When producing the Financial Reporting Exposure Draft (FRED) 7, it seems the Accounting Standards Board (ASB) used as its maxim the well-known phrase: 'The sins of the fathers shall be brought upon the children of future generations.'In recent years, accounting for acquisitions has been criticised for the abuse of over-provisioning and the writing down of assets to significantly below net realisable value.

The ability to write the resultant increased goodwill directly off to reserves has allowed enhanced and, at times, fictitious profits to be recognised in the post-acquisition profit and loss account when excessive provisions are released.FRED 7 was issued by the ASB in December 1993.

It sets out the principles of accounting for a business combination under the acquisition method.

Companies legislation requires the assets and liabilities of an acquired entity to be included in consolidated accounts at their fair values at the acquisition date with results reflected from that date.Assets and liabilities are to be valued using the acquirer's accounting policies, but should not be adjusted to reflect the impact of their intentions for the enlarged entity.

The FRED also does not permit fair values to include provisions for future operating losses or for reorganisation and integration costs expected to be incurred as a result of the acquisition.

Such losses and costs are to be reported as part of the post-acquisition financial performance of the acquiring group.Every effort should be made to fair value assets and liabilities acquired by the date on which the first post-acquisition financial statements are approved by the directors of the acquirer.

If it has not been possible to complete the investigation of fair values by that date, provisional valuations should be made.

These should be amended, if necessary, in the next financial statements with a corresponding adjustment to goodwill.

Where the amount of the consideration is uncertain and payment is to be made after the date of acquisition, possibly based on future earnings, reasonable estimates of the amounts expected to be paid should be included in the cost of the acquisition.The result of applying the FRED will be to prevent acquirers manipulating post-acquisition results and also to reduce the use of acquisitions to avoid the disclosure of poor organic performance.

With the inability to use provisions and the requirement to disclose the impact of acquisition on results, the abuses of creative accounting on acquisitions will largely be eliminated.Fair value accounting was sometimes abused in the past.

However, preventing reasonable reserves being set up for justifiable costs contemplated as part of an acquisition strategy may also lead to problems.

Such reorganisation expenditure might reasonably be argued to be part of the actual cost of the acquisition and reflected accordingly rather than as part of the fair value process.The exposure draft, however, states that the cost of acquisition is the amount of cash or cash equivalents paid and the fair value of other purchase consideration given by the acquirer together with expenses of the acquisition.

It thus prevents the inclusion of planned reorganisation or restructuring costs within the investment consideration.Costs such as those above can be separately identified, shown within the profit and loss account and will be discounted by users when considering performance.

Earnings per share can be shown both including and excluding such costs and investors and others dealing with the company will be able to bas e their assessment on all the information they require.

Will they, however, review the financial statements in sufficient detail and will the commentators on financial statements draw readers' attention to the one-off costs included in the profit and loss accounts? In recent years there has been full disclosure of the setting up and release of provisions within accounts.

It is the abuse of these that has led to the ASB issuing FRED 7, but the information was there for commentators to recognise how performance had been enhanced by the use of creative techniques.Many acquisitions are made with a recognition that full benefit will only be achieved once the enlarged business has been restructured or reorganised.

The introduction of an accounting standard may also reduce acquisition activity.

The many who operated within the spirit of the rules appear to be being punished for the misdemeanours of the few.As an example, a retailer with 100 branches acquires a competitor with 75 similar outlets of which ten are in identical locations to those of the acquirer.

It is thus the acquirer's plan to close ten branches, some of its own and some of the target company's, thus enhancing overall ongoing profitability.

FRED 7 would require the closure and reorganisation costs to be reflected in the post-acquisition profit and loss account rather than being provided for on acquisition as a fair value item or as part of the acquirer's acquisition cost.

It would not amend the treatment even if the target provided for the closure costs in its management or statutory accounts prior to the acquisition.

It would probably be deemed that the provisions had been set up in contemplation of the merger or takeover and thus would be treated as post-acquisition items.Fair value accounting was abused in the past but the ASB may be going too far in preventing provision for some reasonable costs, accepted by the acquirer, as a necessary part of the acquisition process.