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Accountancy shake-up puts goodwill in short supply

Accounting regulators are preparing to ban merger accounting, closing a loophole which has allowed companies to inflate earnings and protect their profits from goodwill write offs for more than 20 years.

The International Accounting Standards Board (IASB) today publishes draft rules setting out how companies should account for business combinations, which will force them to use only acquisition accounting.

Merger accounting is used in only 4% of deals in the UK but features in some of the biggest corporate takeovers. The links between BP and Amoco, Halifax and Bank of Scotland, Glaxo and SmithKlineBeecham, and BHP and Billiton all used merger accounting principles, which are already barred in the US, Canada and Australia.

Sir David Tweedie, chairman of the IASB, said that one reason for setting new rules was to bring UK and European accounting practices in line with those used elsewhere in the world. Under European Union rules all EU-listed companies will be forced to adopt IASB accounting regulations from 2005.

Both merger and acquisition accounting are currently permitted under British rules. Merger accounting is permitted only when strict criteria are met. Some companies have preferred to use merger accounting because it allows the enlarged group to take a full year of profits from both companies. Under acquisition accounting only those profits accruing to the enlarged group from the date of acquisition can be reported.

Merger accounting, unlike acquisition accounting, does not give rise to goodwill – the difference between the value of the acquired assets and the price paid for them by the bidding company. That relieves companies using merger accounting of the obligation to depreciate the value of that goodwill by charges to the profit and loss account.

As part of its review the IASB is removing the requirement for companies to depreciate goodwill included on their balance sheets by an annual charge to the profit and loss account. Instead a detailed annual review of the value of goodwill must be carried out. If the carrying value of the goodwill cannot be justified then it must be reduced by way of an impairment charge.

“Analysts will support this move,” Sir David predicted. “The annual depreciation charge against goodwill is largely ignored. Instead we will be forcing companies to produce more detailed information which supports the value of their goodwill.”

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