Mergers and Acquisitions: Mind the GAAP to Avoid Danger
Mergers and acquisitions of U.S. businesses with non-American firms can cause accounting issues. Head them off to avoid scrutiny from regulators.
For a host of business reasons, American companies have been expanding their global presence with mergers and acquisitions of international businesses. There's little reason to think this trend will change dramatically in the future.
But financial leaders of U.S. companies acquiring businesses based in other countries may want to pause for a minute and consider some potentially significant risks that such an endeavor entails. In a phrase: GAAP vs. IFRS. More specifically, the United States General Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS) differ significantly in how they treat business activities and the consequent financial reports.
In a typical merger or acquisition, chances are overwhelming that a non-U.S. organization will follow IFRS rules while their American partner or buyer will adhere to U.S. GAAP standards, according to Company Watch. That could lead to discrepancies in how revenue is recognized and reported, which may in turn invite an unwelcome examination by regulators.
The SEC's Concerns About Mergers and Acquisitions
The Securities and Exchange Commission (SEC) has stepped up its efforts to investigate and penalize corporations that engage in fraudulent accounting practices. While many of the abuses the SEC seeks to safeguard investors against are blatant attempts by companies to misrepresent their financial status, internal errors can also raise suspicion. Andrew Ceresney, the SEC's director of the enforcement division, warned in a January 2016 speech against gatekeepers who "fail to comply with their legal and professional obligations" with, among other things, "poor oversight in units and subsidiaries" and "growth outpacing the reporting and accounting infrastructure."
For example, your new European acquisition may report inventory on a FIFO basis while you may opt for LIFO, as permitted under GAAP. Development costs may be capitalized under IFRS while they're treated as expenses under the U.S. methodology, according to The American Institute of Certified Public Accountants.
You can quickly see the potential for problems and a charge of misleading revenue recognition. Even if the SEC later finds no violation, the investigation may concern investors and possibly drive down your stock price.
3 Steps to Take After a Merger or Acquisition
Deloitte recommends that organizations take a proactive approach to accounting issues following an acquisition or melding of businesses. Among the suggestions:
1. Develop Strong Internal Centralized Controls
With the expanse and decentralized nature of a business operating in several countries, gaps in methods and methodology can arise. The merged organization needs to follow a single approach and not allow variations that can create reporting issues.
2. Train Non-U.S. Employees and Managers on Expected Accounting Practices
Without a familiarity with GAAP or other methods the American organization follows, you may be causing problems without being aware of it.
3. Create a Whistleblower Hotline
Encourage all employees to inform financial leaders if activities that are potentially fraudulent are taking place.
The benefits of a merger or acquisition may be obvious from a corporation's strategic perspective. However, for financial leaders, it's important to ensure the endeavor works as planned by anticipating and avoiding potential accounting landmines.