Sweet deals may turn sour: A new document may sting company predators, as Heather Connon reports

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The Independent Online
LOOK out Hanson, BTR and Williams, the Accounting Standards Board has set its sights on the way you treat acquisitions. Should it have its way, corporate deals will never be as sweet again.

In a discussion document issued today, the ASB plans to outlaw the use of pre-acquisition provisions before the end of next year.

Pre-acquisition provisions allow predators to ensure that the costs of integrating acquisitions - from redundancies and head office closures to Christies' commission on selling the directors' paintings - are not allowed to detract from the future performance of the enlarged group. For takeover specialists, such provisions can offer a real boost to the bottom line. The biggest and best at the game - Hanson et al - are expert at exploiting the rules, or lack of them.

But they are also one of the biggest remaining black holes of British accounting. The provisions can be used to smooth out dips in earnings for years after the takeover, bamboozling shareholders and analysts who can find it impossible to measure accurately the performance of the company and the success - or otherwise - of the takeover.

Take Coats Viyella. In 1991 it bought Tootal, the thread maker, and provided pounds 80m for rationalisation and reorganisation of the company. That represented more than six times the pounds 12.9m pre-tax profit Tootal made in the year before it was acquired. Coats used pounds 31m of the provisions in the first year and a further pounds 22m in 1992. Even if Coats had disclosed Tootal's contribution to profits in 1991, investors would have found it impossible to tell how much was due to improved trading, and how much to the release of provisions.

The provisions did hit Coats's balance sheet by increasing the amount of goodwill that had to be written off against reserves from pounds 40m to pounds 120m. But Coats clearly thought the long- term benefits were worth the balance- sheet damage.

And well it might. The small print in its accounts reveals a lucrative spin-off from acquisition accounting - clearing up its own business. More than half the provisions - pounds 42.8m - related to planned reorganisation of Coats's own factories. Charging that against its own profits would have made a severe dent in the pounds 111.4m pre- tax it made in 1991.

Coats's treatment was perfectly legal. Other companies have also used pre-acquisition provisions to shelter the cost of restructuring their own businesses. TI Group - which provided pounds 87m following the acquisition of Dowty - has even gone back and adjusted its estimates in subsequent years.

Hanson, however, is justly recognised as the master of the art. In last year's accounts, it provided pounds 1.3bn against Beazer, the building and aggregates group it acquired at the end of 1990. The previous year it provided pounds 105m against Cavenham, while in 1990 it established a record- breaking pounds 1.67bn reserve against Peabody, the coal mining business, largely for future claims for black lung disease among miners. In September 1992, its accumulated provisions of pounds 4.8bn were pounds 500m larger than its shareholders' funds.

Hanson and other conglomerates, such as BTR - which provided a total of pounds 330m against Hawker Siddeley, or twice Hawker's forecast profits for 1992 - have most to fear from the ASB's proposals. Their acquisitions rely less on industrial logic than on the fact that they are far more efficient at managing assets than their targets were. That usually means cutting costs and eliminating loss-makers; both of which require substantial initial expenditure, albeit for substantial future benefits.

Although the ASB's proposals would not stop predators taking such actions, they will ensure that it takes far longer to reap the benefits. The rationale is simple: any reorganisation planned by predators is a result of the takeover. The costs of the action should therefore be taken against the profits of the combined group. Redundancy and closure costs, provisions for integrating factories and anticipated losses on disposing of peripheral interests must all be set against profits as they are incurred.

By the same token, predators cannot flatter future results by providing for losses that may be incurred up until businesses are sold or rationalised.

Companies will still be allowed to revalue stocks, properties and other assets of the acquired business, and to make adjustments for differences in accounting policies. But the scope for creative accounting will be dramatically reduced by proscribing the way in which such revaluations and adjustments can be made.

Perhaps the real sting in the tail is the anti-avoidance provision designed to stop predators forcing their targets into reorganisations in advance of a bid. Any reorganisation carried out in the six months before an agreed takeover will be deemed a post-acquisition cost unless the predator can clearly demonstrate to the contrary.

Some companies may still want to set up provisions following a takeover, even if they have to be charged against profits. While that is painful in the first year, it should ensure suitably sparkling future results.

The ASB cannot stop that - yet. But David Tweedie, its chairman, is already working with international accounting regulators to produce a standard on provisions that would stop companies charging costs years before they are due to be paid out.

Professor Tweedie has no sympathy with those who argue that it is prudent to recognise costs and losses as liabilities as soon as it is clear that they may be incurred. 'If that is the case, you would have to recognise future profits as an asset,' he says. No companies have been pressing to be allowed to do that.

He believes the current abuses are partly due to the British goodwill standard. If goodwill had to be charged against profits, rather than written off immediately against retained reserves, companies might be less willing to increase the amount of goodwill by establishing large provisions. And he points out that goodwill as a proportion of purchase cost increased from 11 to 44 per cent in the three years after the standard was introduced.

Some companies - and corporate financiers who advise on takeovers - may complain that the ASB's proposals will distort the market by making acquisitions less attractive. Professor Tweedie's response is blunt. Why should acquiring companies have an advantage over those who choose to grow organically, and so have to take reorganisation costs on the chin?

'All we are trying to do is to let you see what actually happens in the company. That should not affect the economics of a takeover.'

(Photographs omitted)

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