SEC Examining Company Filings With Large Research Write-Offs
Bloomberg News
August 10, 1998, 3:52 p.m. ET
SEC Examining Company Filings With Large Research Write-Offs
Washington, Aug. 10 (Bloomberg) -- Technology companies are
facing heightened scrutiny at the U.S. Securities and Exchange
Commission to make sure they don't inflate future earnings by
overestimating the value of early-stage research gained through
acquisitions.
The SEC has seen an increase in large one-time research and
development write-offs, taken when one company acquires another
business and attributes much of the purchase price to in-process
research and development work, the commission's top accountant
says. While creating bigger up-front expenses, large R&D write-
offs can boost earnings for years down the road by lowering
future accounting charges for acquisition-related ''goodwill.''
The SEC is closely examining so-called in-process R&D write-
offs in high-tech mergers to make sure companies don't avoid
future earnings hits by exaggerating the value of acquired
research.
''We're looking at filings with a large in-process research
and development write-off and if it appears the amount is
unreasonable in relation to the actual R&D incurred to date and
to other purchased items, then we would challenge the registrant
on whether this is a reasonable value,'' said SEC chief
accountant Lynn Turner.
The issue stems from the fact that, in an acquisition,
companies must, for accounting purposes, place values on
different parts of an acquired firm. Under accounting rules, the
cost of in-process R&D must be written off in full. Some other
costs are written off over a number of years, depressing future
earnings. Companies want to avoid that because higher earnings
can boost share prices and a company's market valuation.
America Online
In one recent case, America Online Inc. last week said it
would delay the reporting of its most recent net income figures
while it worked with the SEC to assign values to the in-process
research it gained from acquisitions of Mirabilis Ltd. and
NetChannel Inc.
''We took the initiative and went to the SEC,'' said AOL
spokeswoman Tricia Primrose. ''We're fully aware this is an issue
they're interested in, so that went into our thinking.'' She
declined to say how much the Dulles, Virginia-based online
service wants to write off now.
Another telecommunications company, Jackson, Mississippi-
based WorldCom Inc., last week said it may take a charge of as
much as $6 billion to $7 billion to account for the value of in-
process research and development it will acquire with the
purchase of MCI Communications Corp.
By reducing future goodwill write-offs from the acquisition,
the initial research charge could add as much as $150 million to
$175 million a year to earnings, WorldCom said in a filing with
the SEC. WorldCom spokesman Gary Brandt said the annual earnings
boost could wind up being less than those estimates.
Independent Appraisers
The company has hired two independent appraisers to value
MCI's tangible and intangible assets and would take the more
conservative of the two estimates when ultimately calculating the
size of the write-off, Brandt said. The company said it does not
expect any problems with the SEC on the write-off.
The SEC would not comment on WorldCom's filing or
discussions with AOL.
Accounting rules governing research and development write-
offs haven't changed since they were established in 1975, the
SEC's Turner said. Since 1990, however, the SEC has seen an
increase in large one-time research write-offs when technology
companies and other businesses heavily dependent on research and
development acquire other firms' in-process research and
development, he said. In-process R&D refers to products ''in the
pipeline'' or the next generation of technologies that will offer
greater features.
Accounting rules require companies to write off that expense
in the year of the acquisition rather than amortizing it over its
useful life. Amortization is the accounting method used for
goodwill, another merger-related expense. Goodwill is the premium
paid over the fair value of the assets of the acquired company,
and must be proportionally deducted from future earnings for up
to 40 years.
'Fair Value'
''Our concern is that all the items get valued at their fair
value the way they should,'' Turner said. ''We'll look at anyone
that may be over-valuing or undervaluing assets.''
Meanwhile, changes to research write-offs and goodwill
accounting methods may be coming for all companies.
The Financial Accounting Standards Board, a professional
group that writes accounting rules for U.S. business, is
considering broad changes to the way companies account for
mergers and acquisitions.
The group is looking at whether all companies should be
required in acquisitions to use a method known as purchase
accounting, instead of giving some the option of simply combining
their assets and liabilities in a method known as pooling of
interests.
Uneven Playing Field
Critics of pooling, which lets companies avoid goodwill
charges, say it makes it hard to compare financial statements and
creates an uneven playing field between the small number of
companies that can pool and the majority that can not.
''With pooling, the merger doesn't value the transaction,
but the marketplace still does,'' said Paul Munter, a University
of Miami accounting professor. ''So if the marketplace values the
transaction, shouldn't the financial statements reflect that?''
If all companies are required to use purchase accounting for
mergers, questions about goodwill and in-process research write-
offs are likely to become more pressing because these charges
only apply when companies use the purchase-accounting method.
Recognizing this, the FASB is likely to propose additional
changes, including possibly providing more guidance on how to
assign a value to in-progress R&D, and perhaps ending immediate
write-offs for the charges, Munter said.
The FASB, which also wants to shorten the period during
which companies amortize goodwill, expects to propose changes
early next year, said Kim Petrone, an FASB project manager.
--Liz Skinner in Washington (202) 624-1831 with reporting by |
