The Securities and Exchange Commission recently completed an investigation focusing in part on the acquisition accounting practices of Meris Laboratories, a California company. Michael M. Mulligan, CPA, a senior attorney in the SEC Division of Enforcement, Washington, D.C., explains the SEC's actions are important because they show what the SEC considers to be the limits on capitalizing costs connected with an acquisition under Accounting Principles Board Opinion no. 16, Business Combinations.
Meris Laboratories engaged in several acquisitions over a two-year period; costs capitalized in connection with those acquisitions were significant. The SEC ultimately determined Meris's acquisition accounting was improper and on September 26, 1994, announced administrative proceedings against the company and two of its officers. The SEC accepted settlement offers from all respondents, which allowed it to issue an SEC order making findings and ordering the respondents to cease and desist from further such violations.
Paragraph 76 of Opinion no. 16 says entities that engage in purchase acquisitions may include certain associated costs in the acquisition price, thereby capitalizing the costs rather than deducting them from income as an expense in the current period. "The cost of a company acquired in a business combination accounted for by the purchase method includes the direct costs of acquisition .... However, indirect and general expenses related to acquisitions are deducted as incurred in determining net income."
Under Accounting Interpretation no. 33 to Opinion no. 16, the types of costs that may be capitalized under paragraph 76 are "direct costs" and "out-of-pocket or incremental costs" rather than recurring internal costs, which may be directly related to an acquisition.
Consistent with this approach is the language of Emerging Issues Task Force Issue no. 84-35, Business Combinations: Sale of Duplicate Facilities and Accrual of Liabilities, which indicates that certain plant closing expenses and related severance costs incident to an acquisition can be capitalized. Also, while limited in volume, literature published by some of the larger CPA firms takes the position certain acquisition-related integration and termination costs can be capitalized. And, Financial Accounting Standards Board Statement no. 38, Accounting for Preacquisition Contingencies of Purchased Enterprises, has been widely taken to mean an acquiring entity can take up to one year to reanalyze its acquisition costs.
Some practitioners, however, have taken this authority to mean that any cost directly attributable to an acquisition that is either out-of-pocket or arguably incremental in nature can be capitalized. Practitioners also have subscribed to the view that under Statement no. 38, a business has up to a full year to determine what those costs are and what portion can be capitalized.
THE MERIS ORDER
The SEC order in the Meris case makes it clear the commission does not subscribe to such liberal treatment. The order provides a list of items the SEC deems to be normal recurring expenses that should not be capitalized as acquisition costs.
Among the significant items the SEC found to be inappropriately capitalized were
* To-be-terminated employees. Costs of employees of the acquired entities identified for termination subsequent to the acquisition date.
* Accounts receivable writeoffs. Those related primarily to acquired receivables written off after the acquisition date.
* Sales commissions paid in error. Those attributable to the acquired businesses.
* Internal costs of integration and new business. In-house overtime for billing and receivable work at acquired entities, accounting supervision of integration activities related to acquired companies' billing systems and part-time medical director fees for supervising integration of acquired laboratory facilities. …