Testimony

Testimony Before the Pennsylvania House Finance Committee on Bank Shares Requirements

Presented by Barry E. Smith, CPA and Bruce K. Darkes, CPA
Representing the Pennsylvania Institute of Certified Public Accountants

August 30, 2006

Chairman Leh, Chairman Levdansky and members of the Pennsylvania House Finance Committee, thank you for the opportunity to be here this morning. I am Peter Calcara, Director of Government Relations for the Pennsylvania Institute of Certified Public Accountants (PICPA).

PICPA represents more than 19,000 Pennsylvania CPAs in business and industry, public practice, government, and education. Our members advise clients on federal, state, and international tax matters, and prepare income and other tax returns for thousands of Pennsylvania taxpayers. They provide services to individuals, not-for-profit organizations, small and medium-sized employers, as well as Pennsylvania's largest employers. It is from this broad perspective that we offer our thoughts today.

Joining me this morning are two PICPA members, Barry Smith and Bruce Darkes.

Mr. Smith is a Partner in Audit and Advisory Services with Smart and Associates, LLP (Smart). Smart is an international accounting and consulting firm and is ranked the 25th largest in the US. He serves the firm as the Professional Practice Director, in which capacity he is responsible for national consultation on technical accounting and auditing issues and quality control. He has over thirty years of experience in both public and industry accounting and auditing.

Mr. Darkes is a Partner of Tax Services with Beard Miller Company, LLP (bmc), a leading Mid-Atlantic regional certified public accounting firm serving middle market and small business companies throughout the Mid-Atlantic region. Mr. Darkes has over twenty years of public and private experience in the financial services industry, and bmc provides professional accounting services to over 200 institutions.

PICPA is not here today to support or oppose any particular legislative proposals. Our objective is to offer technical information that will ensure that the public policy created through this process is done in an informed manner, and to continue to act as a resource for this committee in matters such as this.

Business Combinations - An Overview

Prior to July 1, 2001

• Accounting Principle Board Opinion No. 16, Business Combinations
  • Pooling-of-Interest Method ("Pooling Method")
    - Stock for stock and other criteria
  • Purchase Method
    - Cash or stock (does not meet Pooling Method criteria)
    
• Pooling Method - Assets and liabilities recorded at "historical amounts"
  
• Purchase Method - Assets and liabilities recorded at "fair value"
  
• Purchase Method recognizes:
  
• Intangible assets which may not have had a historical amount
  
• The excess of the purchase price over net assets acquired (Goodwill)

Post July 1, 2001

• Statement of Financial Accounting Standards No. 142, Business Combinations (SFAS No. 142) issued in June 2001
  
• Pooling Method no longer permitted
  
• Reason for issuing:
  - Comparability because different methods of accounting (pooling vs. purchase)
  - Better information about an entity's intangible assets
  - Level the field for mergers and acquisitions
  - Increase disclosure
  
• FASB's view as to benefits:
  - Better reflects the investment made in an acquired entity
  - Improve comparability
  - Provide more complete financial information
  

Post January 1, 2002

• Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, (SFAS No. 142)
  
• Goodwill and indefinite lived intangible assets are no longer amortized but are tested for impairment
  
• If deemed impaired, amounts are adjusted

January 1, 2007

• Exposure draft amending SFAS No. 141
  
• Expense deal costs (fees to broker, accountant, attorney) vs. capitalization
  
• Contingent consideration - estimate fair value vs. recognize when paid
  
• Post deal restructuring liabilities can not be recognized

Effect of SFAS No. 141 on Bank Share Tax

It is not clear that goodwill is taxable under the current bank shares tax. The current statute still refers to the former method of accounting for combinations, the aforementioned Pooling Method. Nonetheless, banks involved in combinations have paid tax on the value of shares including goodwill since the value of their shares for 2001 worked their way into the shares tax base.

With the exception of Ohio and Virginia, which were similarly affected by FAS 141, banks are taxed on their income rather than their equity. Ohio and Virginia have since amended their bank taxes to exclude goodwill.

Under the pooling-of-interests method still referenced in the Pennsylvania bank shares tax, the historical net book value of an acquired company was added to the existing net book of the acquiring company in order to determine the new capital for the combined entity. This net book value was the basis upon which shares tax was calculated. The net book value for the combined company was the SAME as the addition of net book values of the two pre-merger companies. There was no reduction or increase in the bank shares tax that could be ascribed to the accounting treatment of the merger.
The following examples can best illustrate the effect of SFAS No. 141 on bank share tax:

Pennsylvania Bank "A" with average capital of $84 million and Pennsylvania shares tax of $1,050,000 ($84,000,000 X 1.25%) merges with Pennsylvania Bank "B" with average capital of $42 million and Pennsylvania shares tax of $520,000 ($42,000,000 X 1.25%). Prior to FAS 141, the average capital balances of the two banks merged to create a new Pennsylvania Bank "C" with combined capital of $126 million and Pennsylvania shares tax of $1,575,000 ($126,000,000 x 1.25%). The merger price of 1.5 times net book value is not reflected on the financial statements of the bank.

Now, the effect in the first year capital of newly formed Pennsylvania Bank "C", resulting from adopting SFAS No. 141, would be an increase by the amount of the purchase accounting adjustment. Subsequent capital in years following the merger would increase proportionately to the capital that is included in the average.

In the above example, assume that Pennsylvania Bank "B" was merged with a price 1.5 times the book equity, or $52.5 million. Under SFAS No. 141, the purchase adjusts the capital of the bank, but this adjustment is excluded for regulatory capital purposes. Under FAS 141, the shares tax would be computed to be $1,684,375 - the combined equity of ($126,000,000 + ($52,500,000 purchase price X 1/6 percentage of this year's shares tax) X 1.25%). The difference between the post- and pre-FAS 141 shares tax is an increase of $109,375 ($1,684,375 - $1,575,000), and is computed by multiplying the purchase price adjustment of $52,500,000 X 1/6 X 1.25%. The post merger second year increase would be $218,750 ($52,500,000 purchase price increase X 2/6 X 1.25%). After 6 years the increase would be $656,250 ($52,500,000 X 6/6 X 1.25%).

Thank you for your patience as we described SFAS No. 141 and its effect on bank share tax. We will be glad to respond to your questions.