If you are a not-for-profit healthcare organization and are contemplating a merger, acquisition or an affiliation, or have previously recognized goodwill on your books, you will need to consider the impact of recent changes in financial reporting requirements.
The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 164, Not-for-Profit Entities: Mergers and Acquisitions, which establishes accounting principles and reporting requirements governing combinations of not-for-profit entities. The new statement is effective for fiscal years starting on or after Dec. 15, 2009.
Not-for-profit hospital systems are becoming more active in mergers and acquisitions as a result of the economy and changes in the healthcare market. Because of these same conditions, for-profit hospital systems have struggled with determining the fair value of acquired and existing assets, and in many cases have been forced to recognize impairments. Consequently, not-for-profit systems need to plan ahead for the transition to Statement 164.
Statement 164 not only represents new compliance requirements, but may also impact the financing and acquisition decisions made by hospital CFOs. Hospital managers will need to consider how banks, rating agencies and bond investors will react to the recognition of a significant amount of goodwill at the time of acquisition or subsequent goodwill impairments. Indirectly, these events may be seen as a signal of poor financial performance or overpaying for an acquisition. More directly, they may impact credit metrics used in bond covenants.
Statement 164 provides or references specific accounting guidance applicable to not-for-profit entities including the following topics:
- The determination of whether a combination is a merger or an acquisition.
- The application of the “carryover method” in accounting for a merger.
- The application of the “acquisition method” in accounting for an acquisition, including determining which of the combining entities is the acquirer.
- How to test goodwill and other assets for impairment.
Based on the structure of combinations prevalent in the healthcare provider sector, very few combinations would meet the criteria to qualify as a merger – therefore, not-for profit hospital buyers should plan for the possibility of applying the acquisition method and subsequently testing any identified goodwill for impairment.
Developing fair value estimates, and continually updating them over time, will present new challenges and demand greater rigor in the valuation process. Buyers will need to consider the following issues when they are considering acquisitions:
- The increased use of fair value will inevitably produce more volatility in post-acquisition key performance indicators.
- Pre-deal business plan diligence will become even more critical when identifying all assets acquired and liabilities assumed and recording them at fair value.
- Subsequent analysis of goodwill and acquired assets for impairment will fall under ASC 820, Fair Value Measurements and Disclosures (formerly Statement 157), fair value standards with increased disclosures as to methods and assumptions used in the analyses.
- Buyers may consider increasing rigor of due diligence to enhance precision of estimates and reduce the need for true-ups post close.
In 2010, many not-for-profit hospitals with previously recognized goodwill will need to implement the new requirements by assigning all goodwill to appropriate reporting units and performing a transitional impairment test. It is critical that the transitional goodwill impairment test be performed timely and accurately. Any impairment loss recognized as a result of the transitional goodwill impairment test will be presented outside any performance indicators or intermediate measures of operations. However, impairment losses recognized after the initial implementation must be presented as a line item within the results from operations. Subsequent to the transitional period, goodwill must be tested for impairment at least annually.
Given the complexity of Statement 164, the implications to financial reporting and the skill sets required for compliance, not-for-profit healthcare managers should begin to plan for the adoption of Statement 164. This is even more important in the current environment of economic and regulatory change that will generate an increase in mergers and acquisitions and the ability of existing assets to generate returns.
Manish Choudhary is a principal in the Health Care Providers Practice at Deloitte Financial Advisory Services LLP, and Keedick Coulter is a senior manager in the Health Care Providers Practice at Deloitte Financial Advisory Services LLP.