By Ianthe Jeanne Dugan
Washington Post Staff Writer
Thursday, February 25, 1999; Page E01

NEW YORK, Feb. 24 –– U.S. accounting rule makers today proposed killing a popular corporate accounting technique, a move that would make high-technology mergers much less attractive.

Among the biggest assets in high-tech acquisitions are products under development, known in accounting circles as "in-process research and development." Typically, companies write them off instantly, creating one-time profit hits that are virtually ignored by shareholders and never reflected again in profits.

But the Financial Accounting Standards Board, as part of a broader push to eliminate accounting abuses, plans to require companies to write down those costs over several years, just as they do with any other depreciating asset.

Today, for the first time, the accounting group discussed the issue at a board meeting, and officials said it will likely write the change into a broad proposal to be released in June after soliciting public comment.

"Currently, the requirement treats this asset differently than other intangible assets," said FASB Chairman Edmund Jenkins. "The future overhang on earnings is not present. This will require companies to separately identify, amortize into the future, and more clearly define the assets."

The change is expected to reduce the appeal of mergers, particularly those in the high-tech area, which assign a lot of value to research and development in mergers. "We're in trouble, we're in trouble," said Robert Willens, a managing director at Lehman Brothers Inc. "The effect on deals will be immediate and very traceable to this decision."

The average write-off for "in-process research and development" in the past 10 years has been 72 percent of the entire purchase price, according to Baruch Lev, an accounting professor at New York University's Stern School of Business, who recently completed a major study of 400 acquisitions using this accounting method.

Executives in the high-tech industry vowed to fight the plan, saying it would slow the pace of technological mergers that are fueling an industry that some say accounts for 25 percent of the nation's economic growth.

"This is something that, if implemented, will stunt technological innovation and slow economic growth," said Dan Scheinman, general counsel at Cisco Systems Inc., which builds network hardware. "While Cisco will feel the pain, the real pain will be felt by the entrepreneurial community and start-ups."

When a company makes an acquisition, it has to assess the value of all the assets and subtract that number from the price it paid for the company. The difference is called goodwill and must be amortized over several years. This drags down profits and concerns shareholders, so companies tend to keep this number as low as possible. "Goodwill is like Chinese torture, dripping, reducing earnings," Lev said.

Until now, in-process research and development could be written off in one shot. "The market ignored these one-time write-offs," Willens said. "It does not ignore recurring charges."

Deals, Willens said, will become less attractive. "From a business point of view, a deal is a deal," he said. "But a financial profile can make or break a deal."

Lev, who has been lobbying for the current change, said: "Incompleted products are an asset. You paid for it and it should be treated like other assets. This is bad accounting."

When International Business Machines Corp. acquired Lotus Development Corp. in 1995 for $3.2 billion, for example, $1.84 billion was considered in-process research and development. IBM wrote the amount off instantly. "When IBM announced a big loss in the third quarter of 1995," Lev noted, "there was no negative market reaction."

Since its founding 13 years ago, Cisco has made 30 acquisitions. In six years, it has grown from 800 employees to 17,000.

Driving the expansion, said Scheinman, is the ability to take risks on projects that have not been completed. The company will think twice about acquiring those assets, if they have to be treated on the books like other assets. "We're judged by earnings per share," he said. "This change would have an impact on earnings per share, which makes us less likely to go out and buy companies if we can't get quality earnings per share we need."

Dennis Powell, controller of Cisco Systems, noted that most development projects never turn into products. "We're taking a very risky project that hasn't been finished and putting it on our books," he said.