Accounting for Synergies in M&A Transactions

Developing sound financial forecasts and accounting for synergies correctly in the acquisition process can help companies avoid accounting surprises and financial statement delays.

Many of us who are Amazon Prime members and shop at Whole Foods are seeing changes as a result of the Amazon-Whole Foods merger. I was astounded to see an Amazon Echo right in the middle of the produce section of my local Whole Foods last week!

In accounting terms, changes such as these that happen upon a business acquisition and may create additional value for the combined entity and its shareholders are sometimes referred to as “synergies.” For example, current and planned synergies related to this merger likely include:

• Whole Foods offering special benefits to Amazon Prime members
• Amazon selling Whole Foods private-label products on Amazon.com
• Whole Foods selling Amazon products such as the Echo device

In the determination of fair value for use in acquisition accounting, under Generally Accepted Accounting Principles, market-participant synergies are considered, but buyer-specific synergies are not.

In the accounting literature, synergies can be classified in two areas: buyer-specific synergies and market-participant synergies not linked to a particular buyer in a deal.  While buyer-specific synergies are unique to a specific buyer such as Amazon in the merger with Whole Foods, market-participant synergies can, in principle, be realized by any buyer in the market who meets the following definition of a market participant, as per FASB ASC 820:

• Independent of the accounting reporting entity (i.e., they are not related parties before the deal)
• Knowledgeable, having a reasonable understanding about the asset or liability and the transaction based on all available information, including information that might be obtained through due diligence efforts that are usual and customary
• Able to transact for the asset or liability
• Willing to transact for the asset or liability (they are motivated but not forced or otherwise compelled to do so)

For companies planning a merger or acquisition, it’s important to analyze potential synergies up-front and understand which ones can be included in acquisition accounting after the transaction. Understanding which synergies in a given transaction are buyer-specific and which are market-participant synergies can lead to financial forecasts that are better utilized in acquisition accounting.

Supportable and reasonable assumptions going into a financial forecast can help fortify and streamline the valuation and reporting process.  If a forecast is based on well-supported assumptions, it can help facilitate timely completion of the audit process.

For public companies, the consequences of forecasts that contain incorrect synergy assumptions could be costly. For example, if a company does pre-transaction accretion/dilution analysis based on an inaccurate forecast, but then corrects the forecast after the transaction, the transaction could eventually have a different impact on earnings per share for the company and its shareholders than what was implied by the pre-transaction analysis.

If you are going through the M&A process and have questions about the reasonableness of your financial forecasts or what synergies may be included in the acquisition accounting, contact me or another member of Kaufman Rossin’s business valuation team.