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HP/Autonomy-Type Accounting Issues Likely to Proliferate and Trigger Tougher FASB Rules

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Capitalized goodwill and the costly effect of non-cash writedowns. Let the subprime mortgage saga be your guide to how this will play out.

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MINYANVILLE ORIGINAL As we have since learned, at the peak of the mortgage bubble, "no doc" and even "liar loans" were offered in remarkable supply. Thanks to unprecedented confidence in the stability of American home prices, borrower scrutiny was deemed to be superfluous, if not outright unnecessary. At the top, the operating protocol for many in the mortgage industry seemed to be simply a civilian version of the military's controversial "don't ask, don't tell" policy, which was repealed a year ago.

As a socionomist who tracks social mood and how changes in confidence affect our decision-making, it is hard not to see striking underlying behavioral parallels from the mortgage bubble in this week's news regarding "accounting improprieties, disclosure failures and misrepresentations" associated with Hewlett-Packard's (NYSE:HPQ) acquisition of Autonomy.

The inverse correlation of confidence and scrutiny strikes again.

While it will take time for the forensic accountants and the regulators to complete their analysis of the Autonomy merger, I strongly doubt that this will be the last acquisition-related scandal we see. Many of the same risk management failures evident at the peak of the housing crisis appear to have been in ample supply in corporate mergers and acquisitions ("M&A") over the past decade.

For many corporate leaders, oversized complexity-laden acquisitions were required merit badges. And much like the participants in the housing bubble saw home price appreciation out as far as the eye could see, for corporate executives, boards of directors, equity analysts, and investors, the same was true for global growth.

Opportunity, particularly in Asia, was unlimited. Even more, time was of the essence.

But if confidence and urgency weren't enough to bring buyers to the table, there was accounting help (not to mention peak-of-the-market deal-eager investment bankers) too. Until 2001, when a business was purchased at a premium, the acquiring company was forced to amortize the premium paid (goodwill) over time. In 2001, the Financial Accounting Standards Board (FASB) eliminated that requirement.

Rather than amortizing goodwill, companies instead would be required to justify the purchase premium through forecasts provided to its accountants annually. So long as the conditions assumed at the time of an acquisition were sustained or bettered, acquisitions -- even at high premiums -- were costless.

Rather than flowing through earnings as an expense, goodwill and other acquisition-related intangibles were capitalized as assets on the balance sheet.

For business leaders, so long as the economy remained strong, the changes in accounting made business purchases far more attractive than organic growth. Not surprisingly then, 2002-2007 brought with it record M&A and more than $1.0 trillion in capitalized goodwill.
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