule is

applicable only to differences in the amortization period as it applies

to aggregate amount of goodwill or negative goodwill that would be

determined under U.S. GAAP. For example, negative goodwill under IAS 22

(the amount by which the fair value of acquired net assets exceeds the

purchase price) must be reconciled to negative goodwill determined

under U.S. GAAP (the amount remaining after the excess over the

purchase price has been applied to reduce the carrying value of non-

monetary noncurrent assets). In response to commenter's suggestion,

Items 17 and 18 of Form 20-F have been modified to clarify that point.

IV. Implementation and Transition

Issuers will be permitted by the adopted rule to elect to apply the

provisions of IAS 22 in the determination of the method of accounting

for business combinations but not adopt its provisions for amortization

of goodwill and negative goodwill. Similarly, issuers could adopt the

provisions of IAS 22 with respect to goodwill amortization periods, but

need not adopt that standard with respect to any other aspect of

accounting for business combinations.

Transition guidance in the 1993 amendment of IAS 22 calls for its

new provisions to be implemented in financial statements for periods

beginning on or after January 1, 1995, with retroactive application

encouraged but not required. As originally proposed, the relief from

reconciliation afforded by the rule would be available only to an

issuer that implemented IAS 22, as amended, in its financial statements

with respect to all current and prior business combinations for all

financial reporting periods presented. At the suggestion of a commenter

and in consideration of the difficulty of retroactive implementation of

IAS 22, the rule as adopted would also provide relief from

reconciliation for business combinations consummated on or after

January 1, 1995, if, commencing by that date, the issuer accounts for

all business combinations in its primary financial statements in

accordance with IAS 22. For an issuer that does not retroactively

implement IAS 22, full reconciliation to U.S. GAAP would be required

with respect to business combinations consummated prior to January 1,

1995.

As requested by several commenters, the adopted rules clarify how

issuers and their auditors should describe the balance sheet and income

statement amounts which do not reflect full reconciliation to U.S.

GAAP. Amounts reported in the reconciliation should be referred to as

determined in accordance with U.S. GAAP except for the specific items

for which there is a deviation; exceptions should be stated to be in

accordance with Item 17 or 18 of Form 20-F, as applicable, and

different than that required by U.S. GAAP.\5\

---------------------------------------------------------------------------

\5\The accommodation provided under the adopted rule is an

exception to the requirement to reconcile to U.S. GAAP that is

similar to the accommodation that had been provided previously to

foreign private issuers that prepare price level adjusted financial

statements. See Securities Act Release No. 7117.

---------------------------------------------------------------------------

The reconciliation provided pursuant to Item 17 or 18 of Form 20-F

must be included in notes to the financial statements and, accordingly,

must be considered by the auditor when expressing an opinion on the

financial statements taken as a whole. The auditor's report is required

to comply with Rule 2-02 of Regulation S-X, and need not refer

specifically to the note containing the reconciliation. However, if the

reconciliation furnished in the notes to the financial statements fails

to include disclosure of all material departures from U.S. GAAP or the

quantification of the effects of accounting differences is materially

misstated, or, where applicable, is incorrectly stated to be determined

pursuant to the special provisions afforded under Item 17 or 18 by the

rules adopted today, the financial statements would be presumed to be

materially misleading and an exception should be cited in the auditor's

report.

V. Cost-Benefit Analysis

No specific data were provided in response to the Commission's

request regarding the costs and benefits of the amendment being adopted

today. Several commenters noted that the proposal would address to a

large extent the time and cost of additional recordkeeping and

reporting resulting from having to reconcile different accounting

methods for business combinations. The Commission believes costs will

be reduced by this amendment. The Commission believes that the adoption

of these rules will be beneficial to U.S. investors, as it will

encourage more foreign companies to list their securities and raise

capital in the United States and will be consistent with investor

protection.

VI. Regulatory Flexibility Act Certification

Pursuant to the Regulatory Flexibility Act (5 Act U.S.C. 605(b)),

the Chairman of the Commission has certified that the proposed

amendments will not have a significant impact on a substantial number

of small entities. Members of the public who wish to obtain a copy of

the Regulatory Flexibility Certification should contact Wayne E.

Carnall, (202) 942-2960, Deputy Chief Accountant, Division of

Corporation Finance, Securities and Exchange Commission, 450 Fifth

Street, NW., Washington, DC 20549.

VII. Statutory Bases

The Commission's rules and forms are amended pursuant to section 19

of the Securities Act of 1933 and sections 3(b), 4A, 12, 13, 14, 15,

16, and 23 of the Securities Exchange Act of 1934.

VIII. Effective Date

The amendment to Form 20-F shall be effective immediately upon

publication in the Federal Register, in accordance with the

Administrative Procedure Act, which allows effectiveness in less than

30 days after publications for, inter alia, ``a substantive rule which

grants or recognizes an exemption or relieves a restriction.'' 5 U.S.C.

553(d)(1).

List of Subjects in 17 CFR Part 249

Accounting, Reporting and recordkeeping requirements, Securities.

Text of Rule and Form Amendments

In accordance with the foregoing, Title 17, Chapter II of the Code

of Federal Regulations is amended as follows:

PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

1. The authority citation for part 249 continues to read in part as

follows:

Authority: 15 U.S.C. 78a, et seq., unless otherwise noted;

Sec. 249.220f [Amended]

2. By amending Form 20-F (referenced in Sec. 249.220f) by adding

paragraph (viii) to Item 17(c)(2) and adding Instruction (6) to Item 17

and adding paragraph (viii) to Item 18(c)(2) and adding Instruction (5)

to Item 18 to read as follows:

Note: The Form 20-F does not appear and the amendments will not

appear in the Code of Federal Regulations.

Form 20-F

Item 17. Financial Statements

* * * * *

(2) * * *

(viii) Issuers that prepare financial statements on a basis of

accounting other than U.S. generally accepted accounting principles

and which basis conforms with the guidance in International

Accounting Standards No. 22, as amended in 1993, with respect to the

period of amortization of goodwill and negative goodwill may omit

the disclosures specified by paragraphs (c)(2)(i), (c)(2)(ii), and

(c)(2)(iii) of this Item regarding the effects of differences

attributable solely to the period of amortization. Goodwill and

negative goodwill that is subject to the amortization period under

IAS 22 is based on the amount determined in accordance with U.S.

GAAP.

Instructions

* * * * *

(6)(a) A business combination which would be deemed a uniting of

interests under International Accounting Standards No. 22, as

amended in 1993 (``IAS 22''), and was accounted for using that

method in the primary financial statements may be deemed to be, for

purposes of the reconciliation to U.S. GAAP, a pooling of interests.

A business combination which would be deemed an acquisition under

IAS 22 and was accounted for using that method in the primary

financial statements may be deemed to be, for purposes of the

reconciliation to U.S. GAAP, a purchase. This paragraph is not

applicable for promoter transactions, leveraged buyouts, mergers of

entities under common control, reverse acquisitions and other

transactions not addressed by IAS 22. Once the method of accounting

is determined, the reconciliation to U.S. GAAP should quantify

differences between the balances in the primary financial statements

and the amounts determined in accordance with U.S. GAAP as required

by this Item.

(b) To obtain relief from the reconciliation requirement

regarding the method of accounting, or the amortization period of

goodwill or negative goodwill, the primary financial statements

should apply the respective provisions of IAS 22 to all business

combinations consummated on or after January 1, 1995. issuers can

either retroactively adopt IAS 22 in the primary financial

statements for all business combinations consummated prior to

January 1, 1995, or provide a full reconciliation to U.S. GAAP for

such prior business combinations.

or the provisions for amortization of goodwill or negative goodwill

complies with IAS 22, a statement to that effect must be included in

the financial statements. The reconciliation shall state that the

amounts presented comply with Item 17 of Form 20-F and are different

from that required by U.S. GAAP.

Item 18. Financial Statements

* * * * *

(2) * * *

(viii) Issuers that prepare financial statements on a basis of

accounting other than U.S. generally accepted accounting principles

and which basis conforms with the guidance in International

Accounting Standards No. 22, as amended in 1993, with respect to the

period of amortization of goodwill and negative goodwill may omit

the disclosures specified by paragraphs (c)(2)(i), (c)(2)(ii), and

(c)(2)(iii) of this Item regarding the effects of differences

attributable solely to the period of amortization. Goodwill and

negative goodwill that is subject to the amortization period under

IAS 22 is based on the amount determined in accordance with U.S.

GAAP.

* * * * *

Instructions

* * * * *

(5)(a) A business combination which would be deemed a uniting of