Navigating the landscape of completion accounts can sometimes feel like deciphering a code, especially when relying solely on accounting standards.
This may seem contradictory – the accounting standards are the framework most companies apply to their financial statements and often the seller warrants the adherence of those financial statements to accounting standards – so why not use them as the basis for preparation of the completion accounts?
Whilst those statements are true, unfortunately the accounting standards fall short as the definitive solution for measuring a transaction balance sheet for the reasons below.
- Judgement is Allowed: The accounting standards allow judgement, which can lead to a range of acceptable outcomes. For instance, consider a provision for doubtful debts – a group of accountants may justify different provisions that all satisfy the accounting standards. This begs the question: how do parties agree on a position when both are right? How does an independent expert determine who is ‘more right’.
- Optionality: Accounting standards also provide a choice of measurement methodologies, such as fair value versus historical cost and FIFO versus LIFO for inventory. This optionality invites parties to adopt methodologies generating the most value for them. As with judgement under the accounting standards, how do the parties agree who is right and how does an independent expert determine who is ‘more right’.
- Contingent assets and liabilities: Accounting standards only mandate the disclosure of contingent assets and liabilities, but not their inclusion on the balance sheet. This could result in an unfair allocation of risk and rewards between the parties.
- Deal-Specific Positions: Negotiated positions for a transaction may demand a departure from the accounting standards. For example, parties may agree not to include the fair value of derivatives in the completion accounts.
- Misalignment with Cashflows: Accounting standards may require non-cash generating assets and liabilities to be included in the completion accounts. For instance, the recognition of an asset for capitalised debt issuance costs, which reduces the borrowings liability, even though there is no cash inflow to the target business post Completion.
The Kardia Solution: Accounting Hierarchy
Kardia recommends a three-step accounting hierarchy (for most transactions) to bring value-winning clarity to the SPA.
Step 1: Specific Accounting Policies
The first step of any accounting hierarchy should be specific accounting policies contained in the SPA. Kardia’s collaborative process begins with a deep dive into the financial statements with the target’s finance team, unraveling the intricacies that define the balance sheet. This meticulous understanding allows us to codify specific accounting policies and procedures in the SPA.
Step 2: Consistency with Reference Accounts
Moving forward, we engage with finance and diligence teams to identify the most appropriate set of reference accounts for the transaction. It is a crucial part of the hierarchy, fostering the objective of consistency. Kardia can work with you to clarify common misconceptions of the use of management accounts versus audited accounts and options when the accounting records are not reliable.
Step 3: Accounting Standards
The accounting standards are generally positioned as the final step in the hierarchy, as they are the least precise.
Conclusion:
Kardia stands ready to revolutionise your approach, ensuring precision in completion accounts beyond the uncertainties of standard practices. We hope this series has shed light on the intricate nature of completion accounts, advocating for an active, precise game plan to mitigate dispute risks.
As you navigate the complexities of M&A, you can trust Kardia to be your dedicated partner, providing clarity and strategic insight. For any queries spared by this series, Sarah Grant (founder) welcomes your questions at sarah.grant@kardia.au. Explore further on our website www.kardiaadvisory.com.au We are here for you.