The recent accusation of HP against Autonomy, the British software company that HP bought for $11B, raises fingers in all directions. Who is it at fault- Autonomy management, the management of HP, the auditors, or the differences in the accounting standards? Let’s look at the issue and the various parties involved.
HP wrote down the value of Autonomy on its books from $11B to $2.2B. $5B of the $8.8B write off HP alleges is due to serious accounting improprieties and willful effort by Autonomy to mislead shareholders. According to HP general counsel John Schultz, Autonomy created more than $200 million in revenue over a two-year period from 2009, which would amount to 12.5 percent of Autonomy’s $1.6 billion in revenues in their annual accounts for 2009 and 2010. HP accuses that Autonomy booked licensing revenue upfront before deals closed thereby inflating revenue.
In his defense Mike Lynch, head of Autonomy puts part of the blame on the differences between International Financial Reporting Standards (IFRS) (Autonomy maintained books under IFRS prior to its accusation by HP) and US GAAP (The standard HP uses). IFRS as we know is broader and does not have strict rules; it has more room for interpretation vs US GAAP which is rule based.
The question is when HP was buying Autonomy did they not do their own due diligence. When a company spends $11B, the investors expect that they would have reviewed the financials and done thorough check of the acquiree. Why did HP not look into the books deeper? In their defense HP says they relied on the stamp from the auditors, Deloitte in this case. Isn’t it the duty of the board and management to take an extra step and do their own due diligence!
Next party in this fiasco is Deloitte. Not only is Deloitte auditors of Autonomy but also of HP. The issue raises the topic again whether audited financial statements can be relied on completely. Are auditors doing their job properly, because if they were there would not be such big fiasco every few months?
Well I believe all these parties are to blame, HP for not doing their own due diligence, Autonomy for taking the most lenient interpretation of the standards, and Deloitte for not doing their job properly.
A recent study done by researchers at the University of Arkansas and the University of Missouri shows the effect of having different accounting standards in different countries on mergers and acquisitions. The lack of same or similar standards is a deterrent for companies to merge. The CFO’s have more confidence in reviewing the numbers of the prospective entity to merge with if the acquirer uses similar accounting standards as the acquiree.
Based on M&A deals in 32 countries between 1998 and 2004, the study found that differences in versions of generally accepted accounting principles used by acquirers and potential targets in different countries can decrease the number of mergers. When both companies target and the acquirer used GAAP or IFRS or similar versions of accounting principles, the mergers or acquisitions were more likely to occur.
In that line of thought, high number of transactions occurred between US and UK based entities, as both the countries have similar accounting standards. During the survey’s sample period, there were 1,980 U.S. cross-border M&A transactions targeting UK companies, worth a total of $175 billion. In contrast during the period studied, U.S. companies merged with or acquired only 877 German companies (worth $79 billion in all), due to the dissimilarities in the accounting standards of the two countries.
Another reason for the authorities world over to think about working towards common accounting standards.
Even though FASB (Financial Accounting Standards Board) has been working with the IASB (International Accounting Standards Board) towards convergence of US GAAP with IFRS since 2002, the SEC (Securities and Exchange Commission) has only recently in 2010, started to study whether or not to move from US GAAP to IFRS.
The SEC’s decision holds significant weightage as US is one of the biggest economies and its adoption of IFRS would truly make the international standards global. But a recent staff report from SEC made it clear that the IASB cannot be the lead. The report released in July talks about several areas in which the two accounting approaches differ, such as impairment models for property, plant, and equipment, inventory and intangible assets. Another point the report mentions is the cost that will be incurred by large and small corporations for switching from GAAP to IFRS. This might be a good point to put in use the cost benefit convention- that relaxes GAAP requirements if the cost of reporting it under GAAP exceeds the benefit. The question here will be whether the cost of switching to IFRS will provide more benefits to the involved parties.
The coming few months will through some more light on what the future of the convergence project will be from the US point of view.