Untangling the finances of a conglomerate such as General Electric Co. is not as simple as dividing by three, as the company seeks to separate its energy and healthcare businesses from its core business.
The massive elimination of significant parts of the industrial giant’s portfolio will ripple through GE’s financial statements, affecting cash, earnings, debt and assets. Deconstructing a streamlined set of financial data for an aviation-focused GE, as well as writing financial reports for two newly created public companies, will be no small feat.
“It’s really a huge task and a huge lift trying to separate the big companies from each other,” said Ann Gittleman, managing director of Kroll LLC’s Expert Services practice. “You need to understand precisely who is taking what assets and such.”
GE and Johnson & Johnson each announced plans in November to divest substantial parts of their businesses over the next few years. Such large corporate breakups are relatively rare — recent examples include United Technologies Corp., which spun off from Otis Worldwide Corp. and Carrier Global Corp in 2020, and eBay Inc., which spun off PayPal Holdings Inc. in 2015.
More companies are expected to take advantage of a booming deal market and buoyant stock market in 2022 and spin off substantial deals in hopes of building more focused and nimble businesses that are not burdened by historical debt or other obligations such as environmental or litigation liabilities.
The long delays announced by the two companies to complete the first spin-off – nearly a year for J&J’s consumer healthcare division and 2023 for GE’s healthcare business – partly reflect the complicated tax and accounting associated with restructuring.
Here’s a look at four accounting challenges that GE and J&J — and perhaps other companies that may weigh similar disruptions — will face as they prepare to send much of their business to their own devices.
The two corporate giants will have to decide what products and intellectual property the spinoffs will take with them after the split, as well as any revenue or debt payments related to those deals.
An army of accountants, valuation experts and other specialists will work behind the scenes to sort out everything from pension liabilities to the value of equipment and patents to help create a set of financial statements. for what will be several new public companies.
“When there are corporate splits, everyone kind of takes what’s theirs and moves on,” Gittleman said.
This could vary depending on the structure of the deal, she added.
A shared production facility or a loan that paid for the equipment inside cannot be effectively separated – someone has to take ownership of the asset and the debt, she said.
“You’re not going to split the machine in half,” Gittleman said. “A company will have to take ownership of this equipment. And will they owe the other company money as a result? »
The new companies will also spread costs once shared at the corporate level, such as advertising and employee benefits.
In some cases, the tedious work may involve a bill-by-bill review to analyze which part of the expense or revenue relates to the exclusion. Companies will need to document the reasons for these allocations, said Michael Yachnik, CPA and partner at consultancy StoneTurn Group LLP.
“All of these costs that support the whole company, the parent company and all the subcontractors, somehow have to be allocated to this payoff. And that’s where the time and l ‘efforts are really needed, and that’s why you see these kind of long periods’ between the announcement and the spin-off being completed, Yachnik said.
Build healthy balance sheets
J&J and GE estimate that their corporate breakups could cost between $500 million and $2 billion each, or even more.
GE told analysts its estimate reflects legal, audit and IT costs to separate its core businesses, while tax costs could be an additional $500 million. The company also said it would retain certain assets and liabilities of the existing company, including those related to its insurance operations.
GE told Bloomberg Tax it will keep investors informed over the coming year and declined to say which outside accountants or specialists would support its transition work. J&J also said it would comply with SEC requirements and update investors throughout the transition.
U.S. accounting standards require companies to record these costs as they are known and disclose what they cover, such as valuation specialists and severance pay for layoffs, Yachnik said.
Restructuring costs could also reflect write-downs for brands that have faded or obsolete equipment, said Zivia Sweeney, an associate professor of accounting at USC Marshall, whose previous roles at the company included director financial and controller.
“It almost makes your books clean in the future or whatever,” Sweeney said. “You’re not dealing with these past accounting issues or transferring them to your brand new businesses.”
Both companies have told analysts they intend to build companies with healthy balance sheets that will be attractive to investors.
Unlike a bankruptcy restructuring that allows businesses to cancel or repay their debts, businesses could face limits on the amount of debt that can be cleared through a separation, Gittleman said.
Debt generally follows the appropriate party, but some intercompany debt could be forgiven as part of the breakup, Yachnik said.
Less room for errors
A smaller, more nimble business results in less revenue and cash, which means lower thresholds for expenses or accounting errors that investors might consider material to financial statements.
For example, the bar for capitalizing expenses may have been much higher for the conglomerate than for the remaining small businesses, Yachnik said.
Firm-level shared costs could also be proportionately greater for newly established firms, he said.
In addition to choosing a management team and administrators to run new businesses, accounting teams and accounting systems will be needed. This will include implementing a new chart of accounts as well as setting up payroll and accounts payable processes, Sweeney said.
It’s not like flipping a switch, because “people don’t think about that internal aspect,” Sweeney said.
Ultimately, the $15 billion loss in revenue from J&J’s consumer healthcare product line, maker of brands such as Neutrogena and Band-Aid, will hit all four parts of the healthcare company’s financial statements – reshaping its earnings, cash flow, balance sheet, and equity.
These changes will only be reflected once the spin-off is complete, leaving behind a company focused on medical devices and pharmaceuticals. After the dissolution of the business is complete, the surviving parent company presents its simplified financial position to investors, with the assets and revenues of the newly created company(ies) removed as discontinued operations in the financial statements.
In some cases, the spin-off might not be considered a strategic business, so the parent company would describe the impact in a footnote, said Ron Graziano, accounting and tax research analyst for Credit Suisse. LLC.
“Each of these things is different,” Graziano said. “They all have their own twists, and there are so many technicalities of how to set them up for tax reasons, for capital structure reasons. They are very complicated.