New accounting standards go into effect this month that will significantly change how not-for-profit hospitals and health systems report mergers and acquisitions on their financial statements.
Getting specific on M&A
New accounting rules offer added clarity to not-for-profits
Issued in late May by the Financial Accounting Standards Board, the long-awaited standards mark the FASB's first detailed accounting guidance to address not-for-profit M&A deals, which often lack any exchange of cash or stock (also known as the purchase price) found in deals among privately held for-profit or publicly traded companies.
The standards follow years of debate and drafts and were spurred by the accounting board's closer look at for-profits' financial reporting for mergers and acquisitions, auditors say. They also come amid heightened scrutiny of not-for-profits' financial disclosure from regulators, including the Internal Revenue Service and the Securities and Exchange Commission.
Not-for-profits must separately report to the IRS spending for subsidized medical care and other community benefits starting with annual tax forms for fiscal 2009. Meanwhile, the SEC in July proposed rules that would expand financial reporting to include information on bankruptcies and mergers, among other information (Oct. 5, p. 28).
SEC Chairwoman Mary Schapiro said in October that the regulator will propose legislation in the coming year to expand the agency's limited oversight of the tax-exempt bond market. Under the new FASB standards, few deals are expected to qualify as not-for-profit mergers. Instead, most deals will be considered acquisitions and will be subject to new accounting treatment that requires owners to calculate the value of newly acquired assets and liabilities, regardless of what was previously on the books.
The newly issued standards, which go into effect on Dec. 15, also change how not-for-profits account for goodwill, which measures the value of certain intangible assets, such as reputation or the quality of its management. Hospitals or health systems will follow accounting rules for goodwill similar to what for-profit companies use, but with some exceptions when accounting for the initial transaction, says Martha Garner, a managing director at PricewaterhouseCoopers.
For not-for-profits, the new standards mean no more guesswork. “You now have your own standard,” says Brian Schebler, national director of service to the public sector for auditor McGladrey & Pullen. Unlike prior guidance, under the new standard, the difference between a merger and an acquisition is “really not a gray area.”
The standards may have eliminated some ambiguity, but they have added complexity and cost to the accounting for not-for-profit deals, Garner says. Most deals will likely require consultants to help determine what's known as the “fair value,” loosely defined as the value in the principal market for each asset and liability acquired through a transaction.
The changes won't affect credit ratings, a measure of financial and operating strength, for not-for-profit hospitals and health systems involved in deals, says Jeff Schaub, a senior director at Fitch Ratings. And the accounting rule changes won't affect whether a merger or acquisition will benefit the prospective partners' finances or operations, he says. “The way something is reported doesn't change the economics of the situation,” Schaub says.
Previously, not-for-profits relied on interpretation of accounting standards written for for-profit deals, auditors say. As a result accountants often lumped together assets and liabilities from existing financial statements for not-for-profit hospitals and health systems, a method aptly described as “carry-over.”
That method will likely be far less common once the new accounting standards go into effect, auditors say. Mergers will continue to use the carry-over method—but few deals will qualify to use the method under criteria set by the FASB. Garner said the FASB, which eliminated carry-over as an accounting option for for-profits in 1999, allowed for its continued use among not-for-profits as an acknowledgment that tax-exempt organizations may structure deals that create a merger of equals. Mergers must include a new organization with a newly established governing board that cannot be dominated by one not-for-profit party—either as it's being created or once it's established.
Garner says such deals are expected to be less common than those in which one party exerts control, which the accounting standards board defines under the new rules as an acquisition. An acquisition will consolidate one party's assets onto another's financial statements. Acquisition deals among not-for-profit hospitals and health systems will now report goodwill under certain circumstances.
Among for-profit companies, goodwill can be calculated using the purchase price and the fair value of assets of an acquired company. That will change under the FASB rules. For acquisitions without a purchase price, goodwill must be reported if an acquired hospital or health system holds more debt than assets, Garner says. Goodwill reflects an intangible asset that is not itemized among the assets on the books.
Previously, not-for-profit deals without a purchase price did not report goodwill. That will change under the new FASB rules. For acquisitions without a purchase price, goodwill must be reported if an acquired hospital or health system holds more debt than assets, Garner says. The goodwill reflects the intangible value of the acquired organization, which is not among the assets or liabilities on the books, she says.
Under the new rules, goodwill must also be reviewed annually and must be adjusted only when its fair value drops. Mary Corbett, a finance subject matter expert with CHAN Healthcare Auditors in St. Louis, says the change more accurately reflects the value of goodwill, which previously, when reported, was amortized for up to 40 years, a timeline Corbett and other auditors described as arbitrary.
Not included under the new accounting rules are other transactions, including joint ventures; acquired assets that are not businesses, such as land or equipment; deals that transfer assets within a corporation; or deals where acquired assets aren't consolidated onto the parent company's balance sheet and under its governing board.
The timing for adopting the standards varies depending on whether a deal is a merger or acquisition. Mergers that close on or after Dec. 15 must apply the new standards. For acquisitions, new standards apply for transactions that fall in a fiscal year that begins on or after Dec. 15. For those with fiscal years that began July 1 or Oct. 1, for example, the standards won't apply for the subsequent 12 months, Garner says, perhaps allowing some to close deals before they must follow the more complex rules.
The looming accounting switch did not affect the timing of Fargo, N.D.-based MeritCare Health System's deal to merge with Sanford Health, Sioux Falls, S.D., under a newly created parent corporation, says Darren Huber, a spokesman for MeritCare. Executives closed on the deal in November to allow MeritCare to offer insurance under the Sanford Health Plan, Huber says. Though aware of the imminent accounting changes, the deadline for the switch did not factor into when the systems closed on the deal, he says.
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