Page 36 - M & A Disputes

For instance, an agreement may specify consistent accounting treatment with respect to certain items. In
such a case, consistency will typically prevail over GAAP, especially if the agreement provides for or
discloses a non-GAAP presentation of such items. Depending on the circumstances, the best course of
action for sellers may not be to make a blanket warranty regarding GAAP without full knowledge that
such is the case. In addition, disputes may arise over the application of the term consistent. For example,
consider the following language: the company "consistently provides an allowance for bad debts," ver-
sus "provides an allowance using a consistent calculation methodology," versus "provides a consistent
amount in the allowance."

Sellers often argue that buyers have changed historical accounting policies or practices in preparing the
closing financial statements and that the buyer’s change violates representations or covenants in the
agreement. Sellers typically raise this argument with respect to balance sheet allowance or valuation ac-
counts, such as those for inventory obsolescence, doubtful accounts receivable, returns and allowances,
or estimated liability amounts. The process of deriving the balances in these accounts involves signifi-
cant judgment.

The practitioner should read the agreement carefully to see how to address the issues of GAAP versus
consistency related to the closing balance sheet.

Adjustment to Target or Represent True Economic Change

The practitioner should review the agreement to see if it includes a mechanism designed to compensate
the parties only for true economic changes sustained by the business. This true economic change is
measured during the intervening period between the date on which the target purchase price was agreed
to and the closing date. Sellers often hold this true economic change view. In contrast, buyers often hold
the view that the purchase price adjustment mechanism is intended to ensure the delivery of a specified
amount of GAAP working capital or net assets to the buyer at the transaction closing.

Preparing a closing balance sheet in accordance with GAAP may create inconsistency between the ac-
counting at the target date and the closing date. Therefore, the closing balance sheet may not reflect only
the true economic changes that occurred during that time period.

Subsequent Events

Once the closing balance sheet becomes the subject of dispute, there is often disagreement between the
parties about what type of new information, if any, should be considered, which becomes available after
the closing date. Under GAAP, there are different types of subsequent events; these different types of
subsequent events are as follows:

 Type 1 subsequent events provide additional evidence about conditions, facts, and circumstances
that existed at the closing balance sheet date and that affect the estimates inherent in the process
of preparing the closing balance sheet. All information that becomes available prior to issuing
the closing balance sheet should be used by management in its evaluation of the facts and cir-
cumstances on which the estimates are based. The closing balance sheet should typically be ad-
justed for any changes in estimates resulting from the use of such evidence.

 Type 2 subsequent events provide evidence about facts and circumstances that did not exist at
the closing balance sheet date but that arose subsequent to that date. Type 2 subsequent events
should not typically result in any adjustments to the closing balance sheet.

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